In its latest annual letter, released at 8am on Saturday, Warren Buffett’s Berkshire Hathaway said Q4 profit hit an all time high, rising more than five times, as net income soared to a record $32.44 billion, or $19.790 a share, from $6.29 billion, or $3.823 the prior year, while operating EPS fell 24% to $3,338, hurt by losses in the company’s insurance operations, however it was enough to beat the $2,617 consensus estimate.

For the full year, Berkshire earned $44.940 billion, up 87% from last year’s $24.1 billion, despite “only” an 8% increase in total revenue to $242.1 billion. Where did the delta come from? Largely from Trump’s tax reform, which needless to say Berkshire was not a big fan of.

Discussing operating performance, Buffett says that “viewed as a group – and excluding investment income – our operations other than insurance delivered pretax income of $20 billion in 2017, an increase of $950 million over 2016. About 44% of the 2017 profit came from two subsidiaries. BNSF, our railroad, and Berkshire Hathaway Energy (of which we own 90.2%)”

As Berkshire admits in its annual report, while the gain in net worth during 2017 was $65.3 billion – which increased the per-share book value of both our Class A and Class B stock by 23% –  $29.11 billion of its net income to the reduction of the U.S. corporate tax rate, to 21% from 35%.

As Buffett admits in starting the letter, “the format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.”

The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code attributed roughly $29.11 billion of its net income to the reduction of the U.S. corporate tax rate, to 21 percent from 35 percent, that President Donald Trump signed into law in December.”

Next, on the increasingly sensitive topic of Berkshire’s mounting cash pile – which as discussed yesterday is invested mostly in Treasury bills – it grew to $116 billion at year-end, up from $109 billion in the third quarter.

Let’s also recall that Berkshire is one of America’s largest investors. Below is a list of the company’s 15 largest investments, which shows that as of December 31, 2017, Berkshire’s 5 top holdings were Wells Fargo, Apple, Bank of America, Coca Cola and American Express. Of note: Berkshire’s cost basis in AAPL is $20.961BN; the stake was worth $28.21BN as of Dec. 31, 2017.

Compare this to Berkshire’s top holdings as of Dec 31, 2016:

It is worth noting that the 17 page letter was notably shorter than in years past (last year it was 29 pages) and didn’t include commentary on some of the company’s largest stock holdings.

* * *

First a few thoughts on what was not discussed in the letter: the most notable omission appears to be the lack of succession discussion – which is particularly notable given yesterday’s news that Buffett would retire from the board of Kraft Heinz.

Last month, Buffett elevated Ajit Jain and Greg Abel – the two most likely candidates to succeed Buffett and Charlie Munger atop the Berkshire Hathaway hierarchy – to vice chairmen, which the financial press widely interpreted as a signal that Buffett was toying with retirement.

Other things missing: any discussion on Wells Fargo, the recently announced Bezos-Buffett-Dimon employee health plan, Buffett’s traditional American bullishness… oh, and bitcoin.

* * *

Before moving on to discuss his company’s performance in greater detail, Buffett advised readers about a change in GAAP that could lead to significant distortions in Berkshire’s numbers:

After stating those fiscal facts, I would prefer to turn immediately to discussing Berkshire’s operations. But, in still another interruption, I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire’s net income figures and very often mislead commentators and investors.

The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period.

Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire’s “bottom-line” will be useless. The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.

That’s largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse).

As Buffett points out, coverage of corporate earnings releases is often instantaneous, with media reports focusing on the year-over-year change in GAAP net income. Buffett said he would try to alleviate this problem by methodically explaining how the company’s per-share earning power – the key metric that he and Munger use to evaluate the company’s performance – changed during the quarter, and also by continuing their longtime practice of releasing earnings reports late Friday or early Saturday, when markets are closed – allowing investors more time to digest the material.

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