Warren Buffett shareholder letter says Berkshire posted $29 billion gain from tax cut law

Adam Shell | USA TODAY

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Warren Buffett got right to the point this weekend in his folksy and blunt annual letter to investors.

The billionaire and CEO of Berkshire Hathaway highlighted a $29 billion tax gain for his company, bemoaned a lack of good deals and reminded his readers that owning stocks through low-cost index funds was the best way to build wealth over time.

Buffett's yearly check-in with his company's shareholders is a closely watched event on Wall Street and Main Street. He is among the world's best investors, and his insights and nuggets of wisdom on the economy and financial markets, as well as his investment advice, are always in demand.

In 2017, Berkshire saw its net worth grow $65.3 billion, boosting its per share book value by 23%, according to Buffett's letter, published on Saturday. He noted, however, that only $36 billion came from Berkshire’s business operations.

"The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code," he explained. The new law cut the corporate income tax rate to 21% from 35%, a change that has seen boosting the earnings of scores of U.S. companies.

Investors looking for more details on Buffett's successor, however, got no fresh insights. In January, Buffett, 87, narrowed down the list of people who could replace him to two veteran Berkshire executives, Greg Abel and Ajit Jain. Both men were named vice chairmen.

At the end of his letter Buffett reiterated that Berkshire will be in good hands after his eventual departure.

"You and I are lucky to have Ajit and Greg working for us," Buffett told shareholders.

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Buffett, in his investor-friendly writing style, also addressed topics like the overpriced market for mergers and acquisitions and his disdain for Wall Street's high investment fees.

He let investors know why Berkshire, which is now sitting on a record $116 billion in cash, didn't pull the trigger on any mega-deals last year.

The biggest thing missing from the deals Buffett eyed was one of the key qualities he looks for when buying a company: "a sensible purchase price."

"That ... requirement 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," Buffett wrote.

Too many CEOs chased deals because they were given the go ahead, and they ignored price, he claimed.

"Why the purchasing frenzy? In part, it’s because the CEO job self-selects for 'can-do' types," Buffett wrote. "If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life."

Berkshire Hathaway has a broad financial reach. It owns an array of blue-chip stocks valued at over $170 billion (excluding shares of Kraft Heinz). Equity holdings include Apple, Wells Fargo and Coca-Cola. Berkshire also owns scores of businesses that it has acquired over the years: auto insurer Geico, Dairy Queen and BNSF Railway Company.

For all of 2017, Berkshire net earnings rose to $44.9 billion from $24.1 billion the year before, but the bulk of the gains were from the one-time tax benefit.

Berkshire's overall performance was hurt by an after-tax $2.2 billion loss in its insurance underwriting unit, which had to pay out large claims following Hurricanes Harvey, Irma and Maria, as well as for earthquake victims in Mexico and people hurt by California's wildfires.

Last year, however, was another good one for Berkshire stockholders, as the company's "A" shares rose nearly 22%, vs. a gain of 19.4% for the S&P 500, a broad stock market index. Berkshire's "A" shares also became the first stock ever to reach a price of $300,000.

Book value, Buffett's favorite measure of value, is the total amount a company would be worth if it liquidated its assets and paid back all its liabilities. Over the past 53 years, Berkshire has grown its per-share book value at a 19.1% rate compounded annually, better than the 9.9% gain for the S&P 500 stock index, including dividends.

As he often does, Buffett offered up investment advice in his letter:

Treat stocks like businesses

"I view the ... stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their 'chart' patterns, the 'target' prices of analysts or the opinions of media pundits," Buffett wrote. "Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall – and over time – we should get decent results. In America, equity investors have the wind at their back."

Don't invest with 'borrowed' money

Buffett says using borrowed cash to buy stocks, or "buying on margin," is a no-no for individual investors. The reason: losses can be amplified if stocks plunge. To make his point, he showed four major drops in Berkshire's stock going back to 1973 with losses ranging from 37.1% after the crash of 1987 to a 59.1% plunge from 1973 to 1975.

"This (data) offers the strongest argument I can muster against ever using borrowed money to own stocks," he said. "There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions."

Avoid high-fee investments

Buffett touted his win in a bet that he made 10 years ago, in which he basically wagered that a low-cost index fund tracking the S&P 500 stock index would post better returns over the next decade than a portfolio of five fund of funds run by high-fee hedge fund managers, often considered the "smart money" on Wall Street. The S&P 500 won handily, posting average annual gains of 8.5%, topping all five hedge fund products handily.

The takeaway: owning a broad basket of stocks and holding them is a better investment approach than a rapid trading strategy or investing in high-fee investment products run by Wall Street pros that charge fees and whose job it is to "help" investors.

"Addressing this question is of enormous importance," Buffett wrote. "American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money’s worth?"

More, often than not, Buffett's bet shows, the answer is no.