Berkshire Letter Highlights: Shocking $25BN Loss; Buffet Bashes "Deficit Doomsayers", Emerges As Closet "Austrian"

In its latest (surprisingly short at just 14 pages) annual letter released at 8am on Saturday, Warren Buffett’s Berkshire Hathaway shocked investors when it announced that Q4 net earnings plunged to a $25.4 billion loss, or ($15,457) per share, from a $32.6 billion profit, or $19,790 per share a year prior, due to an unexpected write-down at Kraft Heinz and unrealized investment losses even as revenues increased from $58.8 billion to $63.7 billion for the fourth quarter, while operating earnings increased from $3.33 billion to $5.72 billion due to increased earnings from Berkshire’s railroads, energy business and other segments.

For the full year, Berkshire earned just $4.0 billion in GAAP profits, down 90% from $45 billion the previous year, prompting the WSJ to describe this as "one of Buffett's worst years ever." Separately, in 2018 revenue increased 3% to $247.8 billion, while operating earnings hit a record $24.8 billion. As a reminder, Berkshire’s 2017 earnings soared in the fourth quarter of 2017 due to changes in the U.S. tax law that lowered Berkshire’s deferred tax obligations for stock investments that it currently holds.


What was behind the company's sharp drop in 2018 earnings, and the massive Q4 net loss? Think of it as the quarter-end marking-to-market of Buffett's massive equity holdings, coupled with the "unexpected" write-down at Kraft Heinz .

As Buffett explains in his letter, the components of that $4.0 billion full year net earnings figure were $24.8 billion in operating earnings, a $3.0 billion non-cash loss from an impairment of intangible assets (arising from Berkshire's equity interest in Kraft Heinz which as duly noted here before plunged to an all time low on Friday after a perfect storm of negative news), $2.8 billion in realized capital gains from the sale of investment securities and most notably a $20.6 billion loss from a reduction in the amount of unrealized capital gains that existed in our investment holdings. Similarly, for the eye-popping $25 billion net loss in the fourth quarter, it was driven by $27.6 billion in unrealized losses from the investment portfolio.

Why is this unrealized loss appearing now: as Buffett explains, "a new GAAP rule requires us to include that last item in earnings. As I emphasized in the 2017 annual report, neither Berkshire’s Vice Chairman, Charlie Munger, nor I believe that rule to be sensible. Rather, both of us have consistently thought that at Berkshire this mark-to-market change would produce what I described as “wild and capricious swings in our bottom line."

A note on Kraft Heinz: the company contributed a $2.7 billion loss to Berkshire in 2018, compared to adding $2.9 billion to its earnings in 2017; Kraft Heinz on Thursday wrote down the value of some of its biggest brands, disclosed an investigation by federal securities regulators and slashed its dividend, sending its stock tumbling.

Lashing out at the new GAAP requirement, Buffett contrasts the wild fluctuations in the bottom line with the steady moves in operating profits:

in the first and fourth quarters, we reported GAAP losses of $1.1 billion and $25.4 billion respectively. In the second and third quarters, we reported profits of $12 billion and $18.5 billion. In complete contrast to these gyrations, the many businesses that Berkshire owns delivered consistent and satisfactory operating earnings in all quarters. For the year, those earnings exceeded their 2016 high of $17.6 billion by 41%.

Buffett then warns that the swings in its quarterly GAAP earnings will "inevitably continue" largely due to because of the company's "huge equity portfolio – valued at nearly $173 billion at the end of 2018 "which will often experience one-day price fluctuations of $2 billion or more, "all of which the new rule says must be dropped immediately to our bottom line."

Indeed, in the fourth quarter, a period of high volatility in stock prices,we experienced several days with a “profit” or “loss” of more than $4 billion.

How about that for daily trading swings?

Buffett's advice on how to reconcile these numbers? Simple: just ignore the massive MTM losses and "focus on operating earnings, paying little attention to gains or losses of any variety. My saying that in no way diminishes the importance of our investments to Berkshire. Over time, Charlie and I expect them to deliver substantial gains, albeit with highly irregular timing."

And while Buffett has traditionally encouraged shareholders to pay attention to Berkshire’s book value over its market value, he said in the letter that market value is now the more relevant metric. In other words, after railing against non-GAAP, Buffett would be delighted if he could present his own GAAP net income as a non- GAAP number.

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