Like many others, I look forward to Warren Buffett’s annual letter to Berkshire Hathaway shareholders, and like many others, I read his annual letter closely, looking for any investment insights I can glean as well for Buffett’s now-famous homespun brand of wisdom and humor. Although Buffett latest letter to Berkshire shareholders – which was published Saturday morning – does offer readers a little under each of these headings, I think many reading Buffet’s latest letter might have come away a little disappointed, as I discuss further below. Buffett’s 2019 letter to Berkshire shareholders, published on February 22, 2020, can be found here. (Full disclosure: I own BRK.B shares, although not as many as I wish I did.)


As someone who had carefully read Buffett’s letters for decades now, I have to say I am more than a little bit troubled about how short they have become. I was struck last year how short his letter was, and I had the same reaction again this year. Along with the increasing brevity, the letters seem to have become increasingly formulaic and consist of well-worn tropes – such as, for example, the long-term value of equity investing, the importance of accrued earnings, and the value of insurance float. I know he repeats these themes because they are important to understanding how he runs Berkshire, but he is not saying anything on these topics that he has not said many, many, many times before.


For me, it is impossible to observe the uncharacteristic brevity of Buffett’s most recent letters and not to think about his advancing age. Buffett will be ninety years old this summer. To be sure, this year’s letter, arguably by contrast to prior letters, expressly acknowledges and addresses his age. In a section of the shareholder letter captioned “The Road Ahead,” Buffett in fact recognizes that he and Berkshire’s Vice Chairman Charlie Munger “long ago entered the urgent zone.” However, he says, the company is “100% prepared for our departure.” After laying out the case for the company’s continued prosperity, Buffett details the outlines of his estate plan, by which over the course of 12 to 15 years, his A shares will be converted to B shares and then distributed to various foundations.


In yet another tacit recognition of the need for the company to be prepared for its life after Buffett, this year’s letter states that at the upcoming Berkshire shareholder meetings, the two designated management successors, Ajit Jain and Greg Abel will be “given more exposure.”


For me, the acknowledgement of his age, the transparency about Buffett’s long-term estate plan, and the overt management transition are all positive and important developments.


The letter is of course first and foremost a report to Berkshire’s shareholders, and from that perspective, the news is good. Berkshire had GAAP earnings of $81.4 billion, an astonishing figure that requires some significant explanation. Of that $81.4 billion, fully $53.7 billion represents net unrealized capital gains, which Buffett argues should not be taking into account for earnings purposes but is required to be disclosed as such because of changes to GAAP. The more important figure, from Buffett’s perspective, is the company’s 2019 operating earnings of $24 billion, which, it should be noted, is roughly equal with the equivalent figure for the year prior.


Interestingly, while Berkshire had another good year, it arguably did not meet the target under one of Buffett’s standard measurements. For years, Buffett has opened the shareholder letter comparing the annual percentage change in the per-share market value of Berkshire to the annual percentage change in the S&P 500 (with dividends included). Over the long haul, Berkshire has far surpassed the S&P 500 under this measure. However, in 2019, Berkshire fell short, with Berkshire showing a change of 11% and the S&P 500 showing a change of 31.5%. Berkshire’s relative underperformance in 2019 was the largest since 2009. Indeed, in the 11 years from 2009-2019, the S&P has beaten Berkshire four times, and there were three other years in which the measures were essentially even. Berkshire’s most significant changes in value relative to the S&P 500 are now years in the past – Berkshire has in fact underperformed the S&P 500 over the past decade.


One of the basic facts about Berkshire these days is that it is big – really BIG. As of December 31, 2019, the company was carrying $128 billion in cash on its balance sheet. It is hard to put that much cash to work and it is hard to produce the changes in value that the company was able to show in the past. Buffett himself has emphasized many times over the years how much harder it has become as the company has grown larger to be able to produce returns on a percentage basis. A question that gets asked frequently about Berkshire these days is whether it has just grown too big to beat the market.


Another way in which Berkshire is big in almost unfathomable ways is with respect to the company’s equity investment portfolio. The aggregate market value of the company’s equity investments as of the end of 2019 was $248 billion (up from $172 billion as of the end of 2018). In looking at the list of Berkshire’s top 15 equity investments one thing that jumps out is how large the company’s investment in Apple has become. Indeed, with now over $35 billion invested in the company, Berkshire’s investment in Apple represents Berkshire’s largest ever investment in a single company (exceeding even the company’s $32 billion acquisition in 2016 of Precision Castparts).  The Apple investment has done well – as of year-end 2019, the market value of Berkshire’s $35 billion Apple investment was over $73 billion.


At year-end 2019 valuations, Berkshire’s Apple investment represented nearly 30% of the Berkshire’s equity investment portfolio value. This skew in the company’s investment portfolio is all the more curious given Buffett’s famous refusal during the dot-com boom to invest in technology companies because he professed not to understand their businesses. The Apple investment clearly reflects the impact of Berkshire investment managers Todd Combs and Ted Wechsler, who both joined the company in the 2010-2011 time frame. When I look at Berkshire’s Apple investment, I cannot help but reflect that though Buffett is still in charge, the company has already changed in significant ways.


One other thing about Berkshire’s top 15 holdings that I find surprising is how significant the company’s investments in airlines are. Three of the company’s top 15 investments are in airlines: Delta Air Lines (year-end value of $4.1 billion); Southwest Airlines (year-end value of $2.5 billion); and United Continental Holdings (year-end value of $1.9 billion). I find this concentrated investment in airlines curious, as in the past Buffett publicly acknowledged Berkshire’s prior investment in U.S. Air to be one of his mistakes.


