He Beats Up on Generally Accepted Accounting Principle (GAAP) 

For the last few years GAAP changes have been referenced in these letters with the current comments pointed toward a change in how investment income is recorded. Now, changes in unrealized gains and losses will impact the net income number any given year. However, when you have a $170 billion portfolio, moves in the market can lead to giant swings in net income. Buffett noted that their bottom line figures will be rendered ‘useless’ with this change. 

The Next Big Deal Remains Elusive

Buffett commented that while they were able to find many businesses that were investable, the question of price tended to remain a barrier for any deal getting done. Here's Buffett's take on why deals are getting done at high prices: 

“Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”

Berkshire Remains Constructive on the US Economy and Businesses Leveraged to It 

While this was not stated outright, it looks to be evidenced by the bolt-on acquisitions Berkshire Hathaway completed. In 2017 they purchased two conventional home builders and Pilot Flying J which operates gas stations. Also, a company called US Floors, whose business should be self-explanatory.

He Believes That Their Insurance Operations Can Withstand a $400 Billion Natural Disaster, but Others Cannot

The few paragraphs on this topic are interesting to read. In short though, they discuss how while these large catastrophes are a low probability, there is still a chance that they can occur. If they do, Berkshire feels comfortable with their exposure. Other companies though, were cited as being unable to withstand the hit.

He Continues to Beat up on Fees and Promotes Passive Strategies

From the letter:

“American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money’s worth? Indeed, again in the aggregate, do investors get anything for their outlays?”

He then goes on to discuss how simply owning a passive index was all that was needed to beat hundreds of hedge funds utilizing various strategies. This is referring to ‘the bet’ where Warren Buffet pitted an S&P 500 ETF against the performance of five fund of funds.

I will say on this point though, the issue that always sits unsteadily with me in this argument for active vs. passive is that it is coming from someone who in the past made their fortunes on being an active investor. In other words, Warren Buffett did not get to where he is today by holding the S&P 500 ETF. Of course, not everyone is Warren Buffett and this type of advice almost certainly would benefit more people than it would hurt.

The Successor(s) to Run Berkshire Looks to Be a Done Deal 

It looks like it is becoming all clear that Ajit Jain and Greg Abel will be the ones in charge of Berkshire Hathaway when Buffett and Munger step down. 

Some Other Nuggets from the Letter 

“In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”

“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”

So that is our summary of what is always a fun and necessary annual read. You can dive into it yourself here.

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