Warren Buffett released the annual Berkshire Hathaway shareholder letter with the usual fanfare, though this year the news wasn't all great.
After all, the Oracle of Omaha's Berkshire Hathaway delivered just an 11% return to its investors (measured as in per-share market value), versus the 31.5% increase in the S & P 500 index (including dividends).
The gap was glaring because it was the worst underperformance for Berkshire Hathaway since 2009.
Buffett cautioned investors "to focus on operating earnings — which were little changed in 2019 — and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized."
Most are willing to cut him slack, because since he and partner Charlie Munger started their investing odyssey in 1965, they have grown at an annualized rate of 20.3%, versus 10% annualized for the S & P 500's total return. You can buy a lot of patience with those kinds of results.
One potential reason for the underperformance is Berkshire's inability to purchase a compelling entity to add to its portfolio. As the bull market has advanced and private equity money has flowed into companies both large and small, Berkshire has had a tougher time finding what Buffett calls "elephant-sized" targets — acquisitions that can make a meaningful difference to the company's bottom line.
Buffett noted that any deal must "meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price."
The last point has been the biggest hurdle in locating an elephant, because Buffett and Munger are unwilling to pay up just for the sake of making a deal — it has to make sense. As a result of the lack of deal flow, Berkshire Hathaway's cash position has soared to $128 billion, something investors are not thrilled about.
Even so, not all deals work out.
The Oracle compared them to nuptials, saying "In reviewing my uneven record, I've concluded that acquisitions are similar to marriage: They start, of course, with a joyful wedding — but then reality tends to diverge from pre-nuptial expectations. Sometimes, wonderfully, the new union delivers bliss beyond either party's hopes. In other cases, disillusionment is swift. Applying those images to corporate acquisitions, I'd have to say it is usually the buyer who encounters unpleasant surprises. It's easy to get dreamy-eyed during corporate courtships. Pursuing that analogy, I would say that our marital record remains largely acceptable, with all parties happy with the decisions they made long ago."
Regarding the idea that Berkshire invests in companies run by able and honest managers, it is interesting that the company continues to hold an 8.4% position in banking giant Wells Fargo, which just agreed to a whopping $3 billion settlement with the Justice Department and Securities and Exchange Commission over the falsification of bank records and the unlawful misuse of customer personal information. Prosecutors noted the "staggering size, scope and duration" of the unlawful conduct that occurred between 2002 and 2016.
Looking ahead, Buffett believes that a low interest rate environment, combined with rock-bottom corporate tax rates, makes stocks the most attractive asset class for the foreseeable future. But "that rosy prediction comes with a warning: Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50 percent magnitude or even greater."
Even so, equities should be "the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!"
Jill Schlesinger, CFP, is a CBS News business analyst. She welcomes comments and questions at firstname.lastname@example.org.