Chapter 9 Part 2: Berkshire 2017-2018
The Complete Financial History of Berkshire Hathaway | Adam J. Mead | ISBN: 978-0-85719-912-6
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2017 and 2018 are where Mead’s book gets into accounting wars, tax reform, hurricanes, and the biggest portfolio shift in decades: IBM out, Apple in. Berkshire is still compounding, but reading the headline numbers gets harder every year.
2017: Tax reform and the hurricane tax
Berkshire’s $65.3 billion gain in net worth looked incredible. Most of it was not operations. The 2017 Tax Cuts and Jobs Act cut the corporate rate from 35% to 21% and reduced deferred tax liabilities by $29.1 billion. Real operating contribution: about $36 billion, or 12.8% of prior net worth. Still good. Just not a quarter of the company in one year.
Insurance broke a fourteen-year underwriting profit streak. Hurricanes Harvey, Irma, and Maria (plus other cats) produced a $3.2 billion underwriting loss on $60.6 billion of premiums. Float still grew to $103 billion average. Cost of float: 3.1%. Painful year, not a broken model.
The AIG retro deal
Ajit Jain wrote the largest retroactive reinsurance contract in history: $10.2 billion premium for up to $20 billion of coverage on AIG’s old losses. Earned premiums in that segment jumped from $1.3 billion to $10.8 billion. Accounting made it look awful immediately (deferred charge amortization). Economics play out over decades.
General Re’s results merged into BHRG reporting starting in 2017. More clarity for analysts, less standalone Gen Re visibility.
Apple replaces IBM
This is the portfolio pivot Mead emphasizes. Todd Combs or Weschler started Apple. Buffett sized it up. IBM left the top holdings list. Apple jumped to number two at $28 billion market value.
Buffett’s logic: Apple is a consumer products company with a moat, not a commodity tech vendor. Switching costs from the app ecosystem matter. IBM faced Amazon, Microsoft, and Google in cloud and lost momentum. IBM was not a total disaster for Berkshire (buybacks and dividends helped), but opportunity cost was real.
Mead notes something wild: Apple needed no tangible capital. Suppliers and customers financed operations. Berkshire’s ~$21 billion cost for 3.3% implied a $635 billion equity value and about a 12% going-in pre-tax return after adjusting for excess cash.
Buffett also loved Apple’s buybacks. Berkshire’s AmEx stake grew from 13% to 18% without buying a share. Same playbook possible with Apple.
Bank of America warrants converted into 700 million shares worth $20.7 billion at year-end.
Pilot Flying J
Berkshire bought 38.6% of Pilot Travel Centers for a reported ~$2.8 billion, implying ~$7.25 billion for the whole company. Truck stops. $20 billion in revenue. A path to 80% ownership by 2023.
Reporting gets thinner
Buffett dropped the detailed MSR balance sheet from the annual letter. “Focus on the forest, not each tree.” Competitors read Berkshire’s reports. Disclosure has strategic costs when you are the buyer of choice.
McLane’s grocery business got crushed (57% earnings drop). Buffett explained the brutal middle: powerful suppliers, powerful customers, almost nothing left for the distributor.
2018: When GAAP stopped making sense
Operating earnings were a record $24.8 billion after-tax. Under old rules, net income would have been $24.6 billion. Under new GAAP (unrealized stock gains/losses through the income statement), net income was $4 billion.
Buffett had warned this would happen. He told shareholders to watch operating earnings and ignore investment gains/losses, realized or not. The bottom line became “wild and capricious” because Berkshire holds $170+ billion in stocks.
Book value as a metric got its last prominent appearance in the 2018 report. Wholly owned businesses sit at purchase price. Kraft Heinz was on the books at $17.6 billion but traded at $25.3 billion. The gap between book and intrinsic value was too wide to pretend book still worked.
The five groves
Buffett replaced book value guidance with a forest metaphor:
- Non-insurance businesses (80-100% owned): $16.8 billion after-tax earnings in 2018
- Equity securities: $173 billion market value, ~$158 billion after tax on gains
- Control group (Kraft Heinz, Pilot, Berkadia, etc.): $1.3 billion after-tax earnings
- Cash and bonds: $112 billion cash, $20 billion bonds (buffer)
- Insurance float: $123 billion, funds the other groves
Mead values the four asset groves at ~$562 billion using 15x after-tax earnings on operating businesses. Repurchase prices implied ~$485 billion market cap. Either way, shares looked cheap with a 9%+ implied earnings yield.
Buybacks get flexible
Berkshire repurchased $1.3 billion at ~$295,000 per A share in 2018. The board dropped the 120% of book value rule. Now repurchases happen whenever price is below intrinsic value, conservatively calculated. Repurchasing above book widens book vs. intrinsic value over time.
Insurance returned to underwriting profit. Apple got tens of billions more. Kraft Heinz struggled (later writedown coming). BNSF and BHE kept earning. No mega acquisition.
Greg Abel and Ajit Jain became vice chairmen in 2018. Succession chess moved forward.
What 2017-2018 add to the story
These years confirm the post-2014 Berkshire: operating earnings machine, stock portfolio as flexible capital allocator, insurance as funding source, and accounting that obscures more than it reveals.
The IBM-to-Apple swap is the clearest example of Buffett updating his view when facts change. The tax reform windfall is a reminder that reported net worth can lie about annual skill. The hurricane loss year shows insurance risk is real, but survivable at Berkshire’s scale.
And the five groves framework is Buffett’s answer to “how do you value this thing now?” Mead runs the numbers. The market still undervalued the forest, in his view.
← Prev: Chapter 9 Part 1: Berkshire 2015-2016 | Next: Chapter 9 Part 3: Berkshire 2019 →