A Closer Look at Warren Buffett's 2023 Annual Letter to Shareholders
"Managing Berkshire is mostly fun and always interesting."
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Over the weekend, Berkshire Hathaway released its 2023 annual report — alongside Warren Buffett’s much-anticipated letter to shareholders. (And, while I’m not exactly an impartial observer to all things Buffett, I thought it more than lived up to the hype.)
For those of us who try to use his annual writings to better understand both the man’s methods and Berkshire’s larger performance, it can be a bit of information overload. The complete report stretches on for over 150 pages and, as Buffett notes, “is filled with a vast amount of information — some important, some trivial”.
So, in an effort to drill down past the trivial (and, also, to keep this article to a manageable length), I’ve picked out a few of the most significant lines from Buffett’s latest letter for deeper study.
Ones that reveal the most about his current outlook on Berkshire’s prospects and reinforce the timeless lessons that he has spent his life teaching to us.
“In reality, Charlie was the ‘architect’ of the present Berkshire, and I acted as the ‘general contractor’ to carry out the day-by-day construction of his vision.”
Warren Buffett opens the annual report with a heartfelt tribute to his late partner, Charlie Munger. The Berkshire Hathaway vice-chairman passed away on November 28, 2023 — just a few weeks short of his centenary. 💔
As expected, Buffett lavishes praise and gratitude on Munger here — once again crediting his late friend with steering him away from the Grahamian cigar-butt investing of his youth and towards wonderful businesses (at fair prices) instead.
To Charlie’s inimitable eye, scrounging for discarded cigar butts — while undeniably profitable in the decades after the Great Depression — posed inherent limits of scale.
“[Charlie] told me — correctly! — that I had made a dumb decision in buying control of Berkshire,” Buffett writes. “But, he assured me, since I had already made the move, he would tell me how to correct my mistake.”
The Munger message was simple: “Warren, forget about ever buying another company like Berkshire. But now that you control Berkshire, add to it wonderful companies purchased at fair prices and give up buying fair businesses at wonderful prices.”
Throughout his long life, Charlie always insisted that Buffett gave him far too much credit for this awakening. Buffett, in turn, refused to stop — never missing a chance to tell the world about Munger’s pivotal role in the Berkshire story.
There’s probably no better proof of their unshakeable friendship than the fact that these two men spent their entire lives falling all over each other trying to give the other one all the credit for Berkshire’s success.
And, in this year’s letter, Buffett gets the last word.
“Our preference [to exclude unrealized gains/losses from net income] was pretty much the rule until 2018, when the ‘improvement’ was mandated. Galileo’s experience, several centuries ago, should have taught us not to mess with mandates from on high. But, at Berkshire, we can be stubborn.”
This has, quite understandably, become a recurring theme of sorts in Warren Buffett’s letters: An annual lamentation of the misguided FASB mandate to include unrealized gains and losses from stock investments in a company’s net income number.
To illustrate the absurdity of this rule change, Buffett marvels at how Berkshire Hathaway’s net earnings can swing from plus $90 billion in 2021 to a $23 billion loss in 2022 to, finally, a $96 billion gain last year. You’re apt to get whiplash reading that.
Does this rollercoaster ride of highs and lows tell the tale of a conglomerate in crisis?
Nope, it’s just the latest example of mark-to-market madness.
In truth, Berkshire’s operating earnings (Buffett’s preferred performance metric) have marched steadily upwards in recent years. In Q4 2023, these earnings increased by an impressive 28%.
Remember: Accounting should illuminate — not complicate.
And, for companies like Berkshire, the mandate to include paper gains and losses in net income will almost always lead to confused analysis and distorted results. (As Buffett points out in his letter, these unrealized price swings “can exceed $5 billion a day” in Berkshire’s massive common stock portfolio.)
I won’t belabor the point, but I do want to add one thing: No one has championed ethical accounting and consistent methods of financial disclosure more than Buffett. Which makes this whole situation all the sadder. He probably hates having to question the validity of GAAP figures in his widely-read letter.
But, in the interests of his shareholders, he cannot be expected to hold his tongue. The FASB has basically backed him into a corner and cannot complain when he notes that their mandated net income numbers are “worse-than-useless”.
