The BRK CEO takes a melancholy tone while living with the ghosts, and trying to get out without ever having to be the bad guy
Warren Buffett’s most recent letter to his shareholders has a nostalgic tone and melancholy vibe, perhaps befitting a man of his age and years of business experience.
Buffett admits he makes mistakes.
I make many mistakes. Consequently, our extensive collection of businesses includes some enterprises that have truly extraordinary economics, many others that enjoy good economic characteristics, and a few that are marginal.
Buffett doesn’t mention one recent mistake in his letter.
Berkshire and its board, where Buffett insists on being Chairman as well as CEO because of his dominant share ownership, made a rookie mistake that prompted an official notice of noncompliance with NYSE rules on February 16, 2021. Berkshire’s mistake was to let the company fall out of compliance with the exchange’s rules that require the board to have a majority of independent directors. The SEC filing for the mistake, “ITEM 3.01 Notice of Delisting or Failure to Satisfy a Continue Listing Rule or Standard; Transfer of Listing,” is one typically filed by penny stocks and wayward SPACs.
How did this happen? Independent director Walter Scott, Jr. passed away on September 25, 2021 at the age of 90. And then 96-year-old Thomas S. Murphy, who had been Audit Committee Chair for years until 2020, resigned on February 14, 2022, a couple of weeks before the company’s 10-K was filed.
Mr. Buffett said Monday that Tom Murphy, a friend and business mentor who built a media empire that became Capital Cities/ABC, had called him and said that recovering from a recent bout with Covid-19 convinced him that he would feel more comfortable stepping down.
By the time the proxy was filed, Berkshire had nominated someone to fill the independent director vacancy on the Board.Wallace R. Weitz, age 72, founded the investment management firm Weitz Investment Management, Inc. in 1983.
Buffett does mention another mistake in this year’s letter. David Sokol makes an appearance for the first time in forever, at least since his ignominious resignation on March 30, 2011.
BHE’s record of societal accomplishment is as remarkable as its financial performance. The company had no wind or solar generation in 2000. It was then regarded simply as a relatively new and minor participant in the huge electric utility industry. Subsequently, under David Sokol’s and Greg Abel’s leadership, BHE has become a utility powerhouse (no groaning, please) and a leading force in wind, solar and transmission throughout much of the United States.
Buffett had heaped high praise on Sokol in his 2010 letter:
The 2010 letter, ironically, also included a copy of Buffett’s biennial reminder to his executives to “zealously guard Berkshire’s reputation”.
Buffett’s announcement of Sokol’s resignation on March 30, 2011 was a bit unsatisfying in its lack of details.
But not long after, April 12, 2011, the company that Sokol tripped up on, Lubrizol, filed an 8-K with a some more details, then a shareholder filed a derivative lawsuit against Sokol, Buffett, the board and the company on April 18, 2011 in Delaware, and then the Berkshire Hathaway Audit Committee issued a report of an investigation on April 27, 2011, barely a month after the resignation but just in time for the annual meeting three days later, that basically threw Sokol under the bus, saying he had lied to Buffett.
Charlie Munger was not too thrilled, either.
I don’t like any feeling of being victimized. I think that is a counterproductive feeling to think as a human being. I am not a victim. I am a survivor.
Until now Sokol has been a bit of a prodigal son, the name that shall never be spoken or written, but Buffett is feeling nostalgic. You could have had it all, Dave!
Buffett spends nearly 2 pages reminiscing about the recently departed Paul Andrews, founder and CEO of Berkshire Hathaway portfolio company TTI, which was acquired in 2007.
Buffett mentions attending Andrews’ funeral with heir apparent Greg Abel. From the 10-K:
If for any reason the services of our key personnel, particularly Mr. Buffett, were to become unavailable, there could be a material adverse effect on our operations. Should a replacement for Mr. Buffett be needed currently, Berkshire’s Board of Directors has agreed that Mr. Abel should replace Mr. Buffett. The Board continually monitors this risk and could alter its current view regarding a replacement for Mr. Buffett in the future. We believe that the Board’s succession plan, together with the outstanding managers running our numerous and highly diversified operating units helps to mitigate this risk.
