What the experts want Warren Buffett to talk about in his annual Berkshire shareholders letter

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Posted: Wednesday, February 26, 2014 12:00 am

Why is Warren Buffett still investing in Wells Fargo?

How is his 50 percent ownership of H.J. Heinz Co. working out so far?

And will Berkshire Hathaway Inc. get back to its historical record of beating the stock market, after trailing between 2009 and 2013?

Answers to such questions might arrive Saturday when Buffett, chairman and CEO of Berkshire, issues his annual letter to shareholders of the Omaha-based conglomerate.

This week, Fortune magazine posted an essay by Buffett excerpted from the letter, but the rest is secret until it's posted on Berkshire's website Saturday morning. The chatty 25-page letter typically is followed by about 80 pages of accounting and legal details that make up Berkshire's annual report.

Many investors study the letters, and we asked some investment pros to give their takes on what they'd like him to discuss.

The pros: Patrick Brennan, co-chief investment officer for Hutchinson Capital Management in Marin, Calif.; Scott Thompson, managing director of Intrinsic Value Capital of Minneapolis; and Jason Hince, a financial adviser with RBC Capital Markets in Omaha.

This year's letter will note that for the first time, Berkshire had a smaller percentage gain in value over the past five years than the rest of the stock market. Each year, Buffett compares Berkshire's performance with the Standard & Poor's index of 500 stocks, which reflect the overall stock market.

For every five-year, rolling period for the past 43 years — 1988 to 1992, 1989 to 1993, 1990 to 1994, and so forth — Berkshire's value has gained a larger percentage than the S&P stocks'.

That streak ended in 2013 because the S&P outpaced Berkshire from 2009 to 2012 and again in 2013, following a steep decline in the stock market in 2008-09.

In last year's letter to shareholders, Buffett predicted the shortfall, explaining that because of its size and conservative financial position, Berkshire does much better than the stock market “when the wind is in our face,” meaning when the market is struggling or declining.

For the five-year periods since 2001, Berkshire beat the S&P benchmark by an average of 6.7 percentage points, with the biggest margin, 9.1 percentage points, in 2004-08 when the S&P stocks declined.

“In years when the market is particularly strong, expect us to fall short,” Buffett wrote last year, adding that he believes Berkshire's value will exceed S&P returns “by a small margin” over time.

Brennan, a California financial manager and former Omahan, said Buffett has been “incredibly upfront” about the challenge of beating the stock market and for years has cautioned shareholders that the “law of big numbers” works against Berkshire's annual gains.

“He needs elephants to move the needle,” Brennan said, meaning that it takes multibillion-dollar deals to make a substantial difference in Berkshire's performance.

“Value investors a lot of times trail the market as it goes up, but they make up for it by doing better in tougher markets,” Brennan said. “If there is another exogenous shock event, he's sitting on so much cash he'll probably get some more good opportunities to swing the bat.

“A lot of things in the world could go wrong. If they do, there are ramifications for stock prices. He's smarter than all of us, and having excess capital is a very good thing.”

Besides Berkshire's performance, Brennan said he'd like to see Buffett discuss the value of the five-year plan adopted by IBM that set goals for its revenue and profit by 2015. Berkshire owns $12.5 billion worth of IBM stock, and when he began buying shares in 2001, Buffett said he liked the company's business plan.

Brennan said he wonders whether Buffett thinks IBM should set another five-year goal. Does such a plan encourage short-term thinking as the five-year deadline draws near? Should other “mature, slow-growth” companies, such as Microsoft, adopt similar plans?

“He's clearly in this for a long period of time,” Brennan said, so it would be “pretty interesting” to hear Buffett's thoughts about IBM's strategy and long-term outlook in light of changes such as cloud computing, which is shifting software to the Internet rather than large on-site computers.

Brennan also said he'd like to hear Buffett's impression of John Malone, chairman of Liberty Media, especially since Buffett's two investment lieutenants, Ted Weschler and Todd Combs, apparently have been investing in Malone-related businesses such as DirecTV.

Malone uses a different system for allocating capital than Buffett, Brennan said, with more debt, more share repurchases and other practices different from Berkshire's traditional practices.

Malone has created “tremendous shareholder value” by spinning off some of his holdings, Brennan said, while Buffett keeps nearly all purchases within Berkshire. He said he'd like to know what Buffett thinks of the contrasting capital allocation styles.

Hince, the Omaha financial manager, said he wonders if Buffett's view of a global digital currency has changed since he commented last year on Bitcoin, an electronic “currency” created outside government as a medium of exchange.

At last year's meeting with shareholders, Buffett said, “I'll put it this way. Of our $49billion (in cash at Berkshire), we haven't moved any of it to Bitcoin.”

If not Bitcoin, Hince said, would some other type of digital currency save money for businesses by not having to convert currencies in international transactions? And would Berkshire consider creating a currency? Is currency management a source of revenue for Berkshire?

Thompson, the Minneapolis financial manager, said the letter probably will show that Berkshire's stock investments totaled about $105 billion at the end of 2013, up $13 billion from Sept. 30.

He said he would like to see Buffett comment on Berkshire's large investments, including Wells Fargo, Exxon Mobil Corp., Phillips 66 and IBM.

Wells Fargo is especially interesting because Buffett is still buying its shares and now holds about $21 billion in the banking company, Thompson said. Is that a bet that interest rates will rise and banks will get higher returns on their loans? But higher rates also will slow home sales and refinancing.

Buffett also may discuss his investment stake in Graham Holdings Co., the former owner of the Washington Post; the success of BNSF Corp.'s railroad operations; and the performance of Berkshire's insurance operations, Thompson said, as well as his foray into the housing market through a national network of Berkshire Hathaway real estate franchises.

The letter may give more detail about Buffett's decision last year to buy half of H.J. Heinz Co., with Brazilian hedge fund 3G Capital buying the other half. That decision, which took place just before the 2012 letter was published, took up $12 billion of Berkshire's cash, about the same amount of cash the company accumulated during 2012.

If such topics aren't covered in the letter, they might pop up during the five-hour question-and-answer session that Buffett and Vice Chairman Charlie Munger will host during Berkshire's annual shareholders meeting, May 3 at the CenturyLink Center Omaha.

The letter will give details about the meeting, which draws about 35,000 people to the official session and related events during the same weekend.

The Omaha World-Herald Co. is owned by Berkshire Hathaway Inc.

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