“[Ajit Jain’s] achievements since joining Berkshire have been supported by a large cast of hugely-talented insurance executives in our various [property-casualty] operations. Their names and faces are unknown to most of the press and the public. Berkshire’s lineup of managers, however, is to P/C insurance what Cooperstown’s honorees are to baseball.”
Berkshire Hathaway’s insurance operations did a lot of the heavy lifting in 2023 — with all three segments logging successful years. GEICO, in particular, continued its rise from the dead with $3.6 billion in pre-tax earnings. Those six straight quarters in the red (during 2021 and 2022) are now just a distant memory.
The auto insurer’s combined ratio clocked in at an impressive 90.7% — far below last year’s disastrous 104.8%. It even bested Ajit Jain’s own preliminary estimate — “just south of 100%” — given at the annual meeting back in May.
Elsewhere, earnings at Berkshire’s Primary Group rocketed up 250% and Reinsurance followed with a 30% gain of its own.
Berkshire’s float grew to a staggering $169 billion at year’s end. And it continues to come at no cost to the company thanks to these sterling underwriting results.
Just imagine showing up at the bank and asking to borrow $169 billion at a 0% interest rate. You’d surely get laughed out of the building — and quite possibly carted off to the loony bin. But that’s pretty much what Berkshire’s insurance operations have managed to achieve here. Long may that continue.
“Berkshire can sustain financial surprises, but we will not knowingly throw good money after bad.”
Things are not quite as rosy in other corners of Warren Buffett’s fiefdom.
Here, he paints a bleak picture and sounds almost shaken by the situation unfolding at Berkshire Hathaway Energy. The utility’s earnings plummeted 40.3% last year — significantly weighed down by forest fire litigation on the West Coast.
According to the 10-K: “The decline reflected an increase in energy operating expenses, including an increase in estimated pre-tax loss accruals of $1.6 billion … for wildfires in 2020 and 2022 that arose in Oregon and California.”
Buffett levels his harshest criticism at the regulatory apparatus that has seemingly put BHE in its crosshairs. “The regulatory climate in a few states has raised the specter of zero profitability or even bankruptcy,” he writes. “In such jurisdictions, it is difficult to project both earnings and asset values in what was once regarded as among the most stable industries in America.”
Yikes.
He then goes on to mention Pacific Gas & Electric (filed for bankruptcy in 2019) and Hawaiian Electric (seemingly on its way towards bankruptcy). Not an encouraging comparison for PacifiCorp, the BHE subsidiary on the hook for these wildfires.
Buffett goes on to say that the “fixed-but-satisfactory-return pact [of the electric utility business] has been broken in a few states”. And not by BHE.
He adds that it will be many years before Berkshire “can intelligently make decisions about the desirability of future investments in vulnerable western states”.
Buffett sounds incredibly frustrated. Like a guy who is re-thinking a lot of things about BHE’s heavy investment in the western United States. As he says in the quote above, “We will not knowingly throw good money after bad.”
If PacifiCorp is going to get hammered by regulators and juries after every natural disaster in western states, that’s going to be big problem. Not just for BHE. Not just for other electric utilities operating in the area. But for the country as a whole.
“A century from now, BNSF will continue to be a major asset of the country and of Berkshire. You can count on that.”
The situation at Berkshire Hathaway’s railroad is not quite as happy as the above quote might suggest. Earnings fell 14.4% in 2023 due to disappointing freight volumes (led by a big drop in consumer products) and ballooning labor costs.
“BNSF’s earnings declined more than I expected,” Buffett admits, “as revenues fell. Though fuel costs also fell, wage increases, promulgated in Washington, were far beyond the country’s inflation goals. This may recur in future negotiations.”
Most worrying, though, is that BNSF’s profit margins continue to slip compared to its five principal North American competitors. That needs fixing toot suite.
Buffett expects nothing less. “I believe that our vast service territory is second to none and that, therefore, our margin comparisons can and should improve.”
His commentary on BNSF can certainly be read as a shot across the bow at management — but, unlike the BHE section, Buffett ends on a stridently optimistic note about the railroad’s long-term place in the world.
“There remains only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others. Some we can value; some we can’t. And, if we can, they have to be attractively priced.”
