Warren Buffett on their big 4 Investments

 

All the passages below are taken from Berkshire Hathaway 2004 Annual report.

 

                  www.berkshirehathaway.com

 

We show below our common stock investments. Those that had a market value of more than $600 million at the end of 2004 are itemized.

 

Shares

Company

% Company Owned

Cost*     ($ millions)

Market    ($ millions)

151,610,700

American Express Company

12.1

$1,470

$ 8,546

200,000,000

The Coca-Cola Company

8.3

1,299

8,328

96,000,000

The Gillette Company

9.7

600

4,299

14,350,600

H&R Block, Inc

8.7

223

703

6,708,760

M&T Bank Corporation

5.8

103

723

24,000,000

Moody’s Corporation

16.2

499

2,084

2,338,961,000

PetroChina “H” shares (or equivalents)

1.3

488

1,249

1,727,765

The Washington Post Company

18.1

11

1,698

56,448,380

Wells Fargo & Company

3.3

463

3,508

1,724,200

White Mountains Insurance

16.0

369

1,114

 

Others

 

3,531

5,465

 

Total Common Stocks

 

$9,056

$37,717

 

*This is our actual purchase price and also our tax basis; GAAP “cost” differs in a few cases because of write-ups or write-downs that have been required.

 

Some people may look at this table and view it as a list of stocks to be bought and sold based upon chart patterns, brokers’ opinions, or estimates of near-term earnings. Charlie and I ignore such distractions and instead view our holdings as fractional ownerships in businesses. This is an important distinction. Indeed, this thinking has been the cornerstone of my investment behavior since I was 19. At that time I read Ben Graham’s The Intelligent Investor, and the scales fell from my eyes. (Previously, I had been entranced by the stock market, but didn’t have a clue about how to invest.)

 

Let’s look at how the businesses of our “Big Four” – American Express, Coca-Cola, Gillette and Wells Fargo – have fared since we bought into these companies. As the table shows, we invested $3.83 billion in the four [market value is now $24.681 billion], by way of multiple transactions between May 1988 and October 2003. On a composite basis, our dollar-weighted purchase date is July 1992. By yearend 2004, therefore, we had held these “business interests,” on a weighted basis, about 12½ years.

 

In 2004, Berkshire’s share of the group’s earnings amounted to $1.2 billion. These earnings might legitimately be considered “normal.” True, they were swelled because Gillette and Wells Fargo omitted option costs in their presentation of earnings; but on the other hand they were reduced because Coke had a non-recurring write-off.

 

Our share of the earnings of these four companies has grown almost every year, and now amounts to about 31.3% of our cost. Their cash distributions to us have also grown consistently, totaling $434 million in 2004, or about 11.3% of cost [after 12½ years invested]. All in all, the Big Four have delivered us a satisfactory, though far from spectacular, business result.

 

That’s true as well of our experience in the market with the group. Since our original purchases, valuation gains have somewhat exceeded earnings growth because price/earnings ratios have increased. On a year-to-year basis, however, the business and market performances have often diverged, sometimes to an extraordinary degree. During The Great Bubble, market-value gains far outstripped the performance of the businesses. In the aftermath of the Bubble, the reverse was true.

 

Clearly, Berkshire’s results would have been far better if I had caught this swing of the pendulum. That may seem easy to do when one looks through an always-clean, rear-view mirror. Unfortunately, however, it’s the windshield through which investors must peer, and that glass is invariably fogged. Our huge positions add to the difficulty of our nimbly dancing in and out of holdings as valuations swing.

 

Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked.

 

What Charlie and I would like is a little action now. We don’t enjoy sitting on $43 billion of cash equivalents that are earning paltry returns. Instead, we yearn to buy more fractional interests similar to those we now own or – better still – more large businesses outright. We will do either, however, only when purchases can be made at prices that offer us the prospect of a reasonable return on our investment.

 

 * * * * * * * * * * * *

 

We’ve repeatedly emphasized that the “realized” gains that we report quarterly or annually are meaningless for analytical purposes. We have a huge amount of unrealized gains on our books, and our thinking about when, and if, to cash them depends not at all on a desire to report earnings at one specific time or another. A further complication in our reported gains occurs because GAAP requires that foreign exchange contracts be marked to market, a stipulation that causes unrealized gains or losses in these holdings to flow through our published earnings as if we had sold our positions.

 

Despite the problems enumerated, you may be interested in a breakdown of the gains we reported in 2003 and 2004. The data reflect actual sales except in the case of currency gains, which are a combination of sales and marks to market.

 

Category

Pre-Tax Gain (in $ millions)

 

2004

2003

Common Stocks

$ 870

$ 448

U.S. Government Bonds

104

1,485

Junk Bonds

730

1,138

Foreign Exchange Contracts.

1,839

825

Other

(47)

233

Tota

$3,496

$4,129

 

The junk bond profits include a foreign exchange component. When we bought these bonds in 2001 and 2002, we focused first, of course, on the credit quality of the issuers, all of which were American corporations. Some of these companies, however, had issued bonds denominated in foreign currencies. Because of our views on the dollar, we favored these for purchase when they were available.

 

As an example, we bought €254 million of Level 3 bonds (10 ¾% of 2008) in 2001 at 51.7% of par, and sold these at 85% of par in December 2004. This issue was traded in Euros that cost us 88¢ at the time of purchase but that brought $1.29 when we sold. Thus, of our $163 million overall gain, about $85 million came from the market’s revised opinion about Level 3’s credit quality, with the remaining $78 million resulting from the appreciation of the Euro. (In addition, we received cash interest during our holding period that amounted to about 25% annually on our dollar cost.)

 

* * * * * * * * * * * *

 

The media continue to report that “Buffett buys” this or that stock. Statements like these are almost always based on filings Berkshire makes with the SEC and are therefore wrong. As I’ve said before, the stories should say “Berkshire buys.”  [15-17]

 

February 28, 2005                     Warren E. Buffett

Chairman of the Board