omagh

https://www.barrons.com/articles/warren-buffett-berkshire-hathaway-tax-51673028329?mod=hp_DAY_0 Berkshire Hathaway Could Face a Big Tax Hit if the Bull Market Resumes ... Ever since a 15% corporate minimum tax was included in the Inflation Reduction Act in 2022, there has been uncertainty about whether corporations would owe taxes on paper profits, or unrealized capital gains, on stocks starting this year. The treatment has long been that these paper profits created a deferred tax liability that is only paid when the stocks are sold, and the profits realized. Berkshire Hathaway (ticker: BRKb ) probably has the most at stake, and faces the biggest potential tax bill among U.S. corporations since its equity portfolio is so large—more than $300 billion. It has periodically had big unrealized gains in the portfolio, including $58.6 billion in 2021, and $26.8 billion in 2020. Recent guidance from the Internal Revenue Service, while not definitive, suggests that paper profits on stocks could be subject to a 15% tax this year, according to New York tax expert Robert Willens. The issue involves the tax treatment of applicable financial statement income (AFSI), a measure of earnings. “The IRS left open the question of whether ‘mark to market’ gains and losses should be disregarded when computing AFSI,” Willens wrote to Barron’s in an email. “As of now, they are included in AFSI. The IRS solicited the comments of investors as to whether these gains and losses should be backed out of AFSI or whether they should remain in the tax base. My guess is that they will remain in AFSI, potentially exposing Berkshire to a massive amount of book minimum tax.” ...

Seems like some magical thinking -- somebody pays for lunch and the government gets paid. ETFs have some tax avoidance workarounds through some creative structures that effectively defer most taxes until sale of the ETF by the holder. The workaround for ETFs is that they can exchange shares amongst themselves without conversion to cash - the taxable event. Payment is done in delivered shares avoiding taxation. This helps deal with underlying index churn and securities turnover. So, that works well in highly liquid markets, but in less liquid markets, and in severe market dislocations, conversion to cash is a reality. Nobody talks about the black swan case in these typical articles which are thinly disguised marketing pitches. Some ETFs use leverage and options which invokes different short/long term capital gains taxation. https://www.jhinvestments.com/viewpoints/etfs/creation-and-redemption-etfs-secret-sauce-explained But, in the end, if there is a capital gain distribution, the ETF investor is still responsible for the cap gain taxes annually. https://www.fidelity.com/learning-center/investment-products/etf/tax-basics-etfs Distributions. Both mutual funds and ETFs generally are required to distribute capital gains to investors, which can potentially result in a significant tax cost annually. Dividends. ETF dividends are taxed according to how long the investor has owned the ETF fund. If the investor has held the fund for more than 60 days before the dividend was issued, the dividend is considered a “qualified dividend” and is taxed anywhere from 0% to 20% depending on the investor’s income tax rate. If the dividend was held less than 60 days before the dividend was issued, then the dividend income is taxed at the investor’s ordinary income tax rate. This is similar to how mutual fund dividends are treated.

Phil Fisher gave a 1987 interview. Would love to find the original if anyone has it. https://investmenttalk.substack.com/p/a-rare-interview-with-phil-fisher?r=i1bs On the circle of competence: “I think a weakness of many people’s approach to investment is that they try to be jacks of all trades and masters of none.” On management: “Getting to know the management of a company is like getting married. You never really know the girl until you live with her. Until you’ve lived with a management, you don’t really know them to that same degree.” On waiting for big payoffs: "I don’t want to spend my time trying to earn a lot of little profits. I want very, very big profits that I’m ready to wait for." On avoiding stock market favourites: “Nor will I buy market-favored stocks. I particularly notice it when I attend meetings for technology stocks and see all the people crowding into the room and so on. If there’s standing room only, that’s usually a pretty fair sign it’s not a good time to buy the stock.” On retirement, as a then 80-year old: “I could wax for a half-hour on the utter folly of people being forced to retire at the age of 65. I think I have produced better results in the last five years than in any other five-year period. The refinement that comes from contemplating your own mistakes and improving yourself has continued. I have seen enough people start to go senile as they get older that if it should happen to me, with my responsibilities, I would cut myself off. But unless that happens, I think it’s ridiculous to stop the work I enjoy.”

@uncommonprofits DD - With inflation picking up after a period in which governments were giving people COVID money and also making the cost of money effectively zero to encourage borrowing, this post has stood up well. Now we're in for a period of belt tightening and working off the excesses.

To Munger's point, there's a constant tax bill with holding the SP500 index whereas Berkshire is a buy-and-hold-forever. So buying SP500 and selling after 10 years incurs taxes each year and taxes at year 10 whereas the same scenario for BRK would incur taxes only in year 10. I'm purposely ignoring dividends which are a wash. BRK's float leverage would amplify the amount of taxes paid. That structural difference will add up over longer periods of time (10 years or more). https://www.businessinsider.com/sp-500-index-constituent-turnover-2015-6?op=1 Among other things, Parker points out that the makeup of indexes like the S&P 500 is constantly evolving. "One of the main items that changes over time in the S&P500 is the actual constituents of the index," Parker writes. "While there has been relatively less turnover lately, with only 3% of the companies changing since 2013, the cumulative effect of adding and subtracting companies is surprisingly substantial. Ten percent of the companies in today's index are different since 2011, 17% are different since 2009, and fully half the companies are different since 1999. Said another way, at least half the companies in the S&P500 today were not in the S&P500 when your average portfolio manager started running a portfolio." To put it another way, there is a healthy amount of trading going on in the S&P 500. Parker charted the number of companies that have been added each year since 1965. "On average, 22 companies, or 4.4%, are added to or removed from the index each year," Parker wrote.