Maybe they should not fly on the same plane!
But when was the last time Buffett mentioned TTI or Paul Andrews in his annual letter?
In his 2007 letter Buffett briefly mentions the acquisition of TTI, and in 2008 Andrews makes an appearance in the letter because he will be on the showroom floor with with his 1935 Duesenberg at that year’s “Woodstock of Capitalism” annual meeting. There’s no mention at all of TTI or Andrews in 2009.
In 2010 TTI and Paul Andrews warrant a short paragraph boasting how the company achieved record earnings — up by 127% since its acquisition in 2007 — and another short paragraph in 2011 when TTI hits $2 billion in revenue.
There’s no mention at all of TTI or Andrews in letters for 2012 through 2016 and then the company gets an identical mention in each of the 2017, 2018, and 2019 letters as one of the five companies in Berkshire’s third-tier of non-insurance companies in the conglomerate. That tier, in aggregate, brought in about $2 billion more or less in earnings in each of those years. TTI is now lumped in with five other companies, with no break out for its performance or for Paul Andrews until he died.
The last word from Buffett on Paul Andrews? How Andrews served a purpose for Berkshire Hathaway beyond the contribution of TTI.
The BNSF acquisition would never have happened if Paul Andrews hadn’t sized up Berkshire as the right home for TTI.
Why mention Paul Andrews and TTI now?
Perhaps at 91 years old, with his sidekick Charlie Munger now pushing 98, and his directors dropping off the roster, Buffett is feeling his own mortality. But Buffett selects which stories to tell in a careful manner. There was no mention in his letter of the death last September of longtime director Walter Scott or any mention of the resignation of longtime director Tom Murphy, as a result of a serious bout with Covid-19. Buffett’s letters are a master course in using the right personal stories and colorful anecdotes that, in the end, serve primarily to enhance the myth and legacy of Warren Buffett.
Accounting information in Buffett’s 2021 letter
Buffett’s regular rant against the GAAP rule, ASU 2016-01 — the one that requires Berkshire Hathaway to report the realized and unrealized gains and losses on investments beginning in 2018, and that has been the subject of the first several paragraphs of the letter every year since 2017 — is missing in this year’s letter.
That may be because this is one of the shortest letters in the last 10 years, clocking in at 11 pages, compared to the bibles of over 20 pages he wrote in each of the fifteen years prior. For some reason 2014’s letter was 42 pages!
I wrote about Warren Buffett’s fury at ASU 2016-01 in February 2018:
Warren Buffett, in his annual letter to Berkshire Hathaway shareholders on Saturday, criticized a new accounting rule he said would “severely distort” the company’s future net-income figures and render its bottom line “useless” for analytical purposes.
And I wrote more about it the following week because Buffett’s adamant disdain for the requirement drives him to use non-GAAP metrics to distract investors from the recognition of the gains and losses when reporting results. I also mentioned Berkshire’s habit, fairly rare among large cap companies, to report its results after hours Friday or Saturday morning.
Warren Buffett’s concern about new accounting rules will keep Berkshire Hathaway reporting its quarterly results during the weekend.
In his recent letter to shareholders, Buffett complained about the new accounting requirement that he believes will “severely distort” Berkshire’s results and potentially “mislead commentators and investors.”
The rule, according to generally accepted accounting principles, the standards all public companies must follow, requires net unrealized investment gains and losses in Berkshire Hathaway’s portfolio to be included, along with actual gains and losses, in reported earnings each quarter.
Buffett says that will produce “truly wild and capricious swings” in Berkshire’s bottom line.
Berkshire holds $170 billion of marketable equities, not including its interest in Kraft Heinz. Berkshire may reports earnings swings of $10 billion or more each quarter, rendering the GAAP bottom-line “useless,” Buffett says.
In his letter, he expressed frustration that reporters could push inflammatory news about Berkshire’s earnings that “highlights figures that unnecessarily frighten or encourage” readers or viewers. He promised that Berkshire will now “take pains every quarter to explain the adjustments you need in order to make sense of our numbers.”
