US-based billionaire investor and Berkshire Hathaway chief Warren Buffett’s insight into the investment world is something every investor looks forward to. And when he says something, every investor takes note of that. Buffett released his annual letter to Berkshire shareholders on Saturday. The letter covered a wide range of investment-related topics. Here are the five key learning points from the investment guru: "The annual change in Berkshire's book value...is a metric that has lost the relevance that it once had." "Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses...while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years," Buffett added. Buffett continues to "hope for an elephant-sized acquisition," but "prices are sky-high for businesses possessing decent long-term prospects."
Warren Buffett indicates that Berkshire Hathaway hopes to own much of its excess liquidity into the business that the company will permanently own, hence, terming it as an “elephant-sized acquisition.” However, the short-term prospect of those is not good which includes, prices being high for businesses possessing long-term prospects.
“That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition," Buffett said.However, the company has pledged to hold at least $20 billion in cash equivalents to protect against external calamities. Berkshire's cash "stash" was $112 billion at the end of 2018.
"It is likely that--over time--Berkshire will be a significant re-purchaser of its own shares."
Warren Buffett in his letter signals to return significant funds to his company’s shareholders through the method of repurchasing, stating that this particular way will abandon his former focus on book value.
Buffett clarifies that share repurchases will be untaken only if the shareholders can “buy at a discount to Berkshire’s intrinsic value,” as in this way they can benefit from an increase in per-share intrinsic value with each repurchase by the company.“By contrast, blindly buying an overpriced stock is value-destructive, a fact lost on many promotional or over-optimistic CEOs," Buffett warns.
"Those who regularly preach doom because of government deficits" have been proven wrong by US history.
Since its first investment in stock on March 11, 1942, through January 31, 2019, Buffett notes that each dollar invested in the S&P 500 index would have grown to $5,288, with dividends reinvested and before taxes and transaction costs. Meanwhile, the national debt has increased roughly 400-fold, or by about 40,000 percent, during the same time period.
However, investors who feared in investing in stocks bought gold back then and saw each dollar grow to only about $36, “less than 1 percent of what would have been realized from a simple unmanaged investment in American business," Buffett notes. "The magical metal was no match for American mettle," he said.Buffett added, “The compound annual growth rate (CAGR) delivered by the S&P 500, with dividends reinvested, has been about 11.8 percent across nearly 77 years. Reduce that CAGR by just by 1 percentage point annually, to 10.8 percent, paying for "various 'helpers' such as investment managers and consultants," and he observes that each dollar invested in 1942 would have grown to only about $2,650 now, roughly half the result in the no-fee example.”
On mark-to-market accounting: "Focus on operating earnings, paying little attention to gains and losses of any variety."
Berkshire’s chairman focused on the new Generally Accepted Accounting Principles (GAAP) accounting rules that when applied, has compelled Berkshire to value the securities in its investment portfolio based on current market prices.
The new accounting rule has two distinct impacts. First, Berkshire’s balance sheet will reflect the market values of these securities and secondly, any change in these market values from one reporting period to the next will flow into Berkshire's reported earnings.
Declines in the market value will produce mark-to-market losses resulting in poor earnings while increases in market value will generate mark-to-market gains adding to the earnings, Buffett said.
According to Investopedia, mark-to-market losses are losses generated through an accounting entry rather than the actual sale of a security. Mark-to-market losses can occur when financial instruments held are valued at the current market value.“As I emphasized in the 2017 annual report, neither Berkshire’s Vice Chairman, Charlie Munger, nor I believe that rule to be sensible. Rather, both of us have consistently thought that at Berkshire this mark-to-market change would produce what I described as “wild and capricious swings in our bottom line,” Buffett added.