Warren Buffett (Trades, Portfolio)'s letters to shareholders provide vital insights for long-term investors, and we can always learn a variety of valuable lessons for taking advantage of emerging opportunities while preserving portfolios during times of risk.
In his 2022 letter to shareholders, Buffett shared insights on Berkshire Hathaway Inc.'s (BRK.A, Financial) (BRK.B, Financial) "secret sauce" by highlighting the importance of time in generating significant returns. Historically, Berkshire's investments in The Coca-Cola Company (KO, Financial) and American Express Company (AXP, Financial), which were completed nearly 30 years ago at a total cost of $1.3 billion each, have generated significant gains in stock appreciation. In 2022, Berkshire's holdings in Coca-Cola and American Express were valued at $25 billion and $22 billion, respectively, and accounted for roughly 5% of Berkshire's net worth. Nowadays, the dividends alone are well worth holding on to these stocks considering Berkshire bought them at such low prices.
Interestingly, the cash dividends received from these investments were not spectacular back in the day, but they still became important because they contributed to the overall gains through reinvestment. Moreover, over time, the dividends per share grew substantially.
A few winners can work wonders over time, and investors should focus on the long term and not be distracted by short-term fluctuations, according to Buffett. It's not only possible but common that an investment that may seem disappointing in the short term can become highly substantial over time. Buffett also jokes that it helps to start early and live into your 90s as well.
Issues with GAAP earnings
Buffett's annual letter provides insight into his perspective on investing and Berkshire's performance. One of the key themes is the importance of taking a long-term view and avoiding the short-term focus on quarterly earnings that dominate Wall Street.
Notably, the problem with GAAP earnings (for some companies, not all) is that they require companies to consider fluctuations in the value of their stock portfolio as part of earnings. As a result, GAAP earnings figures get skewed when the value of a company's equity portfolio is large compared to its operational earnings. In other words, changes in the stock market can significantly impact a company's GAAP earnings, making them appear more volatile than they are.
On the other hand, operating earnings, which exclude unrealized capital gains or losses from equity holdings, provide a more accurate representation of a company like Berkshire's underlying performance. Berkshire's operating earnings were at a historical high in 2022 ($30.8 billion), but the GAAP earnings fluctuated significantly throughout the year while the operating earnings remained relatively stable.
Finally, Buffett concludes that the GAAP earnings figure is subject to manipulation by company managers. Therefore, investors should focus on operating earnings instead and be wary of managers manipulating numbers to beat expectations.
Insurance as a favorable factor
Buffett also discusses Berkshire's purchase of Alleghany Corporation, a property-casualty insurer. Alleghany delivers unique value to Berkshire because its financial strength allows its insurance subsidiaries to follow valuable and enduring investment strategies that are unavailable to virtually all competitors. Moreover, with disciplined underwriting, the funds generated from insurance floats have a decent chance of becoming cost-free over time. Since purchasing its first property-casualty insurer in 1967, Berkshire's float has increased eight-thousand-fold through acquisitions, operations and innovations.
Issues with the US federal taxes and treasury
During 2012–2021, Berkshire paid around $32 billion in taxes, almost 0.1% of all tax payments taken in by the Treasury Department. Over the same period, the U.S. government took in about $32 trillion in tax receipts while spending closer to $44 trillion.
Overall, the Treasury garnered $32 trillion in revenue through various types of taxes, with individual income taxes accounting for 48%, social security and related receipts accounting for 34.5%, corporate income tax payments accounting for 8.5%, and a wide variety of lesser levies. An interesting observation Buffett noted is that if around 1,000 taxpayers in the U.S. matched Berkshire's payments, no other businesses, nor any of the country's 131 million households, would have needed to pay any taxes to the federal government.
Finally, Buffett's letter highlights the significant amount of debt owed by the U.S. government and the unfavorable consequences of the country's vast and entrenched fiscal deficits. However, he also reassures investors that effective management of a company's operations and finances will achieve an acceptable result over time while preserving the company's unmatched staying power when financial panics or severe worldwide recessions occur.
Holding large liquidity
Berkshire Hathaway is known for keeping a large cash position, which means it holds significant liquidity on its balance sheet. It contrasts with many other companies that may use their cash reserves for various purposes, such as reducing debt, stock repurchases, dividend payments, or business reinvestments. Berkshire believes that keeping a significant cash position is essential for taking advantage of new opportunities.
Interestingly, in 2022, when the S&P 500 was grounded by the worst performance hit since 2008, Berkshire considerably accumulated stocks and executed major acquisitions. Berkshire could take advantage of these opportunities and make investments when prices were low by keeping a significant amount of cash on hand. Additionally, Berkshire has reduced its outstanding share count by more than 10% in the last 10 years, resulting in higher earnings per share and higher shareholder value.
Source: Yahoo Finance
Takeaway
Buffett is an engaging gladiator in the colosseum. He and his leadership team have a significant stake in the company's success. In his 2022 letter to shareholders, Buffett highlighted the importance of investing long-term and focusing on operating earnings rather than GAAP earnings. The favorable factors of insurance and holding a significant cash position allow Berkshire to take advantage of emerging opportunities. With the U.S. federal taxes and treasury attached to the potential consequences of the country's massive fiscal deficits, Berkshire's "secret sauce" offers valuable lessons for investors seeking to achieve significant returns over time.