Warren Buffett remains on the hunt for that all-too-elusive elephant. A company both large enough — and priced reasonably enough — to make an impact. As Buffett says, that leaves a very small universe of possibilities to choose from.
This dilemma has resulted in Berkshire Hathaway’s cash pile soaring to $163.3 billion. And, while its staggering size rankles some who would prefer to see this money put to work, I rest comfortably knowing that Buffett has so much dry powder with which to attack the market. I’d rather that he remain patient and carefully pick out just the right pitch to swing at — because that invariably means good things for shareholders.
FYI: I don’t typically include cash from “Railroads, Utilities, & Energy” in this total, so you may see a bigger cash number — like $167.6 billion — elsewhere.
“All stock repurchases should be price-dependent. What is sensible at a discount to business-value becomes stupid if done at a premium.”
In all, Berkshire Hathaway repurchased $9.2 billion worth of its own stock during 2023 — with $2.2 billion of that total coming in the fourth quarter.
Here’s what Warren Buffett spent each month on share repurchases:
October — $948.8 million
November — $1.1 billion
December — $55.7 million
Despite buybacks coming to a screeching halt in December, they’ve picked right back up again in the new year. If my back-of-the-napkin math is correct, Berkshire has repurchased 995 Class A equivalents in the first six weeks of 2024.
And, based on that “price-dependent” quote above, one would assume that the lion’s share of these repurchases came in the first half of January — before Berkshire’s big run-up in price.
“Though we very much like our ownership, as well as the option [to increase our stake in the future by exercising warrants], Berkshire has no interest in purchasing or managing Occidental.”
Here, Warren Buffett reiterates that he has no interest in acquiring a majority ownership interest in Occidental Petroleum. But, importantly, he does describe it as an investment that he “expects to maintain indefinitely”.
It’s always a fun little parlor game to see who does — and does not — receive shout-outs in Buffett’s annual letter. And, on that score, Vicki Hollub must be feeling pretty good today.
“Under Vicki Hollub’s leadership, Occidental is doing the right things for both its country and its owners,” Buffett enthuses. “No one knows what oil prices will do over the next month, year, or decade. But Vicki does know how to separate oil from rock — and that’s an uncommon talent, valuable to her shareholders and to her country.”
Berkshire Hathaway currently owns 28.2% of Occidental Petroleum. If Buffett exercises those aforementioned warrants, it would jump up to 34.4%.
“In 1863, Hugh McCulloch, the first Comptroller of the United States, sent a letter to all national banks. His instructions included this warning: ‘Never deal with a rascal under the expectation that you can prevent him from cheating you.’ Many bankers who thought they could ‘manage’ the rascal problem have learned the wisdom of Mr. McCulloch’s advice — and I have as well. People are not that easy to read. Sincerity and empathy can easily be faked. That is as true now as it was in 1863.”
I’m sure I’m not the only one who read that passage and immediately thought of Berkshire Hathaway’s recent legal wranglings with the Haslam family.
Berkshire paid $2.6 billion for the final 20% of Pilot Travel Centers after both sides shelved their respective lawsuits and agreed to a settlement back in January. That’s quite a bit less than the $3+ billion that most were expecting. We’ll never find out for sure, but it sure seems like Berkshire got the upper hand in settlement negotiations.
“Sincerity and empathy can easily be faked.”
Hmm, now who can he be talking about there?
¯\_(ツ)_/¯
A few more great lines from the letter…
“Over the years, Berkshire has attracted an unusual number of such ‘lifetime’ shareholders and their heirs. We cherish their presence and believe they are entitled to hear every year both the good and bad news, delivered directly from the CEO and not from an investor-relations officer or communications consultant forever serving up optimism and syrupy mush.”
“When you find a truly wonderful business, stick with it. Patience pays, and one wonderful business can offset the many mediocre decisions that are inevitable.”
“Though the stock market is massively larger than it was in our early years, today’s active participants are neither more emotionally stable nor better taught than when I was in school … Markets now exhibit far more casino-like behavior than they did when I was young. The casino now resides in many homes and daily tempts the occupants.”
“America has been a terrific country for investors. All they have needed to do is sit quietly, listening to no one.”
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