In the world of investing, Berkshire Hathaway and its iconic Chairman Warren Buffet occupy rarified space. The Oracle of Omaha and his team have chalked up annual gains of 19.1% since 1965, beating the S&P average of 9.9% handily. For 2017, investment gains were $65 billion (+23%), helped by a one-time gain of $29 billion as a result of the lower corporate tax rate circa the Tax Cut and Jobs Act passed last month.
A tradition for 50 years has been Chairman Buffet’s Letter to Shareholders, released Saturday. It provides Berkshire Hathaway followers a summary of the fund’s performance and a glimpse of how he views markets and investing. It’s a must-read in the investment community and business schools.
I read his 28-page 2018 edition over the weekend along with his 1965 letter. The folksy style is unchanged. His deference to Vice Chairman Charlie Munger’s conservative, common-sense investing judgement is a constant in both letters. But what sets these letters apart from others is the down-home business counsel that guide’s readers through the fund’s rationale for the investments it’s made, the rationale for deals they chose to pass up and a look forward to how markets are likely to change in years to come. From the 2018 letter, these passages caught my attention:
On the volatility of markets: “Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period - or even to look foolish - is also essential."
On acquisitions and deals: “In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.
That last 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. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.
Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types. 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.
Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”
On forecasting the future: “In the next 53 years our shares (and others) will experience declines… No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow. When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If: “If you can keep your head when all about you are losing theirs . . . If you can wait and not be tired by waiting . . . If you can think – and not make thoughts your aim . . . If you can trust yourself when all men doubt you... Yours is the Earth and everything that’s in it.”
In every sector of healthcare, whether competing locally or globally, the market signals are clear:
· The regulatory environment is uncertain and public funding is limited.
· Cost pressures are intensifying.
· Investors and lenders are seeking less risk and high returns.
· Increased scale (size) and scope (services, capabilities) are keys to sustainability.
Much has been made of the mega-deals recently disclosed in the U.S. healthcare market: Walgreens, CVS, Optum, Humana, Amazon and others have announced major acquisitions that are certain to change the scale and scope of their businesses in healthcare outside the confines of their traditional sectors. And reputable not for profit health systems and leading investor-owned hospital management operators are diversifying generic drug manufacturing, health insurance, digital health and retail services while continuing to consolidate the acute market. All recognize that our market has changed: clinical innovation is changing how we diagnose and treat, regulatory constraints are becoming less restrictive, and the upside is attractive for those who make the right moves.
At Berkshire Hathaway, investments in healthcare have not been a staple. Instead, it owns substantial chunks of Delta Airlines, American Express, Coca Cola, Apple, Wells Fargo, GEICO, Pilot Flying J along with 60 other companies. But none in healthcare.
At a business conference at Ohio State years back, I shared the stage the stage with Buffet. I spoke to the opportunities for innovation in healthcare, and he countered it’s an industry about which investors should be cautious. In his unique style, he told the audience that healthcare is too dependent on the federal government and too complicated for most investors. I and most in that audience that day agreed with the Oracle of Omaha.
Backstage, he was quite inquisitive about how the healthcare industry might look if middle-men were out and consumers were in charge. He imagined investors could unlock huge value by simplifying the system and cutting middle-men out. And he was adamant the health system needed a kick in the a—from new competitors with better models.
Reflecting on that conversation, it was no surprise he joined with Amazon and JP Morgan January 30 in announcing a new venture focused on modernizing health benefits for the 1.14 million employees of the three organizations. He observed: “Our group does not come to this problem with answers. We share the belief that putting our collective resources behind the country’s best talent can, in time, check the rise in health costs while concurrently enhancing patient satisfaction and outcomes.”
Berkshire Hathaway is the world’s 8th largest company based on its balance sheet assets. It’s investment strategy is simple: focus on management performance, operational execution, efficient use of capital and aggressive competitive positioning.
It’s a formula not new to healthcare, but it seems to me the stakes are higher now. There will be winners and losers in each of our sectors. There will be those paralyzed by regulatory uncertainty and reimbursement constraints and others that work around them successfully.
There will be Boards lulled into strategies that placate traditional assumptions about the future and pander to internal constituents fearful of change. And there will be others who see healthcare’s future as a huge opportunity wherein purpose and profit are not mutually exclusive.
I have no idea whether Warren Buffett will ever warm to healthcare as a Berkshire Hathaway investment target, but I have no doubt he and his team have it on their radar because there’s value to be unlocked.
P.S. Next week, I will begin a series “The 10 Biggest Myths about the U.S. Health System” providing hard data showing the disconnect between widely held views and reality. Healthcare will be a major issue in Campaign 2018: a discussion based on an informed, objective, nonpartisan view of the facts is necessary. Stay tuned!