The annual letter to Berkshire Hathaway investors from Warren Buffett is hot off the presses with some interesting comments on investing techniques and criticism of the way earnings reports are evaluated.
Winners Can Carry the Load and Dividends are Pretty Great
One of the first topics Warren Buffett covered in his annual letter was Berkshire Hathaway’s (BRK.B) investments into Coca-Cola (KO) and American Express (AXP) that were completed in the mid 1990s. The total cost for each investment was $1.3 billion but the same bottom line principle can be applied at much smaller numbers.
The cash dividend for Coca-Cola increased nearly tenfold from $75 million in 1994 to $704 million in 2022 while dividends from American Express rose from $41 million in 1995 to $301 million in 2022. Additionally, the dividends increased at a very steady rate year-after-year compared to the volatility one might see in a growth stock. With Coca-Cola seeing its share price rise from roughly $10 to $60 during that time and American Express increasing from around $10 to $170 also, Berkshire Hathaway saw those $1.3 billion investments be valued at $25 billion and $22 billion today.
Those are two huge wins that Buffett did clarify took nearly 30 years to reach the current level and require living into his 90s to see. An interesting comment as Buffett would later go on to explain how many investors don’t actually invest and use all earnings after retirement but instead tend to continually invest and have a large sum leftover after passing that is then either handed down or donated to charities.
But the intriguing investment point Buffett expanded upon was related to the weighting of those investments. Coca-Cola and American Express both maintain roughly 5% accounting of Berkshire Hathaway’s net worth from long ago while if they had stayed flat at $1.3 billion during those nearly 30 years they would account for just 0.3% of Berkshire’s net worth. The overall point being that losses or disappointing investments wither away in importance and significance over time especially as other investments grow and enhance the portfolio.
Criticisms of Earnings “Beats”
Earnings season is always a big deal for investors as they gauge corporate performance over the past quarter and wait to hear what companies are expecting going forward. Warren Buffett though criticized (not for the first time) how companies are required to report their financial results in accordance with the generally accepted accounting principles (GAAP).
One of Buffett’s biggest problems with GAAP standards has been that it forces firms such as Berkshire Hathaway to report unrealized gains and losses in its stock portfolio each quarter. The famous investor noted that capital gains have been instrumental to Berkshire’s success over past decades but quarterly changes in asset prices can mislead investors.
Buffett doesn’t just have a problem with the GAAP in particular though as it's easy for companies to play with some of the numbers in order to make the reported earnings look better than they actually are when using other metrics.
Many companies will also report additional numbers separate from GAAP earnings that they may deem better reflects the company as GAAP can be rigid and forces firms to include items that are non-recurring. These additional numbers though can have even more accounting gymnastics to make the company look better than how they are actually performing.
The criticisms around GAAP and non-GAAP financial results have led to Buffett’s stance that there is simply too much significance placed on earnings “beats” as those can often be more the result of fancy accounting than actual performance. Instead, the focus should naturally be on the underlying numbers along with changes in macro and microeconomic trends in addition to comments from the CEO and competitors in the industry.
Something that is often seen in markets with stocks rising for a short time after an earnings beat before losing those gains as investors and analysts delve deeper into the earnings report beyond just the headline numbers.
Wrapping Up
Warren Buffett’s annual letter to Berkshire Hathaway shareholders is always an intriguing analysis from one of the world’s most famous investors. There was nothing too bold this year with criticisms surrounding earnings reports not being new and the changing weight of investments over time being known as well but important to keep in mind for even the most sophisticated of investors.
Other than that Buffett commented how important it was to have a great partner when investing and some analysis of the scale of Federal taxes. Overall, a relatively short annual letter for 2023 but a good and informative read nonetheless.
