Buffett’s Annual Letter: Berkshire Records $29 Billion Gain From Tax Law

Berkshire Hathaway’s bottom line for 2017 got a big lift from the new tax law.

In an annual letter to Berkshire’s shareholders on Saturday, the company’s chief executive, Warren Buffett, said the conglomerate recorded a more than $29 billion gain related to the tax overhaul that became law in December.

He also said that a “purchasing frenzy” had raised deal prices to a level that the company could not stomach. That was why, he said, that Berkshire had largely avoided big acquisitions last year.

Here’s a look at some of the highlights from the letter:

Berkshire recorded a hefty windfall from the tax bill that Congress passed at the end of last year. The annual report said the tax overhaul produced a $29.6 billion gain that was offset slightly by $1.4 billion of tax payments on repatriated foreign earnings. The tax gain contributed nearly two-thirds of Berkshire’s $44.9 billion in net earnings for 2017.

Each year, Mr. Buffett highlights the change in Berkshire’s book value, a measure of the company’s net worth. The company’s book value rose by $65.3 billion to $358 billion in 2017, a 23 percent gain from $282 billion at the end of 2016. The tax benefit made up a hefty 45 percent of the book value increase. In commenting on the contribution from lower taxes, Mr. Buffett said: “The $65 billion gain is nonetheless real — rest assured of that.”

Mr. Buffett did not use his widely read shareholders’ letter to expand on his recent criticisms of certain types of tax cuts.

Purchasing frenzy. While Mr. Buffett didn’t say stocks were overvalued, as he has done in past letters, he did say that acquisitions have gotten too pricey.

One of main ways that Berkshire has grown over the years is by spending large sums to acquire other companies.

But the company hasn’t done a big deal for some time. While that may make it harder for Berkshire to grow, Mr. Buffett said acquisitions have to have “a sensible purchase price.” That requirement, he said, “proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.”

Cheap money. Mr. Buffett singled out a driver of the acquisition boom: Acquirers could borrow money at low interest rates to finance their deals. And he added, “At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low.”

Some investors in Berkshire may become impatient if it doesn’t do some big deals. But Mr. Buffett said he and Charles T. Munger, Berkshire’s vice chairman, were happy to sit on the sidelines:

Mr. Buffett has long set the goal of beating the Standard & Poor’s 500 index and in 2017, Berkshire did just that.

The company’s book value rose 23 percent, while its stock price climbed 21.9 percent. The S.&P. 500 climbed 21.8 percent.

For years, Berkshire’s book value was Mr. Buffett’s preferred measure for comparing Berkshire’s performance to the S.&P. 500 and he highlighted the comparison on a table on the first page of the letter. But outperforming the S.&P. 500 has become more difficult as Berkshire has grown and shifted to buying whole companies. A few years ago, Mr. Buffett added Berkshire’s annual stock price performance to the table.

Hurricanes. The insurance segment of Mr. Buffett’s letter contains an interesting discussion on hurricane losses. It says that the hurricanes that hit Texas, Florida and Puerto Rico last year will lead to $100 billion of losses for insurers. Berkshire estimates that its hit will total $2 billion after taxes, or less than 1 percent of its net worth. That percentage, according to Berkshire, is far below the 7 to 15 percent losses suffered by some reinsurance companies.

Introducing the mega-catastrophe. Mr. Buffett puts a 2 percent annual probability on the occurrence of a “mega-catastrophe” causing losses of $400 billion or more, but he said the risk could rise. “No one, of course, knows the correct probability,” he wrote. “We do know, however, that the risk increases over time because of growth in both the number and value of structures located in catastrophe-vulnerable areas.”

And according to Mr. Buffett, Berkshire need not fear a mega-cat. “No company comes close to Berkshire in being financially prepared for a $400 billion mega-cat. Our share of such a loss might be $12 billion or so, an amount far below the annual earnings we expect from our non-insurance activities,” he wrote.

Truly wild. Early in the letter, Mr. Buffett rails against a new accounting rule that will affect future quarterly and annual reports. This change requires companies to include in their earnings the gains and losses on the stocks they hold but have not sold. These paper gains and losses will change each quarter as the prices of the stocks change, and Mr. Buffett said that because Berkshire holds $170 billion of stocks, the impact on Berkshire’s bottom line could be significant. “That requirement will produce some truly wild and capricious swings in our G.A.A.P. bottom-line,” he said, referring to the corporate accounting method known as generally accepted accounting principles.

Warming to adjusted earnings? Mr. Buffett said Berkshire would help investors tune out the noise created by the unrealized gains and losses. “We will take pains every quarter to explain the adjustments you need in order to make sense of our numbers,” he wrote. It would indeed be notable if Berkshire started to publish “adjusted earnings,” or financial statements that exclude certain items. In last year’s annual report, Mr. Buffett criticized companies that publish adjusted earnings that leave out costs like stock awards to executives.

Content originally published on https://www.nytimes.com/2018/02/24/business/dealbook/buffetts-annual-letter-berkshire.html by PETER EAVIS and STEPHEN GROCER