One way he plans to mitigate the perceived threat is to continue his practice of publishing Berkshire’s quarterly and annual results late on Fridays, after the markets close, or early on Saturday mornings. Buffett writes that this approach allows everyone to have maximum time for analysis and gives investment professionals a chance to develop “informed commentary” before the markets open again on Monday.
MarketWatch asked [Kevin] LaCroix which Berkshire Hathaway investors he thought Buffett was worried about when made these remarks and when he promised to continue making earnings announcements on Friday nights/Saturday mornings.
“I am not sure. There is hardly any trading volume minimal options activity. Even if the market or an individual investor did overreact to some unusual investment gain or loss the situation is bound to correct itself quickly.”
It’s a good thing Berkshire continues to report results on Saturdays because this year the company made another a huge mistake when it reported. Berkshire announced its 2021 4th quarter and full-year earnings on Saturday, February 26, , and had to quickly correct the press release with a follow-up press release later that day. However, the corrected press release was not available on the SEC’s Edgar site until Tuesday, March 1st.
The erroneous press release overstated 4th quarter unrealized investment gains by $24.6 billion! And that press release also overstated after-tax realized gains on sales of investments in the 4th quarter by $1.745 billion!
What’s a few billion here or there for Berkshire Hathaway?
Buffett spends all of page 5 of the letter talking about the fundamental insurance concept of “float” — insurance premium cash Berkshire holds and can invest but that does not belong to the company — and then he whines that an increase in this cash it’s safeguarding in case it’s needed to pay out claims is not on Berkshire’s balance sheet because of GAAP!
To my surprise, our float increased $9 billion last year, a buildup of value that is important to Berkshire owners though is not reflected in our GAAP (“generally-accepted accounting principles”) presentation of earnings and net worth.
Later Buffett appends a paragraph in a discussion of Berkshire’s buyback strategy on page 9 to pat himself on the back for basic math — reducing the denominator of any per share metric via buybacks makes the metric look better without having to do anything else.
Finally, one easily-overlooked value calculation specific to Berkshire: As we’ve discussed, insurance “float” of the right sort is of great value to us. As it happens, repurchases automatically increase the amount of “float” per share. That figure has increased during the past two years by 25% – going from $79,387 per “A” share to $99,497, a meaningful gain that, as noted, owes some thanks to repurchases.But that’s not the only mistake Buffett and Berkshire made when reporting results for 2021. Let’s start with Buffett’s remarks about Apple in his letter to shareholders.
I have to emphasize that Warren Buffett is so in denial about the GAAP rule that requires Berkshire to report realized and unrealized gains on his equity portfolio in net income that he now pretends that it just does not exist. That’s even though he provides a table on page 7 of the 2021 letter to boast about size of the unrealized gains of the company’s top fifteen equity investments that are carried on the balance sheet at market value.
This list includes Apple, the company’s largest holding by market value by far and one he is very proud of. On the prior page, page 6, Buffett crows:
It’s important to understand that only dividends from Apple are counted in the GAAP earnings Berkshire reports – and last year, Apple paid us $785 million of those. Yet our “share” of Apple’s earnings amounted to a staggering $5.6 billion. Much of what the company retained was used to repurchase Apple shares, an act we applaud.
Except that’s not really true.
A significant portion of the 2021 full-year unrealized investment gains and losses of $58.6 billion are likely attributable to unrealized gains on the 5.6% of Apple Berkshire Hathaway owns. According to GAAP, those unrealized gains are reported in Berkshire Hathaway’s unadjusted net income of $89.8 billion.
If we go to the 2021 10-K we can see a number, the difference in fair value of the Apple holdings between year-end 2020 and year-end 2021 of approximately $40.8 billion. Add to that the $785 million in dividends from Apple and, well, Buffett or his successors could be collecting “2 and 20” from his shareholders for running a pretty good hedge fund without all the hassle and potential sad thoughts from owning operating companies run by CEOs that leave you.
