Berkshire Hathaway 2015 Annual Letter & Report - Notes



The Book Value (BV) of Berkshire Hathaway per 2015 AR (released 2/27/2016) is $155,501 per BRK.A share or $103.67 per BRK.B share compared to $146,186 per BRK.A share or $97.46 per BRK.B share. The stock currently trades at $198,190 or 127% of BV - the premium over book value has gone down significantly over the last year as that percentage was at 151.25% ($221,180 share price) this time last year. Buffett’s repurchase criterion is 120% of BV or $186,601. The premium to book value has narrowed as the stock lost 12.5% over the last year compared to book value growth of 6.4%. Net earnings are at $14,656 per BRK.A share for a ttm-PE of 13.52. This is compared to a ttm-PE of 18.29 last year and 14.66 the year before.

Historical Book Value (BV) and Market Value Growth:

Book Value CAGR 1965-2015 is at 19.2% and for 2015 it is 6.4%.
Market Value CAGR 1965-2015 is at 20.8% vs 9.7% for S&P 500. For 2015, it is (12.5%) vs 1.4% for S&P 500.

Earnings per Share (EPS):

$14,656 in 2015 vs $12,092 in 2014 vs $11,850 in 2013 and $8,977 in 2012 per BRK.A share.  21% YOY increase compared to 2% YOY last year and 32% the year before. The increases are attributable to impressive cash generation of its operating entities. It was also helped by realized investment gains (after tax) of $4,092 in 2015. PE is 13.52 including investment gains. This time last year, PE was at 18.29.  Roughly a third of Berkshire earnings are realized gains historically. 

Intrinsic Business Value

The two quantitative components of value:
  1. Per-share investments grew 8.3% to $159,794. The growth achieved is marginally lower compared to 8.4% in 2014. CAGR since 1970 is at 18.9% but was only 6.6% in the 2000-2010 time period: long-term growth is stunning but recent growth is lower, and 
  2. Pre-tax earnings from businesses other than investments increased 2.1% to $12,304. CAGR since 1970 is 23.7%. It is higher compared to 20.6% reported last year mainly because Berkshire changed reporting so as to include insurance earnings. Those businesses has become more predictable and profitable and hence the change. Earlier, the assumption was that underwriting businesses will breakeven over the long-term but Berkshire has done substantially better over the last two decades.
The third is a measure of the efficacy with which retained earnings will be deployed in the future - the subjective component.

Growing operating earnings is the main focus. Berkshire did a few deals recently whereby ownership stakes in businesses were exchanged for parts of operating businesses: Phillips 66 and Graham Holdings shares were exchanged in 2014 in tax-free transactions. Also, they have a contract with Procter and Gamble to acquire Duracell the same way. It is set to close on February 29, 2016. For 2016, contribution from this area should be substantially higher as Duracell & Precision Castparts will be included.

Plans to continue building Berkshire’s per-share intrinsic value by:

  • Focusing on increasing earning power at subsidiaries both organically and through bolt-on acquisitions,
  • Growth of equity investments,
  • Repurchasing when there is meaningful discount to intrinsic value,
  • Making acquisitions while rarely issuing new shares.

Non-insurance businesses:

Earned $18.8B in 2015 compared to $17.5B in 2014 and $15.5B in 2013.

“Powerhouse Five”: Berkshire Hathaway Energy (BHE - formerly MidAmerican Energy), BNSF, IMC (Iscar), Lubrizol, and Marmon - $13.1B of the 2015 earnings is from these five businesses. This is compared to $12.5B last year.

Due to the addition of Precision Castparts, “Powerhouse Five” is set to become “Powerhouse Six” from 2016.

For 2015, they contracted for 29 bolt-on acquisitions - $634 million in aggregate. Last year, they contracted for 31 bolt-on acquisitions - $7.8B in aggregate. Also, Duracell close is delayed - H2 2015 was the projection in the last AR. It is now expected to close on February 29, 2016.

Berkshire Hathaway Energy (BHE) & BNSF Railway are capital intensive businesses with a huge amount of regulated assets partially funded by long-term debt. The debt coverage is very good (8:1 for BNSF currently). Even under worst-case assumptions about economic conditions, earnings should cover interest payments easily. Further, the 8:1 coverage ratio is based on EBIT rather than EBITDA. EBITDA to interest is the commonly used measure but that is flawed as it ignores the capital-intensive nature of the business.

Manufacturing, service & retail operations: ROC at 18.4% after-tax on $25.6B of tangible assets. This is compared to 18.7% and $24B last year.

Finance Products: 34,397 homes sold compared to ~31K last year - $12.8B mortgage portfolio down slightly from $13B last year. Mortgage originations by Clayton are pristine as they are incentivized to do so - they keep 100% of the originations and so losses are theirs - no securitizations at all. Also, they borrow short-term and lend long-term. This may be viewed as a recipe for disaster, as there is no hedge against the risk of short-term rates rising sharply. However, Berkshire has a natural hedge - they have $20B in cash-equivalents that earn short-term rates.

Underwriting profit at the insurance businesses stood at $1.8B for 2015 compared to $2.7B for 2014.