Buffett is on point in the video. Let's not forget that rail assets are depreciated over a fixed number of years but have asset life that extends well beyond the depreciation period. Most of BNSF's capex in this cycle is done. Furthermore, most of these assets aren't replicable and in an inflationary period, their replicability becomes an even larger hurdle. BHE as a regulated provider can earn a regulated margin above cost which is passed on to the consumer. BHE has ready access to capital (from its parent) and won't be starved out should capital become scarcer (inflation) and will continue to have a lower cost of capital than its competitors (borrows from parent's credit rating). Most of BRK's companies are franchises with moats and provide necessary goods/services. They have some degree of pricing power that will become more evident in an inflationary period. I sleep well.

@Swedish_Compounder Great point that you make here! There are probably a few other factors to consider... https://static.fmgsuite.com/media/documents/2bde00e4-7037-4c39-beb8-9946b2b2dce3.pdf (page 104 onward) Chris Bloomstran suggested that BRK's cash balances are roughly in line with historical levels (~15% of assets). It's doubtful that BRK would have allocated 4-5% annually without giving up some other capital allocation choices. At present, BRK seems to be allocating the remainder of operating earnings less growth capex to share repurchases (per Bloomstran on a podcast if I recall correctly). So, a dip in operating earnings likely means a dip in buybacks. As well, any acquisitions would eat into the available capital and may further eat into any share repurchases. It's very likely that acquisitions would be done in preference to share repurchases. Let's not forget as well, that BRK has the largest asset base in the SP500 which has come about by a combination of acquisitions and growth capex. I've made the point before that the market is underestimating the compounding story in BRK, so it will be a band of stability and (somewhat) unexpected growth in the portfolio for those who hold.

@gfp It doesn't change the narrative. The $51B is the amount repurchased since they started in quantity which for context is more than they spent on AAPL shares. For those who care about the trees instead of the forest, here you go... https://ycharts.com/companies/BRK.B/stock_buyback https://www.barrons.com/articles/berkshire-hathaway-stock-price-earnings-51636202458 Berkshire continued to repurchase stock in October, buying back $1.8 billion of shares from Sept. 30 through Oct. 27, the date of the 10-Q report, Barron’s estimates. Buffett prefers buybacks to dividends; the company doesn’t pay a dividend. Berkshire has repurchased about 1% of its outstanding shares during each quarter in 2021. Its current market value is around $648 billion. Berkshire has repurchased $20.2 billion of stock so far in 2021 and is on pace for about $27 billion for the full year, above the $24.7 billion repurchased in 2020.

Fairfax's approach is complicated compared to Berkshire's approach which is to use operating earnings to buyback shares. Imagine a Fairfax with an appropriate capital structure and you'll have a much better company. Imagine Berkshire having to sell part of National Indemnity or GenRe to allocate capital to buybacks...I'd rather not. Yet here we are with Fairfax selling OdysseyRe ownership to raise capital. Both BRK and FFH believe their shares are undervalued, so you can pick your own path. BRK has bought back $51B in 5 quarters. Check back to see how much FFH *actually* buys over the next 5 quarters.

The value transfer from outgoing shareholders to remaining shareholders is being widely underestimated. Here's hoping prices stay low for a while longer to allow that reverse compounding to really kick in. It's at $51B cash (outbound) + discounted intrinsic value (inbound) since the buybacks started in earnest as well as the earnings per share boost (5%) so far.

https://www.sec.gov/Archives/edgar/data/1709323/000170932321000005/xslForm13F_X01/13fq32021.xml https://dataroma.com/m/holdings.php?m=HC BRK.B - Berkshire Hathaway CL B 11.41 897,749 Buy $272.94 $245,032,000

Latest 13F is available here... https://www.sec.gov/Archives/edgar/data/915191/000110465921138402/xslForm13F_X01/a21-32105_1informationtable.xml

Chris Bloomstran posted his 3Q 2021 notes https://threadreaderapp.com/thread/1457045107765559296.html Berkshire Hathaway released its 3Q financials this morning. A few quick observations. Cash at $149.2B and share repurchases of $7.6B during 3Q and $20.2B through 9/30 will draw media headlines, but inflation is the real story, as is the case with so many companies of late. ... ... ... Despite $BRK shares outpacing major indices this year, the company will continue to draw criticism. Many expect a company with $472B in shareholder equity that earns a normalized ~10% on unleveraged equity capital to "beat the market" over all short and intermediate periods. 33/ With the S&P 500 trading at an earnings yield well below 5% and with margins at record highs, a bet against Berkshire's LONG-TERM continued outperformance is one I wouldn't take. Soundness looks silly at extremes of optimism. When capital suffers, Berkshire takes advantage.

15%...let's put some reality to that. http://financials.morningstar.com/balance-sheet/bs.html?t=FFH&region=can&culture=en-US So over the last 4 years, FFH compounded BV at 9%. Except that it issued $2.2B in equity capital after the first year, so excluding that capital raise, the BV compounded at a 4.4% rate. Per share values will be modestly higher than 4.4% but I'll leave that for someone with a calculator and ambition.

@bearprowler6 Thanks for the insight into your reasoning. Although it's a reasonable policy, it reminds me of macro investors who fear the next move by the Fed, an expected recession or a depression and hang back with their special insight into the future. We each have our own approaches to value investing and portfolio resiliency. I sleep well regardless of any extraneous events to either FFH or BABA.