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Berkshire Coverage

Buffett Says Focus on the Forest, Forget the Trees

In his annual letter to Berkshire Hathaway shareholders, Warren Buffett argues why the whole is much greater than the sum of its parts--and comments on that sizable cash stake.

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In his annual letter to shareholdersBerkshire Hathaway Inc's (BRK.A)/(BRK.B) Warren Buffett explained why investors should focus on the forest rather than the trees and commented on Berkshire's sizable cash stake. Here are a few takeaways from this year's tome.

'Focus on the Forest--Forget the Trees'
Buffett notes that investors too often focus on the details of Berkshire's individual business, which he calls their "economic trees." Given that Berkshire owns a variety of businesses--"ranging from twigs to redwoods"--he argues for looking at the entire "forest."

"A few of our trees are diseased and unlikely to be around a decade from now," admits Buffett. "Many others, though, are destined to grow in size and beauty."

(One of those "diseased trees" may very well be beleaguered Kraft Heinz (KHC), for which Berkshire took a $3 billion writedown in the fourth quarter. Kraft Heinz's woes continued this week with news of an SEC investigation into its procurement accounting and a dividend cut.)

He divides Berkshire’s holdings into five "groves": its non-insurance businesses that it controls; its collection of marketable equities; its controlling interest with other parties in several businesses; its cash and fixed-income instruments; and its insurance business.

Buffett calls its non-insurance businesses that it controls "the most valuable grove in Berkshire's forest." The "runner-up grove" by value is its stake in marketable equities. He makes particular note of these companies using retained earnings to repurchase shares, saying, "We rejoice when management employs some of its earnings to increase Berkshire's ownership percentage."

He uses American Express (AXP) as an example: Berkshire's holdings in the company have remained unchanged in eight years, but ownership has increased from 12.6% to 17.9%, thanks to share repurchases

The Cash Pile
Cash is one of Berkshire's "groves." Buffett admits that he'd love to put some of Berkshire's cash to work with an "elephant-sized acquisition": "Even at our ages of 88 and 95--I'm the young one--that prospect is what causes my heart and Charlie's heart to beat faster." However, he admits that's unlikely: "Prices are sky-high for businesses possessing decent long-term prospects." Instead, he expects to expand Berkshire's holdings of marketable securities.

Morningstar analyst Greggory Warren, who covers Berkshire,notes that its large cash balances--$112 billion at year end--are an ongoing challenge. Warren suspects that with investment opportunities few and far between, Buffett is more likely to use share repurchases to reduce the cash balances--albeit being cost-conscious when doing so as he has in the past.

Indeed, Buffett mentions that Berkshire will occasionally repurchase its own stock, if shares can be bought at a discount to Berkshire's intrinsic value.

Succession Planning
Buffett briefly touched upon the management change made in early 2018: Ajit Jain being put in charge of all insurance activities and Greg Abel given authority over all other operations. He comments that Berkshire is now better managed than when he was overseeing operations solo, and says that "Berkshire blood flows through their veins."

Morningstar's Warren notes that both Jain and Abel are fine candidates for the CEO role down the road; he thinks they broth bring "unique insights."

"Our preference, though, would be to have Jain take control of all of Berkshire's insurance operations while Abel (who has experience with both operations and acquisitions) fills the role of chief executive," he says.

We'll be reporting from the annual meeting in Omaha on May 4.

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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