Viking

Vinod, for me what a company does with its retained earnings is a super important part of the decision to own shares. Berkshire carrying +$100 billion in cash (more than 20% of its market cap) every year is simply not an effective use of cash and Buffett has said as much. I would love for them to demonstrate they are serious about using meaningful amounts of cash to buy back shares (not all the time but certainly at times when the shares get cheap and they are sitting on too much cash with few opportunities in sight... like perhaps now). If this process starts when Buffett is still around then we should be able to safely assume it will continue when Buffett is gone. In my mind this also makes the decision easier to be a long term shareholder (post Buffett).

He then goes on to say this about buybacks: Call me crazy, but that sounds to me like reluctance to buy back in size when he was providing investors with per-share book value as the metric to be used to calculate intrinsic value. I think this is him telegraphing that he is now open to large buybacks, now that potential sellers have been "warned". Wisowis, i think you have nailed it. In the past Berkshire has pretty much NEVER bought back much stock; even when the shares were dirt cheap. However, i think this will now change in the future. More importantly, i think Buffett finally is ok with Berkshire making significant purchases of shares. But for this to happen, Buffett first felt he needed to do a couple of things: 1.) remove the handcuffs he has self imposed: In the past Buffett has said BRK might buy back stock when it trades at a certain price level to book value (1.2 then 1.4). In this letter he shreds this commitment. He says BV is no longer a good measure to use when valuing BRK; this is a massive change for Buffett and BRK. Now Berkshire will buy shares when they feel they are cheap and shareholders will find out when quarterly results are published; no longer being constrained to only re-purchase when the stock drops below a pre-specified price to book amount is a big benefit to BRK. And what is cheap? Whatever Berkshire decides. 2.) provide current shareholders with an updated way to properly value the company: he spends a great deal of the current letter doing this and he lays it out quitewell. I am sure there is a reason for this. Buffett did not repurchase in Q4 because he first wanted to communicate Berkshire’s new philosophy in the Feb shareholder letter, which was probably written before the Dec meltdown. Buffett always looks longterm; the stock will get cheap again and now he will have no self imposed constraints on when to buy back shares. And, perhaps most importantly, Buffett has now gone out of his way to ‘warn’ or ‘inform’ investors. If they sell and Berkshire subsequently buys back a big amount of shares and this leads to a higher share price they cannot blame Berkshire for not being transparent.

A key take-away for me was Buffett’s summary of lower taxes and the impact on BRK. This was a major one time boost to BRK value and looks to me to have been largely shrugged off by Mr Market. This also may mean that Buffett’s current intrinsic value calculation is much higher than people estimate. From Page 7: “Begin with an economic reality: Like it or not, the U.S. Government “owns” an interest in Berkshire’s earnings of a size determined by Congress. In effect, our country’s Treasury Department holds a special class of our stock – call this holding the AA shares – that receives large “dividends” (that is, tax payments) from Berkshire. In 2017, as in many years before, the corporate tax rate was 35%, which meant that the Treasury was doing very well with its AA shares. Indeed, the Treasury’s “stock,” which was paying nothing when we took over in 1965, had evolved into a holding that delivered billions of dollars annually to the federal government. Last year, however, 40% of the government’s “ownership” (14/35ths) was returned to Berkshire – free of charge – when the corporate tax rate was reduced to 21%. Consequently, our “A” and “B” shareholders received a major boost in the earnings attributable to their shares. This happening materially increased the intrinsic value of the Berkshire shares you and I own. The same dynamic, moreover, enhanced the intrinsic value of almost all of the stocks Berkshire holds.”

True. But FFH growing book value in a meaningful way (which will then drive the stock price) is tied to them being positioned correctly with their investment portfolio. The company recently completely reversed their investment orientation and expressed a great deal of optomism in the future with Trump as President. They are not short term thinkers so they must have thought stocks had many years of solid returns ahead. 2018 was not a good year for financial markets. With the global economy slowing, including the US, 2019 might be another tough year for financial markets. If so, this will be a continuing headwind for FFH.

“Book value per basic share at December 31, 2018 was $432.46 compared to $449.55 at December 31, 2017 (a decrease of 1.5% adjusted for the $10 per common share dividend paid in the first quarter of 2018).” Investment results continue to drag on results. I wonder if they remain as bullish on Trump and still expect great things from equities the next couple of years.

Holding period is a key. If you are planning on living in the same area for the next 10 or more years then buying at historically high prices might make sense. However, if you might want to move then buying today does carry risks. If you buy in Vancouver or Toronto today and prices fall 10 or 15% over the next couple of years (certainly possible) and then you are offered a promotion at work but have to change cities then you will need to sell your place and realize your loss. This happened to some people in the late 80’s.

I am pretty sure that Canada’s population grow rate has actually been slowing every decade since confederation in 1867. We have had a housing boom since 2000. Something has happened in the past +18 years to drive this. Has population growth spiked? No. What then? 1.) mortgage rates: went as high as 20% in the early 80’s and have fallen steadily to about 2.5% today. Inflation is running about 2%. When you have free money it normally results in asset bubbles (financial assets and housing). 2.) China factor: wealthy Chinese looking to get part of their net worth out of China (Huawei COO owns a house in Vancouver); given current chill in relations with China and Canada this may slow for a while. Bottom line, housing is not affordable for average family in Vancouver or Toronto. And, yes, there is a chance that this is the new normal (permanently higher pricing). Time will tell.

It seems the BC and Federal gov'ts have done what needs to be done to end this bubble. I hope they have the guts to let it die. I expect the boomers will be agitating soon... Right now all the policy dicussion is around how to make housing more affordable. The flip side of this is people who currently own homes do not want to see them go down in value (boomers) as they likely see their home equity as their retirement nest egg. Vancouver real estate is in a wickedly difficult situation and it is going to be very interesting to see how it plays out in 2019. Interest rates look headed lower; my read is global deflationary forces are starting to overwhelm the strength of the US economy. Lower interest rates and a resumption of QE will likely allow governments to kick the can down the road a little longer. I am wondering if all the talk about much higher US rates last year (Gundlach and others) was just not a head fake and we have seen the peak in interest rates for this cycle. Not good if true.

Real estate stats for Greater Vancouver for January are out and they are ugly. If supply continues to build in the coming months and pricing continues to soften we could be seeing the end of the great housing bubble in Canada (Vancouver anyways). Year over year, inventory up 56% and prices (for detached houses) down 9%. The threat of missing out (as prices go continually higher) may be shifting to fear of trying to catch a falling knife (as prices go lower) which may slow sales even more. Real Estate Board of GV: https://www.rebgv.org/market-watch/monthly-market-report/january-2019.html And we have a Federal election this fall. What is a politician to do? Loosten mortgage rules (allow 30 year amortizations for first time buyers so young people can ‘afford’ that + $1 million home by taking on an obsene amount of debt). https://www.theglobeandmail.com/politics/article-morneau-taking-close-look-at-return-to-30-year-insured-mortgages/ Some highlights: Supply is continuing to build - The total number of homes currently listed for sale on the MLS® system in Metro Vancouver is 10,808, a 55.6 per cent increase compared to January 2018 (6,947) Prices are starting to fall - Sales of detached homes in January 2019 reached 339, a 30.4 per cent decrease from the 487 detached sales recorded in January 2018. The benchmark price for detached homes is $1,453,400. This represents a 9.1 per cent decrease from January 2018, and an 8.3 per cent decrease over the past six months. Australia also seems to be having its own housing correction...

Shalab, the biggest driver of wealth in Canada since 2000 is the housing bubble. Real estate has fuelled a great deal of proserity in Canada over the past 18 years. 1.) People’s net worth is at record highs; this has allowed for higher consumer spending (i know of many people who are spending part of their housing gain via their line of credit). 2.) government tax revenues from housing are at all time highs (property purchase tax, taxes on real estate commissions etc). 3.) employment in real estate related parts of the economy is at record levels (as a % of GDP); these sectors pay very good wages. Look at US prosperity in 2005 and 2006. Their economy was booming. But evaluating how ‘successful’ the US was with its economy and even family wealth at that time would have been a mistake (as i am sure lots of people were sitting on significant unrealized real estate gains when calculating at their net worth); we all saw what happened to US consumers and their economy in 2008-12. We sill see how Canada fairs in the coming years. Similar to Cardboard, i have my concerns. I think bubbles can be identified; however, it is impossible to predict the timing of when they will pop.

It will be very interesting to see what they have done with the $100 billion in cash in Q4. I think the most likely meaningful stock purchases are JPM and AAPL (however, the downside with Apple is it is already such a large part of BRK that it now influences the price of BRK; i am sure Buffett does not want the price of BRK to be too closely tied to fortunes of AAPL). An update of buybacks will also be good. If it has simply grown by another $7-8 billion (with no meaningful purchases) that will be disappointing. Although i think it is fair to say winter is coming and stocks and businesses will likely be going on sale at some point in the next 12-24 months (perhaps fire sale).

Another interesting tidbit of information. It really is amazing the amount of cash BRK and Apple are sitting on. And the US financials are over capitalized, unable to aquire, and forced to return +100% of earnings to shareholders. Clearly, Buffett is hot for companies that are cash machines and return most of it to shareholders in a tax efficient way (while still growing their businesses). BRK has about $100 billion in net cash; about 20% of its market cap ($489 billion). It is generating about $25 billion in free cash flow per year. It recently raised the threshold for stock buybacks. Buffett really does need to find a use for this excess cash. BRK’s single largest equity position (worth $40 billion), Apple has $130 billion in net cash and a market cap of about $740 billion. It is earning about $55-60 billion per year. It is already buying back significant stock and this will continue. (It says it wants to get to cash neutral down the road). It is paying a dividend that is currently yielding 2%. Stock buyback = +5%? This is yielding Berkshire a total return of +7% in a very tax efficient way. Year after year. BRK’s largest equity group (worth $80 billion), the big US banks have lots of excess capital and as a result will be buying back 5-7% of shares outstanding over the next year. They all pay solid dividends in the 2-3% range. This is yielding BRK a total return of 8-10% in a very tax efficient way. Year after year. So Apple and Financials, worth about $120 billion, will be yielding BRK about 8% or $9.6 billion per year moving forward. In a very tax efficient way. Looks like Buffett likes buying cash machines that return it to shareholders mostly via buybacks and dividends. Oh, and these businesses continue to grow their top line and total profits.

Here are my guesses for BRK underperformance YTD: 1.) AAPL and financials big price decline in Q4 and upcoming substantial hit to Berkshire BV when year end results are reported in Feb. Headline will be ugly. 2.) AAPL profit warning (caused immediate decline in BRK) and concern about AAPL results going forward and potential impact on Berkshire BV. 3.) flight to safety reversing: as thepupil mentioned, BRK dramatically outperformed in the Dec panic, and now it is underperforming as investors shift to riskier stocks. The good news: 1.) since the start of the year, financials are on fire and we all know they are twice the size of AAPL in the BRK portfolio. 2.) AAPL, re-priced in the portfolio at $155, is now cheapish. It could go a little lower but the big decline is behind us. At some point in the next year or two Apple will launch a must have phone and when they do sales and profit will hit new records and the company will be valued over a billion $. At $155 this is a great long term hold for BRK. Having said that, i do think 2019 could be a very difficult year for Apple. China may be a big problem, and may persist for a year or two. And the current lineup of iPhone’s looks uninspiring with the result that people will hold on to their current phone a little longer on average (which will impact unit sales and profits. Fortunately, Apple does have a pretty good track record of recognizing mistakes with the iPhone lineup and making the proper course corrections the following year. 3.) at the end of Q3 BRK had $100 billion in cash. BRK bought $25 billion in stocks in Q3. With the decline in stocks in Q4 i would expect more than $25 billion in new stock purchases in Q4. Perhaps big additions to APPL, JPM etc. If so, this will meaningfully increase earnings power of company. 4.) BRK buying back its own stock: I expect more commentary from Buffett about this in this years annual letter. Given the size of APPL and financials, and the investment portfolio in general, we could see large swings in BV from quarter to quarter. Buffett has his own idea of intrinsic value of BRK and it obviously doesnot swing so dramatically quarter to quarter. Perhaps we will see BRK buy back its own stock at 1.4x BV when it feels the stock portfolio is being undervalued by Mr Market (resulting in BV being understated). 5.) as the US banks have communicated, the US consumer and economy continues to perform well. We can expect the Berkshire op co’s to report very strong results. 6.) tax reform: BRK was one of the big winners and the benefits of tax reform will continue into future years. The stock price today is trading close to where it was trading in Nov of 2017 when tax reform was being discussed. Bottom line is it does not look to me like Mr Market Is valuing Berkshire higher even though its future after tax earnings will be much higher as a result of tax reform. 7.) long term bond yields look like they have peaked and may be headed lower. All things being equal this will allow for a higher PE to be attached to stocks (in general). 8.) as volatility returns to the market, Mr Market may start to value ‘stalwart’ (bond like) stocks like BRK a little higher. 9.) insider buying: $20 million purchase by Jain in Dec likely around $192 is encouraging. BRK looks attractively priced at current levels. I buy it in place of holding a bond. When it runs up 5-7% i am happy to sell. Rinse and repeat.

At the end of the day you need to find a strategy that lets you sleep well at night (and have great relationships). You may find that what you have learned in the past will help you at some point in the future. Best of luck on your journey :-)

GOOG. 3 or 4 years from now he will look like a genius :-)

I recently established a position in BRK. Price is ok; not crazy cheap and not crazy expensive. I like its defensive nature (should outperform when markets sell off again). At current prices, I like Apple and the big US banks; holding BRK gives me some exposure to companies i like for the long term. Buffett having $100 billion in cash also appeals to me right now; my guess is he will make a couple of large purchases over the next year or two. I would love to see them buy a chunk of GOOG if we get another big sell off. Main risk is Buffett’s age.

Calculated Risk is my favourite go to for US economic information. Here is the link to his 2019 forecasts: https://www.calculatedriskblog.com/2018/12/ten-economic-questions-for-2019.html Here is a link to a review of his 2018 forecasts. Pretty accurate. - https://www.calculatedriskblog.com/2018/12/review-ten-economic-questions-for-2018.html

Well said. I have stayed away from Fairfax for years because of different reasons. Today: 1.) their brand of value investing (more Ben Graham - cheap - than Buffett - cheapish quality) 2.) Prem is too promotional in communication 3.) extra cash will likely be used to buy back minority stakes in subs 4.) managements focus does not appear to be shareholders, but rather empire building Having said all that, i do have Fairfax on a watch list. I am very impressed with the insurance side of the business they have built over the years. And yes, Bradstreet/bond investing has been very good.

No-free-lunch, i agree with your comments about Lynch and Buffett. I think the overlay is every investors situation is different and they therefore need to modify the teachings of the masters to fit their personal situation so it is a good fit. Canadian author David Chilton also says that wherever strategy you employ, it must allow you to sleep well at night. Lynch also says that you should own cyclicals at the start of an economic cycle, not the end.

Sorry for the updates to this post; my thumb posted it before i was done with my thoughts :-) Since February of 2018 the financial markets have been steadily weakening. However, i have been focussed on the strength of the US economy. All of the leading indicators were not even on recession watch. So i remained 100% invested, heavily skewed to US banks. I was also focussed on 10 year US treasuries, which peaked out at 3.3%, which supported the idea that the US economy was doing well. The economic data coming out of the US recently looks to be to be now flashing yellow (no recession imminent but things are trending in the wrong direction). - ISM Manufacturing Index Decreases Sharply to 54 in December: https://www.calculatedriskblog.com/2019/01/ism-manufacturing-index-decreased.html The 10 year US bond is now trading at 2.57%, which is not healthy. The bottom line is it looks like the US economy has turned (growth slowing) and the data coming out will now show declining numbers with risk to the downside. Weakness in China looks to be getting worse: https://www.theguardian.com/business/2019/jan/02/stock-markets-dive-china-manufacturing-contracts-ftse-wall-street-us-economy-business-bleak-start-to-2019 Europe is not great. Italy is a mess. The UK is a mess. Trade wars add to the complexity (and the risks). Politically, populism is just getting started; as economies slow and enter recession it makes sense to me workers will not be so patient. Politicians will fan the flames to get reelected. Nationalism will be a natural outcome. The 1930’s can perhaps provide some insight. In Washington we have a President that i have little confidence in (to be able to handle a crisis in the proper way). This simply increases the risk of a bad situation getting worse. Bottom line, i have been increasing my cash weighting. Capital preservation is more important to me in the current environment than return. I guess what i am really asking is can things get worse from here? Is this the bottom? Or are we only in the early innings of this 9 inning game? My read is we are perhaps only 33% of the way though this current weakness in financial markets (with another year or two of turbulence ahead). PS: Gundlach does his annual forecast presentation on Jan 8 and he will be going over all the US data. https://doubleline.com/latest-webcasts/

In your view, is anything at a "fire sale" price right now? If so, which companies? After Christmas I purchased BAM, AAPL, JPM, FDX and a smaller amount of GS I would love to add GOOG (below $1,000), DIS (below $103) and BRK (below $195). Facebook and Fairfax are also on my watch list.

Finished the year at -3.7%; first negative year in last 15. Not a great year to be way overweight US banks. Could have been much worse. The silver lining is there are many well run and profitable companies trading at what look to be very readonable valuations (which bodes well for 2019 returns). My big learning is to pay a little more attention to where we are in the economic cycle and modify my portfolio accordingly. My guess is the volatility we saw in 2018 will continue into 2019. The big changes are: 1.) on strength (when market gets optomistic) build cash 2.) on weakness (when market gets pessimistic) buy best in class large caps

Have cash to take advantage of market dislocations. It looks to me like the easy money has been made from the 10 year bull market in stocks and 30 year bull market in bonds. If Druckenmiller is right and liquidity matters (and is contracting) we should see continued volatility in stocks and bonds (perhaps similar to 2018). Having cash to take advantage of fire sale prices would be ideal. To keep this strategy working it will also be important to rebuild cash reserves on strength. Rinse and repeat.

Happy holidays to everyone... lots to be thankful for :-)

Agreed. Right now Mr. Market is very pessimistic. Why? Not really sure. The stock market's ability to predict the future is less than stellar. The bond market, with 10 year US yields at 2.79%, does not look overly fussed (and I think the bond market is a much better predictor than the stock market of what may be going on in the general economy). Perhaps the ending and reversing of QE is having a much, much bigger impact on financial assets (especially the stock market) than most understand or recognize. Perhaps the current sell off in stocks has little to do with trade wars or slowing economies.