Buffett adjusts GAAP earnings for the realized and unrealized gains/losses on the investment portfolio and for impairments of intangible assets — which has in the past included the gigantic write-downs associated with Kraft Heinz and Precision Cast — to create a non-GAAP metric “operating earnings”.
Later in Buffett’s 2021 letter, he hypocritically rails, pun intended, against “deceptive ‘adjustments’ to earnings” when talking about the results for BNSF, even though Berkshire Hathaway does the same thing to divert attention from a Moby Dick-sized equity portfolio that has almost completely swallowed its operating companies.
Your railroad had record earnings of $6 billion in 2021. Here, it should be noted, we are talking about the old-fashioned sort of earnings that we favor: a figure calculated after interest, taxes, depreciation, amortization and all forms of compensation. (Our definition suggests a warning: Deceptive “adjustments” to earnings – to use a polite description – have become both more frequent and more fanciful as stocks have risen. Speaking less politely, I would say that bull markets breed bloviated bull . . ..)
Let’s look at it a bit more closely.
Back in 2017, Buffett wrote in his letter that the requirement to capture unrealized as well as realized gains and losses in net income in future quarterly and annual reports would “severely distort Berkshire’s net income figures and very often mislead commentators and investors” by producing some “truly wild and capricious swings in our GAAP bottom-line.”
The first year of the new GAAP rule, 2018, was unusual because it created reportable net losses on both his equity investments and his equity method investments.
(A Barron’s report at the time attributed the dramatic decline in Berkshire’s equity portfolio to a 4th quarter decline in its five largest equity positions —Apple, Bank of America, Wells Fargo, Coca-Cola, and American Express — which at the time of the article had fallen by $18 billion since Sept. 30. Apple accounted for the majority of the decline because, at that time, it had tanked to the tune of about $15 billion in just that quarter.)
However, Buffett’s lieutenants, investment managers Todd Combs and Ted Weschler, have figured out how to buy and hold some of the best performing investments in the universe and deliver consistent gains.
The value locked up in this portfolio, as reflected in GAAP net income, is consistently dominating the earnings on the insurance and non-insurance operating companies.
I mean, why are we still doing this?
In a future newsletter I will describe my strategy for how Berkshire Hathaway should be broken up, now or very soon. It’s time!
© Francine McKenna, The Digging Company LLC, 2022
A short postscript regarding ‘independent” director, and now deceased, Walter Scott and Buffett’s potential successor Greg Abel.
Walter Scott joined the Berkshire board in 1988. Scott was also the holder (along with family members and related entities) of approximately 8% of the voting stock of Berkshire Hathaway Energy Company in which Berkshire owned approximately 91% of the voting stock until 2020 when BHE repurchased 180,358 shares of its common stock from certain family interests of Scott for an aggregate cost of $126 million.
“The per share purchase price was based on a price deemed to represent fair market value and agreed upon by Berkshire, Mr. Abel and Mr. Scott and approved by the Audit Committee,” according to the Berkshire Hathaway proxy for 2020.
Why was Greg Abel involved?
Mr. Abel, a director of and the holder of approximately 1% of the voting stock of BHE, also has an agreement with Berkshire with terms similar to the terms of the agreement with Mr. Scott. The major difference between the agreement with Mr. Scott and the agreement with Mr. Abel is that Mr. Abel can also put his shares to BHE and BHE can call Mr. Abel’s shares. The purchase price under either a BHE Put or BHE Call shall be payable in cash and determined in the same manner as the purchase price under Mr. Scott’s agreement.
I wrote recently about Berkshire Hathaway’s mistake of not providing enough details about its goodwill balances and adjustments related to its numerous acquisitions.
Fortunately the SEC saw that and quickly issued a comment letter to make sure it got fixed. I’ll be following up now that we’ve got a new whopper of an acquisition, Allegheny.
I wrote extensively about Buffett’s Kraft Heinz mistake.
I’ve written quite a bit about Berkshire Hathaway and its many other mistakes. Here’s a newsletter edition with a lot of links.