Even if there were no major revelations in Berkshire Hathaway (BRK.A) (BRK.B) chairman and CEO Warren Buffett's annual letter, it still provided us with plenty to chew over, from a discussion of why the firm won't be paying a dividend anytime soon to why Buffett is still actively looking for new acquisitions.
Overall, Buffett described his performance in 2012 as "subpar" as the book value per Berkshire share increased by 14.4% versus the S&P 500's 16% gain. Buffett still thinks that the gain in Berkshire's intrinsic value will over time likely surpass the S&P 500's returns by a small margin, but that much of the firm's outperformance will come when the broader market is facing challenges. Morningstar's Berkshire analysts are taking a deep dive into the financial results and performance of the firm's units.
Here are some themes from this year's letter that jumped out as us.
Elephant Search Continues
Buffett said that one of his biggest regrets in 2012 was the inability to bag an enormous acquisition. He was on the lookout all year, and despite some near misses (rumors have it that he was close to purchasing NYSE Euronext late in the year) the company ended up short on the mega-deal front. This of course all turned around early this year, when he teamed up with Jorge Paulo Lemann to take over
H.J. Heinz . Buffett seems very excited to be putting $12 billion to work, particularly given the very generous terms the firm got on the $8 billion in preferred shares it holds.
And it sounds like Berkshire may not be done yet. Buffett wrote that he, along with Berkshire vice chairman Charlie Munger, have again put on their "safari outfits and resumed [their] search for elephants." Buffett also talked a few times elsewhere in the letter about the positive potential for putting cash to work in very large deals. It wouldn't be surprising if he's out there looking to execute on the next Heinz deal as soon as possible.
Don't Hold Your Breath for a Dividend
One of the top questions every year at the Berkshire annual meeting is when or if the company is going to start paying out some of its cash hoard to investors in the form of dividends. This year's letter gave a fairly clear answer: Don't hold your breath.
Buffett laid out his case against Berkshire paying a dividend by pointing to three better ways to use the funds and providing what he sees as a better option for investors looking for income. His first example of a superior use of cash was reinvestment in existing businesses. The firm has a lot of capital-intensive units (such as BNSF and MidAmerican Energy) that can soak up a ton of cash. Buffet sees the $12.1 billion the company laid out in 2013 for fixed-asset investments and bolt-on acquisitions as money well spent.
Buffett also pointed to prudent acquisitions unrelated to existing businesses as a good way to build shareholder wealth. He wrote that Berkshire has a satisfactory track record in getting deals done and that "shareholders are far wealthier today than they would be if the funds [Berkshire] used for acquisitions had instead been devoted to share repurchases or dividends." Buffett conceded that deals big enough to truly move the needle are rare, but he said there are still some "whales in the ocean."
Finally, Buffett made the case for share repurchases. He said "disciplined repurchases are the surest way to use funds intelligently: It's hard to go wrong when you're buying dollar bills for $0.80 or less." Buffett seemed open to buying back a large amount of stock as long as the shares were trading lower than 120% of book value.
He then suggested that investors looking for income are better off selling a portion of stock every year for cash than receiving a dividend directly from the company. To bolster his point, Buffett provided an example of a firm that is able to grow its tangible net worth by 12% a year and that it is possible to sell shares at 125% of book value. Under these conditions, an investor ends up better off by selling shares every year instead of taking an equivalent dividend. Buffett contended these are reasonable assumptions for Berkshire.
Buffett said that when you add in the fact that different investors have very different needs for current income, he doesn't see the case for the firm to start paying out cash. He said Berkshire will stick with its current policy as long as the firm's "assumptions about the book-value buildup and the market-price premium seem reasonable." In other words, barring any exceptional circumstances, as long as Buffett is in charge, the firm won't be sending out dividend checks.
Combs and Weschler Settling In
Speaking of Berkshire after Buffet, the chairman showered praise on his investment lieutenants, Todd Combs and Ted Weschler. He described them as a "perfect cultural fit" and said they both managed to outperform the S&P 500 by "double-digit margins." Consequently, Buffett has increased the fund managed by each to close to $5 billion.
But he's not totally handing over the investment reins yet. Buffett wrote that his stake four core investments ( American Express (AXP), Coca-Cola (KO), Wells Fargo (WFC) and International Business Machines (IBM)) will likely increase in 2013 either through new purchases or because of share buybacks at those firms. The implication here is that some of his other holdings may be fodder for the sale pile to give Combs and Weschler more money to invest.
Buffett Still Buying Newspapers
Another area that Buffett is expanding his investment in is newspapers. He's bought 28 during the last 15 months for $344 million. This bet has always seemed a bit perplexing as Buffett has said that "circulation, advertising, and profits of the newspaper industry overall are certain to decline." However, Buffett thinks if he buys these at the right price, he can still make a profit despite those secular headwinds. His bet is that local news targeted toward "tightly bound" communities will remain valuable if it is delivered in print or via the Internet. Even if profits fall from today's levels, Buffett thinks the deals will beat his "economic test for acquisitions."
Don't Stress Out About Uncertainty
The Oracle of Omaha also gave some advice to his fellow CEOs: Don't worry about uncertainty in the economy. He said that ever since the country was founded, we've never been quite sure what is around the corner but that American business has always been able to come through it. And as businesses have flourished, so have stocks. Given the long-term upward trajectory, Buffett warns against trying to time the market and posits that "the risks of being out of the game are huge compared with the risks of being in it."
Stay tuned to Morningstar.com for a complete analysis of the firm's 2012 earnings and what it means for shareholders. We'll also be on the ground in Omaha, Neb., this May to cover the Berkshire Hathaway annual meeting.