In his 2007 letter, he described the airline industry as a “bottomless pit” that has sucked up investors’ money; he said “to his shame,” he had “participated in this foolishness.” He said of Berkshire’s 1989 investment in U.S. Air preferred shares that “as the ink was drying, the company went into a tailspin and before long our preferred dividend was no longer being paid.” Even though he later was able to sell the preferred shares for a gain, the airline itself ultimately went bankrupt – twice. Once again, it seems to me when I look at Berkshire’s current investment in multiple airlines that while Buffett is still around, there are signs that the company is already changing in arguably significant ways.


By way of contrast perhaps, one industry Buffett has always favored is the insurance business. As Buffett says in this year’s letter in talking about Berkshire’s vast portfolio of controlled businesses, “our insurance business has been the superstar.” During the past 17 years, Berkshire has produced an underwriting profit in its insurance operations, with an aggregate pre-tax profit during that period of $27.5 billion (of which $400 million was recorded in 2019).


As has always been customary in his commentary on this topic, Buffett is cautious to forewarn that Berkshire will not always produce these kinds of returns. As he puts it, “we will most certainly not have an underwriting profit in 16 of the next 17 years. Danger always lurks.”


In discussing what future danger might look like, Buffett slides in a comment that may be of particular interest to readers of this blog. Among the list of things that could produce adverse underwriting results, Buffett mentions some familiar items but  adds one further item that is not always on the list. He says that “’The Big One’ might come from a traditional source, such as wind or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate.”


The possibility of a cyber event causing consequences beyond anything insurers now contemplate is a nightmare that the insurance industry as a whole would rather not confront. Buffett’s suggestion of that possibility seems to me to be something of a message to the industry about the dangers out there. It is interesting to me and particularly telling that in identifying the possible source of the ultimate catastrophe, Buffett refers not (as he might have given recent history) to a terrorist event, but rather to a cyber security event. This strikes me as something important for the insurance industry to consider.


Buffett’s exploration of one other topic may also be of interest to this blog’s readers. In this year’s letter, Buffett has a lot to say about boards of directors, noting that he has himself over the course of the last 62 years served as a director of 21 publicly-owned companies. He notes during the first 30 years of that period, it was rare to find a woman in the room, and that the efforts for more women to be heard in the board room “remains a work in progress.”


Buffett goes on to note that despite many changes, most boards are still controlled by their company’s CEO. For example, audit committees now work harder than they once did, but “they remain no match for managers who wish to game numbers.” Acquisition proposals “remain a particularly vexing problem for board members,” because the deck is stacked if favor of deals the CEO backs. And while there is increased emphasis on board independence, director compensation in recent years has soared, making the lure of rich board fees a “subconscious factor affecting the behavior of many non-wealthy members.”


The upshot of it all is that while almost all of the directors Buffett has served with were “decent, likable and intelligent,” many of these “good souls are people whom I would never have chosen to handle money or business matters. It simply was not their game.”


In the face of this negative picture of captive boards filled with underqualified members, Buffett identifies a few things that might make a difference. For example, at Berkshire, he says, “we will continue to look for business-savvy directors who are owner-oriented and arrive with a strong specific interest in your company.” Buffett also notes that he feels better about directors who have purchased shares in their company’s stock using their own money rather than just receiving them through grants. And as far as board governance goes, there has been at least one “very important improvement” – that is, the increase in the use of regularly scheduled “executive sessions” of directors at which the CEO is barred.


While Buffett seems to suggest that it is possible for boards to be filled with sufficiently skilled individuals who have independent financial motivations, and while there are governance processes that can encourage board independence, the overall picture he paints of board capture and lack of competence is really pretty discouraging.


In the context of his letter to Berkshire shareholders, Buffett’s comments about companies in general and about their boards all come back to Berkshire itself. In his list of reasons why he believe the company is “100% prepared” for his departure, he states that he believes that the company has “skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and prestigious job” and that the company’s directors — “your guardians” – are constantly focused on both the welfare of owners and the nurturing of a culture that is rare among giant corporations.”


In other words, Berkshire’s performance on “The Road Ahead” depends a lot on the caliber and performance of the company’s managers and directors.


Buffett will still be at center-stage at the upcoming annual shareholders’ meeting. But it seems to me, in a number of ways I noted above, the company may (finally?) be readying for what comes next, after Buffett. And that is a good thing, if we truly are to believe that the company is “100% prepared” for Buffett’s eventual departure.


The Upcoming PLUS D&O Symposium: This upcoming week I will be in New York for the PLUS D&O Symposium. On Tuesday, February 25, 2020, I will be moderating a panel at the Symposium on the topic “Time for Another Round of Securities Litigation Reform?” I will be joined on the panel by Sara Brody of the Sidley Austin law firm; Sean Griffith of the Fordham Law School; Jeremy Lieberman of the Pomerantz law firm; and Jarrod Schlesinger of Chubb. It should be a great session and I hope to see everybody there.


I know that many of this blog’s readers will be at the Symposium. If you see me at the Symposium, I hope you will make a point of saying hello, particularly if we have not previously met. See you all in New York!


And Finally: The February 22, 2020 Wall Street Journal carried a wonderful tribute in recognition of the 50th anniversary of the release of the album “Nilsson Sings Newman,” which features a range of songs written by Randy Newman and sung by Harry Nilsson while Newman plays the piano. Even though I know I am showing my age, I fully endorse to the author’s view that this album is one of the greatest of all times. I recommend the article, and I strongly recommend the album, which, if you have never heard it, is a revelation. The songs on the album, as interpreted by Nilsson’s vocals, are wry, entertaining, and occasionally moving. As the Journal article’s author notes, “Half a century on, ‘Nilsson Sings Newman’ still sounds singular, inspired and fresh. If you haven’t heard it, a sparkling aural discovery awaits you.”


Here is a recording from the album of Nilsson singing Newman’s “Love Story”: