Sunday, 3 March 2013

A Comment on Warren Buffett's 2012 Letter to Shareholders

Warren Buffett's eagerly-awaited annual letter to shareholders was recently released.  As ever, Buffett highlights the negative, even as he downplays his accomplishments.  For example, he refers to last year's performance - 14.4% growth - as "subpar."  This is true in the literal sense that par is the S&P index, which returned 16%.  However, that's not much of a difference, and a gain in book value of $24 billion isn't all that shabby.

He quickly summarizes the basic terms of the Heinz deal, agreed to after the end of 2012, without a hint of the "Gotcha!" that he must feel.   Many long-time Buffett watchers likely scratched their heads when they learned that the Master offered a price that valued the venerable seller of ketchup and beans at about $28 billion (including debt).  However, once the details emerged, it became clear that the terms of the deal were extremely favorable to Berkshire shareholders.  Alice Schroeder responded to the deal in the Financial Times, explaining that it was the Buffett brand that allowed for the one-sided benefits of the deal, a transaction that will be studied decades from now in business case studies.

As usual, much of the letter's space was devoted to a summary of Berkshire's large business categories - a range of insurance companies; regulated, capital-intensive businesses; manufacturing, service and retail businesses; and finance and financial products - plus a few words about the stock portfolio.  Most of this section is similar to the comparable coverage in years past, with a few added comments, and, of course, numbers that are more recent by one year.

Buffett always offers sharp, clear insights into the sometimes fuzzy world of accounting.  This year, he illustrated the difference between "real" and "non-real" amortization charges – software-related write-downs are generally legitimate, while charges to the value of customer relationships tend not to be – and how they diminish the reported earnings of IBM and Wells Fargo, two of Berkshire's "Big Four" stock holdings.  He also holds forth on some of the arcana of GAAP purchase accounting as it relates to Berkshire's steadily increasing investment in Marmon.

This year, Buffett spilled much ink on the newspaper industry.  Because he has long prophesied that newspapers are in permanent decline, many have wondered about his sudden spending spree on them (people must not lose their sense of proportion, however: while he has bought many different papers, even in aggregate they represent only a small fraction of Berkshire's resources - so small in fact, that one wonders if his focus might be better used elsewhere).  Still, he offers a clear and insightful history of the newspaper industry, where it stands at present, and the direction it might take in the future.  While he remains pessimistic about papers in large, hyper-competitive markets, smaller papers with "primacy" in matters of interest to readers - high school sports, local coverage, obituaries - plus a sensible internet strategy can make for a buy, though only at very low prices.

Using the topic of dividends as a launching point, Buffett offers a concise general theory of capital allocation.  While he's shared most these thoughts in the past, this primer is excellent.  Both experienced and novice investors ought to read and re-read this section.

Now well into his 80s, Buffett's mind remains razor-sharp, and his performance continues to be stellar.  The 2012 letter to shareholders belongs in the same exalted company as all of the previous ones.  Here's hoping for many more to come.

Here is a rare summary of Warren Buffett's early letters to partners.

Disclosure: At the time this article was published, the writer was long IBM stock.

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