Warren Buffett

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For a certain class of investors who look to Warren Buffett for investing advice, today is like Christmas in March. That’s because Mr. Buffett, one of the most successful investors in history, released his annual letter to the shareholders of his Berkshire Hathaway Inc. early this morning.

As our own Anupreeta Das notes . Mr. Buffett typically begins penning his annual letters months ahead of their release. His letters are known for their witticisms . nuggets of advice, and his assessment of Berkshires performance the previous year. Often, the letter is the best glimpse the market gets into how Berkshire is faring.

But the letter is widely read well beyond the loyal community of Berkshire shareholders as well because the notes cover a range of topics of interest to retail investors and seasoned businessmen alike. In an advance excerpt from this year’s letter published on Fortune magazines website earlier this week . Mr. Buffett warned investors against being swayed by market chatter and pundits exhorting them to buy or sell their investments.

The MoneyBeat team is live blogging our thoughts on the letter in real time as we read it Saturday morning.

There are a couple things we can say for certain about Mr. Buffett’s letter, even before it comes out.

The first: He’ll be sure to warn that Berkshire won’t grow as quickly in the future as it has in the past. He’s been alerting shareholders to that reality for years. Berkshire’s current size, he often notes, make it impossible for him to repeat the astronomical growth that he’s achieved for shareholders in the past. The second: That he’ll take a moment to acknowledge that over the past five years, Berkshire’s book-value growth has underperformed the S&P 500. He warned as much in last year’s letter. It’s worth noting because it’s the first time in Buffett’s five-decade tenure

Journalists have learned in recent years that Mr. Buffett is unlikely to bury the big news of the letter somewhere on page 27. If he’s got something major to say, it’s likely going to be in the first couple pages. That’s where Mr. Buffett revealed that he was looking for a big deal in 2011, and where he confirmed that Berkshire’s board had identified a single individual to succeed him as chief executive in 2012.

But the loyal Buffett acolytes (the ones who are currently hitting reload repeatedly on Berkshire’s website) will pour over every word of the letter, of course.

The letter is out. If you want to take a look, click here .

Well, were a couple paragraphs in and Im already wrong. My prediction that hed immediately acknowledge Berkshires underperformance versus the S&P since 2009 didnt pan out. Last year, Mr. Buffett wrote to date, we’ve never had a five-year period of underperformance and warned our streak of five- year wins will end if the market does well in 2013.

Instead, one the first page, he moves the yardstick! Now hes talking about beating the S&P since 2007: Over the stock market cycle between yearends 2007 and 2013, we overperformed the S&P. Through full cycles in future years, we expect to do that again. If we fail to do so, we will not have earned our pay.

Berkshire Hathaways fourth-quarter and full-year profit and revenue jumped as the giant conglomerate’s businesses benefited from the improving U.S. economy.

Net income for the fourth-quarter was $3,035 per Class A share, or nearly $5 billion, up 9.6% from a year ago. For the full year, Berkshire posted net earnings of about $19.5 billion, compared with $14.8 billion for 2012.

Berkshire brought in about $182 billion of annual revenue, exceeding analysts’ expectations of $180 billion, according to Thomson Reuters data.

Page 2 includes a prediction that the collection of Berkshires five biggest non-insurance businesses could see an increase in earnings of $1 billion before taxes in 2014. Until recent years, Mr. Buffett hasnt been very specific about his expectations for earnings growth, but hes clearly very enamored with these Powerhouse Five companies, as he calls them here.

The five include the Burlington Northern railroad; Berkshires utility, MidAmerican; a chemical company called Lubrizol; an Israeli machine-tool business called Iscar; and a manufacturing powerhouse called Marmon. All but MidAmerican were acquired by Mr. Buffett in the past nine years.

If the U.S. economy continues to improve in 2014, we can expect earnings of our Powerhouse Five to improve also – perhaps by $1 billion or so pre-tax, he writes.

Mr. Buffett mentions on page four that Berkshires insurance float increased to $77 billion from $73 billion last year. Float, or the policyholder premiums that Berkshire sets aside to pay future claims, are one of the key engines that have driven Berkshires growth over the past five decades. Mr. Buffett describes it here as the money that doesnt belong to us but that we can invest for Berkshires benefit. Thats because Berkshire gets to keep any profits they make.

Thats followed quickly by a plug for Geico. Jeez. That freakin gecko is inescapable.

8:38 am
• Buffett: Look to Heinz as a Model Berkshire Deal
• by Maureen Farrell Edit Add a Comment

Warren Buffett has written about his hunt for elephants over the past few years, i.e. large acquisitions. In 2013, the purchase of ketchup maker H.J. Heinz was one of the two elephants he and his partner Charlie Munger slayed.

In his annual letter, Mr. Buffett called the purchase and financing of Heinz as a template that Berkshire Hathaway could use in future acquisitions. Mr. Buffett teamed up with the Brazilian private-equity firm 3G Capital, to buy the ketchup maker for $23 billion in February 2013.

He hints that investors might expect Berkshire to jump into more deals with PE firms.

Mr. Buffett admits that Berkshires side of the deal looks like a private-equity deal. The crucial difference he says is that Berkshire Hathaway never intends to sell a share of the company. Instead by teaming up with a PE firm, Berkshire Hathaway has the option to buy more of it. (He currently owns about half via $8 billion of preferred stock with a 9% coupon).

But Mr. Buffett will likely pick his partners carefully. Mr. Buffett calls the head of 3G Capital Jorge Paulo Lemann a friend and deems his associates talented, notably Bernardo Hees, the new CEO of Heinz and its chairman Alex Behring.

Mr. Buffett gives a shout-out to his relatively new investment managers, Todd Combs and Ted Weschler, on page five. Each handily outperformed the S&P last year, and apparently bested the returns Mr. Buffett made from his own investing activities at Berkshire by a lot.

If such humiliating comparisons continue, I’ll have no choice but to cease talking about them, Mr. Buffett jokes.

Mr. Buffett has said previously that the two men will handle all the investing duties for Berkshire when hes no longer running the show. Notably, he reports that each is now managing a portfolio with more than $7 billion in assets. Thats up from the roughly $5 billion mentioned in last years letter.

The bottom of page 8 includes the annual shout-out to Ajit Jain, Mr. Buffetts insurance lietenant and the man that many Buffett-watchers believe is the leading candidate to be the next CEO of Berkshire . This year, Mr. Buffett describes Mr. Jains prodigious mind as an idea factory that is always looking for more lines of business he can add to his current assortment.

In 2013, Mr. Jain was instrumental in creating a new insurance division at Berkshire that focuses on business insurance. On page nine, Mr. Buffett heaps praise on Peter Eastwood, the head of the new unit, a high-profile defection from American International Group Inc.

Peter has assembled a spectacular team that is already writing a substantial amount of business with many Fortune 500 companies and with smaller operations as well, Mr. Buffett writes. The new unit will be a major asset for Berkshire, one that will generate volume in the billions within a few years, he promises.

9:08 am
• Still Content With Small Prey or Bolt-on Deals
• by Maureen Farrell Edit Add a Comment

Warren Buffett is still hunting elephants, he said, but in the 2013 letter, he wrote much more about bolt-on acquisitions or the hunt for smaller prey to beef up Berkshire Hathaway’s existing portfolio of companies.

Last year, Buffett said that Berkshire Hathaway made 25 such additions to its existing portfolio of companies spending $3.1 billion in aggregate for them.

“Charlie and I encourage these deals,” he wrote, referring to Berkshire’s vice chairman Charlie Munger. “The result is no more work for us and more earnings for you. Many more of these bolt-on deals will be made in future years. In aggregate they will be meaningful.”

Compared to the 25 small, bolt-on deals, Berkshire Hathaway made just two mega-deals last year: financing roughly half of the $23.6 billion buyout of H.J. Heinz Co. and buying all of NV Energy. Mr. Buffett noted that he spent $18 billion on those two acquisitions.

NV Energy, for which Berkshire spent $5.6 billion, was  also an add-on to an existing company MidAmerican Energy, Berkshires utility subsidiary. NV Energy, Mr. Buffett noted, offers many possibilities for large investments in renewable energy. He specifically called this area one where there will be more major acquisitions.

In previous letters, Mr. Buffett has talked much more specifically about his hunger for big buyouts.

A chart of Berkshire’ top equity holdings on page 16 includes mentions of three investments that don’t get a lot of attention: Munich Re, Sanofi, and Tesco PLC. They’re his three largest holdings of overseas stocks.

Mr. Buffett must disclose Berkshire’s holdings of U.S. equities every quarter, but sometimes can go a year before revealing moves in his largest international holdings. Comparing to last year’s chart, we can see that the Sanofi and Tesco stakes fell and Munich Re was unchanged.

The Tesco decline was previously reported . but we believe the smaller drop in Sanofi hadn’t been disclosed before now. (This chart is a broader look that we normally get of his holding of Sanofi ADRs, a U.S. investment that’s disclosed quarterly.) Please let us know in the comments if we’re wrong about this being new info.

In addition, Berkshire no longer lists POSCO, a massive Korean steelmaker, among its top holdings. Berkshire owned 5.1% of the company a year ago. Again, were not sure if this is entirely new information. But it may mean that Berkshire has exited the position.

9:43 am
• Still Regrets Investment in Largest PE Buyout Ever
• by Maureen Farrell Edit Add a Comment

In this years letter, Mr. Buffett once again discussed his mistaken investment in Energy Future Holdings. The Texas utility is on the verge of filing for bankruptcy, as the WSJ has reported and Mr. Buffett notes.

Its a rare miss for Mr. Buffett, and in this letter, he admits that he didnt consult his partner Charlie Munger on his decision before he spent $2 billion on Energy Futures bonds in 2007. Berkshire Hathaway ultimately suffered a pre-tax loss of $873 million when it sold the entire stake last year, Mr. Buffett said.

Most of you have never heard of Energy Future Holdings. Consider yourselves lucky; I wish I hadnt, he wrote.

This isnt the first time Mr. Buffett has bemoaned this investment in an annual letter. In his 2011 letter, he wrote: In tennis parlance, this was a major unforced error by your chairman.

Like Energy Future Holdings PE buyers, including KKR and TPG, Mr. Buffett was erroneously bullish on the price of natural gas. The investment, the largest private-equity buyout in history, was predicated on the continued rise in natural gas prices. Mr. Buffett who constantly touts the unending innovation of American companies didnt foresee what a role American companies would play in increasing domestic natural gas supplies.

After that comes a lengthy section that was excerpted earlier this week in Fortune . It gives investors four long-term investing tips. The upshot: “Ignore the chatter, keep your costs minimal, and invest in stocks as you would a farm.”

You can read more about it here.

Then comes the long pitch for Berkshires annual meeting in May, a widely attended event thats often called Woodstock for Capitalists Buffett reveals on page 23 that hes again looking for a credentialed bear to ask him skeptical questions about Berkshire. This was something he began last year, when Doug Kass of Seabreeze Partners Management Inc. did the honors .

Mr. Buffett says applicants to fill the role should please include evidence of your position.

Warren Buffett’s annual goal is to beat the S&P 500.

In 2013, he again fell short of that goal. Berkshire’s book value increased 18.2% in 2013, trailing the 32.4% return of the benchmark S&P 500. Si nce 2009, Berkshire’s book value has increased more than the return of the S&P only once (2011), according to Berkshire’s annual report.

Since 1965, Buffett has beaten the index 39 times.

Near the end of his annual letter, Mr. Buffett pens a few graphs on his worries about the accelerating dangers of local and state financial problems. Pensions, he says, have become a gigantic financial tapeworm because public entities promised pensions they couldnt afford.

During the next decade, you will read a lot of news bad news about public pension plans, Mr. Buffett wrote.

Most Americans dont understand the math behind pensions, Mr. Buffett wrote. In his letter, he points to 18 pages (pages 118-136) in his annual report where hes reproduced a memo he wrote in 1975 to Katharine Graham, the then-chairman of the Washington Post Company, about the pitfalls of pension promises.

And thats it for the letter.

It was rather uneventful this year. That was thanks in part to the fact that a good chunkprobably the best chunk for people who are interested more in Mr. Buffett than Berkshireshowed up in Fortune in advance.

Still, it was true to form. There was praise for Berkshires executives, some self-depreciation, a review of Berkshires operations, and a repeat of some favorite jokes.