finweek

Investors should view their portfolios as mini-conglomerates

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Simon Brown, founder and director of investment education website Just One Lap. (Photo: JSE/Twitter)
Simon Brown, founder and director of investment education website Just One Lap. (Photo: JSE/Twitter)

In his annual letter to shareholders, Berkshire Hathaway’s billionaire owner, Warren Buffett, discusses real profits, being minority shareholders and the importance of customer service.


The month of March has a traditional twang to it in the investment community; it is the time when Warren Buffett publishes his letter to the shareholders of Berkshire Hathaway (one can find the letter on berkshirehathaway.com).

For me, it is always a great read that, more often than not, makes me a smarter investor after having read it.

This year he again starts the letter with a criticism of the general accepted accounting principles (GAAP) that is used in the US.

GAAP shows Berkshire with earnings of $42.5bn for 2020. Yet, as Buffett points out, this figure is wrong, as the actual (operating) earnings figure is $21.9bn.

The difference is added capital gains from stocks they have sold and $26.7bn of capital gains from stocks they still hold(there is also a negative write down).

The unrealised capital gain is nonsense in terms of earnings. Sure, they bought shares, in for example Apple, that have shown huge price growth since the purchase. But this is a paper profit and not in any way earnings.

The earnings for Apple mostly remain in the business to be reinvested, while dividends will flow to Berkshire. But share price fluctuations are not earnings and while they help in some years, such as 2020, in others when prices fall, they will hurt and neither gives a fair reflection of the actual operational business.

The lesson here is that companies must report using accounting standards (IFRS locally), but they do not always make sense and we need to do our homework deconstructing the numbers to get a fair reflection of actual profits.

Buffett also talks about being a conglomerate and how the risk here is wanting to own businesses outright that requires paying a hefty control premium or having to buy second rate businesses, as the quality ones will not sell or will only do so at crazy valuations.

He and Charlie Munger are happy to be minority shareholders, sharing in profits but without any effort required. This is exactly how we should view our own portfolios; as a mini conglomerate. We own small minority stakes in listed businesses that management manage, and they share some profits with us retaining the rest to grow the business.

Our job is then to keep an eye on the results, but not the day-to- day management. It also means only ever buy the best quality at good prices. If we cannot get the right quality or valuation, we are better off walking away.

Buffett also comments on share repurchases (also called share buybacks) by companies. If done at the right price they increase our holding in the business without us having to do anything.But the crux here is the right price.

Berkshire has a simple formula to buy back their own shares at 10% above intrinsic value.

Far too many companies (more so in the US than locally) buy back shares at ridiculously high prices that destroy value. So keep a very close eye on buybacks and ask yourself if you’d be happy buying more shares at the price being paid, as this is essentially the price you are paying (shareholder cash is your cash after all).

Another great point he makes is in relation to See’s Candy, but with bigger implications. “When a business manufactures and distributes a non-essential consumer product, the customer is the boss.”

This is an excellent point many management teams should heed. With essential products the consumer may have some choice, but ultimately, they must buy. With a non- essential product, the customer can choose not to buy at all, so service, quality and price are really what matters.

Berkshire Hathaway’s annual general meeting will take place virtually through Yahoo.com on 1 May at 20:00 SA time, well worth the couple of hours it’ll last.

Read more
This article originally appeared in the 18 March edition of finweek. You can buy and download the magazine here.


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