Van Tuyl Automotive named Berkshire Hathaway Automotive - consists of 81 auto dealerships in 10 states.

3G Capital Partnerships:

3G’s methods are diametrically opposite compared to Berkshire’s approach to investing in businesses: Berkshire lets acquired businesses operate on their own in a decentralized fashion (except capital allocation) and avoids mass layoffs. 3G’s methods on the other hand are focused on changing the business to reach optimum profitability quickly - it generally involves cost cuts and layoffs. However, the following commonality makes 3G a very good partner: 3G and Berkshire are both focused on buying, building, and holding businesses that satisfy basic needs and desires.

Co-Managers:

·         2015: Precision Castparts acquisition partly credited to Todd Combs. In their investment management roles, Todd Combs and Ted Weschler are each managing $9B each.
·         2014: their roles were expanded to also include running businesses - they took over as Chairman of one business each - combined, those businesses are very small earning around $100M annually - Buffett’s way of developing a deep-bench!
·         2013: Todd Combs and Ted Weschler invested $7B each and they outperformed Buffett in 2013.


Long-term economic goal:

Maximize average rate of gain in intrinsic business value on a per share basis. Preference is to own a diversified group of businesses with consistent above-average ROC and second choice is to own parts of such businesses (security ownership of Berkshire’s insurance subsidiaries).

Look-through earnings relevance:

“Undistributed earnings of our investees, in aggregate, have been fully as beneficial to Berkshire as if they had been distributed to us”. So,
  1. It is preferable to purchase $2 of earnings that are not reportable rather than $1 of reportable earnings for the same acquisition cost, and
  2. Look-through earnings realistically portray yearly gain from operations.
“Big Four investments” (AXP, KO, IBM, WFC) - Berkshire’s share of their earnings was $4.7B - this is compared to the $1.8B dividends that is reported. But, since these are excellent businesses, the unreported $3B in earnings are as valuable as the $1.8B reported. 

Use of leverage:

“We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis”

Selling businesses:

No interest in selling good businesses Berkshire owns. Sub-par businesses are also not sold as long as they are able to generate at-least some cash and managers/labor relations are good. Capex decisions for the latter are made in a much more cautious fashion compared to the former - it is unlikely that sub-par businesses will see increased profitability with increased spending. Couple of excellent quotes in this regard:

The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.)

Gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.


BV growth vs S&P 500 Performance Comparison:

While this comparison is shown in the first page of the Annual Letter, it has become less meaningful over time. The reasoning has to do with how Berkshire’s business structure has evolved: equity holdings tend to move with S&P 500 and that is now a much smaller portion of overall value. Also S&P 500 gains are reported at 100% while Berkshire’s realized gains get reported at 65% because of taxes.

Also, there is another major shortcoming with this comparison: The carrying value of the businesses that are controlled by Berkshire is much more than their carrying value and so the BV far understates Berkshire’s Intrinsic Value (IV). But, IV by definition (discounted value of cash that can be taken out during the remaining lifetime) is an estimate and so is not quoted in any of the releases.

Below is a YoY comparison of Berkshire Hathaway’s largest equity investments:




·         AT&T, Charter Communications, and Phillips are new in the 2015 list as they have become large stakes. DirecTV is no longer in the list because of the AT&T acquisition. Munich RE and USG Corporation did not make the list as they are no longer in the top stakes. A regulatory filing in December 2015 showed Berkshire’s stake in Munich RE has dropped from 11.8% to 4.6% of the business.


Below is a comparison of Berkshire Hathaway's asset distribution in the "Insurance and Other" area for the last three years: 



The equity exposure is at  ~52%. It is ~10% below the highs reached in 2013. On the other hand, cash has gone up by ~44% over that same period. It is probable that Berkshire would look to allocate some of that cash this year.

Expects America to do well for the foreseeable future:

It is incorrect to say that the next generation will not live as well as we do. The current 2% real growth in annual GDP should ensure over one-third increase in per-capita GDP growth over 25 years (assuming population growth remains steady at 0.8% and GDP growth also remains steady at 2%). As the country is starting from a high base of about $56,000 in per-capita GDP, the small 1.2% net increase per year still translates to a huge $19,000 increase in real GDP per capita or $76,000 gain for a family of four.

Warren Buffett's writings (pdfs) are a treasure trove of information and are a very good option for anyone starting out on individual investing. Two books that Warren Buffett recommended in this year’s letter follow:

  1. Limping on Water: My 40-year adventure with one of America's outstanding communications companies by Philip Beuth and K.C. Schulberg, and
  2. Warren Buffett's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor by Jeremy C. Miller.
To learn more about how to profit from a strategy of cloning super-investors, check out our book Profiting from Hedge Funds: Winning Strategies for the Little Guy.


Related Posts:
  1. Berkshire Hathaway 2016 Annual Report - Notes.
  2. Berkshire Hathaway 2015 Annual Report - Notes (this post)
  3. Berkshire Hathaway 2014 Annual Report - Notes
  4. Berkshire Hathaway 2013 Annual Report - Notes .  

Last Updated: 03/2017.


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