Warren Buffett’s annual letter to Berkshire Hathaway shareholders was released this week. Part of this annual ritual includes many financial professionals poring over the letter and analyzing every word in an attempt to gain unique insights in The Oracle of Omaha’s thinking. I looked it over myself and found interesting comments that relate to ESG, a topic about which Buffett is famously non-committal.
The importance of selling what people buy
Let’s begin with this statement near the beginning of the letter:
“Over the years, I have made many mistakes. Consequently, our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal. Along the way, other businesses in which I have invested have died, their products unwanted by the public. Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon ‘creative destruction.'”
This is Business 101 and has broad applicability to business prospectively. If customers are making buying decisions now – and are expected to in the future – about product attributes, then ignoring those signals is bad for business. I’ve written and spoken for years about the importance of exploring how ESG links to customer “key buying criteria” as a way to find real-world economic value of ESG initiatives. Clearly Buffett believes in a “sales and revenue first” approach, rather than being laser-focused on satisfying equities analysts (we’ll see more on that later). I wrote about this concept in the ESG context last year in blogs and it is a major theme in my book. Too many companies try to “sell” their ESG ethos to capital markets as their primary strategy, which is backwards. PracticalESG.com checklists and Guidebooks are available to help members determine and communicate ESG value.
Stock pricing is irrational
Moving to his view of why stocks move, he said:
“It’s crucial to understand that stocks often trade at truly foolish prices, both high and low. ‘Efficient’ markets exist only in textbooks. In truth, marketable stocks and bonds are baffling, their behavior usually understandable only in retrospect.”
This may hit ESG professionals right in the gut as many have long sought to directly link a company’s ESG initiatives to stock pricing, or argue that ESG transparency contributes to market efficiency. Academics have studied this topic for years with conflicting results. As I said above, my view is that companies should focus on ESG as a key buying criteria for customers and as a lever for managing costs. I’d say Warren and I are on the same page here.
Climate change insurance losses
Berkshire Hathaway has significant holdings in insurance underwriting and reinsurance. Theoretically, the company stands to lose a lot of money from paying more and larger property claims due to climate change. Indeed, the company cites this in more than one 10-K Item 1A risk factor. Yet the following statement in Buffett’s letter gives a different feel:
“Aided by Alleghany, our insurance float increased during 2022 from $147 billion to $164 billion. With disciplined underwriting, these funds have a decent chance of being cost-free over time.”
Underwriting losses (i.e., insurance claims) are a component of float, as is income generated from investing the premiums. I could be wrong, but this statement appears to imply that the company expects either (a) insurance claims – including property claims in general – won’t be significant enough to impact the cost of float, and/or (b) investment income from the insurance business is expected to exceed incurred property claims losses. Either way, Buffett doesn’t seem worried about the impact of climate change on his insurance business – which I believe represents Berkshire-Hathaway’s largest financial exposure to climate risk. Take this for what you will – I thought it was interesting and could be a reason Buffett is relatively non-committal when it comes to climate and other ESG matters. I could also be completely wrong here.
Fraud – “one of the shames of capitalism”
Finally, Buffett made a point of speaking to fraud and accounting manipulation:
“Even the operating earnings figure that we favor can easily be manipulated by managers who wish to do so. Such tampering is often thought of as sophisticated by CEOs, directors and their advisors. Reporters and analysts embrace its existence as well. Beating ‘expectations’ is heralded as a managerial triumph.
That activity is disgusting. It requires no talent to manipulate numbers: Only a deep desire to deceive is required. ‘Bold imaginative accounting,’ as a CEO once described his deception to me, has become one of the shames of capitalism.
Obviously fraud in financial management and reporting is a big deal and illegal. ESG data management and reporting face similar external pressures that can lead to fraud. The closer a company ties ESG to investors and related reporting/disclosures, the more significant the risk “bold and imaginative” ESG reporting may be to regulators. I think that is a good way to end this piece.