THE POINT OF NO RETURN THE PATH FROM DEFLATION TO HYPERINFLATION; EXPEDITION EVEREST; AND – BERKSHIRE: THE GOAT GOES FULL REPO 2020 LETTER TO CLIENTS February 15, 2021 CONTENTS THE POINT OF NO RETURN THE PATH FROM DEFLATION TO HYPERINFLATION; EXPEDITION EVEREST; AND – BERKSHIRE: THE GOAT GOES FULL REPO IN THE LETTER – INTRODUCTION 5 INTRINSIC VALUE UPDATE – OPPORTUNITY KNOCKS AND OPPORTUNITY COST 8 Disney 9 Portfolio Activity 10 Fundamentals Versus the Market 12 Key Common Size Figures for the Semper Portfolio and S&P 500 (Table) 13 Forward Expectations 15 EXPEDITION EVEREST 18 100 Years of Peaks and Troughs (Table) 19 Price to Sales at a Record 19 Market Cap to GDP at a Record 20 Peaks to Troughs 20 You Gotta’ Be SPACKING Kidding Me 27 THE POINT OF NO RETURN 29 We’re All Keynesians Now 36 The Path from Deflation to Hyperinflation 42 BACK TO SCHOOL 45 On the Job Training 46 TAMS ARE THE NEW EYEBALLS 50 The Price Paid to Sales is Steep 53 TO READ OR NOT TO READ 57 BERKSHIRE HATHAWAY: REPO MADNESS 59 Mr. Repo Man 60 Beyond the Repo – Capital Allocation 63 Berkshire Hathaway: Ten-Year Expected Return 66 Estimating Fourth Quarter and Full-Year GAAP Net Income and Change in Book Value 73 The Stock Portfolio 74 Got Bonds? 76 A Bite of the Apple 78 The Full Record 80 Berkshire’s Performance vs. the S&P 500 (Table) 82 Berkshire Hathaway Intrinsic Value Update 83 Net Income Basis 83 Other Methods for Valuing Berkshire 85 Sum of the Parts Basis 86 2 Berkshire Hathaway Energy 87 BNSF 88 Manufacturing, Service, Retailing and Finance 89 Insurance 90 Reinsurance 90 GEICO 92 BH Primary 92 Overall Insurance Results 93 Equity Method Investments 93 Simple Price to GAAP Book Value Basis 95 Two-Pronged Approach 96 GAAP Adjusted Financials Approach 96 Summary of GAAP Adjustments to Economic Earnings (Table) 108 SUMMARY 109 APPENDIX 111 Appendix A – Key Business Segment Information – Berkshire 2020 Expected 111 Appendix B - Capital Expenditures and Depreciation; Deferred Tax Liabilities 112 Appendix C – Cash and GAAP Tax Reconciliation 112 Appendix D – Reported Segment Profit by Berkshire’s JV Partners 113 Appendix E – MSR and Finance Summary Figures 113 Appendix F – Semper Augustus Investments Group Historical Returns 114 Copyright© 2021 By Christopher P. Bloomstran All Rights Reserved 3 2020 LETTER TO CLIENTS February 15, 2021 THE POINT OF NO RETURN THE PATH FROM DEFLATION TO HYPERINFLATION; EXPEDITION EVEREST; AND – BERKSHIRE: THE GOAT GOES FULL REPO THE POINT OF NO RETURN I heard the fools printing fiat Governments tell they pay you well And they say they need credit men to Show how to debase today Was it Alan that said, how low? How low? They say money turns so fast that You know it's time, you see no sign They say the point debasers set is No interest rate for all that’s saved Was it Ben that said, how low, how low How low to the point of no return? Fed governors, you know they bleed you Your secretary, she said she loves you Your lenders, they echo your words How low to the point of no return? To the point of no return O How low, how low? Today I found a dollar floating In the air from you to me The note that when you could spend it You cried for gold, the point was near Was it Jay that said How low, how low, how low to the point of no return? How low, how low to the point of no return No return How low How low How low How low How low How low How low How low 4 IN THE LETTER – INTRODUCTION One short year seems like a decade ago. With the 2019 letter put to bed, I had the good fortune to speak to the finance and economics students at my daughter’s school in Southern California over parents’ weekend. From there, a couple of quick business trips to the hearts of auto country and horse country. The second weekend of March was circled in anticipation of seeing said daughter tee it up in Phoenix for her first collegiate spring tournament. Who would have known that instead, she and I would be driving her Jeep back from L.A. to St. Louis, with me riding shotgun spending the entire drive on the phone and iPad, navigating the early financial stage of a pandemic? Just east of the junction of I-15 and I-70, Salina to Green River is a desolate 110-mile stretch across Utah with no motorist services, the longest in the U.S. interstate system. There is a point beyond which your remaining fuel is insufficient for a return to the “last chance for gas” station that you decided to breeze by. The economy is low on fuel and past such a point. Thanks to the gents from Topeka for inspiring the theme of this year’s letter. Who knew that a pandemic would send interest rates back to zero and monetary and fiscal policy past the point of no return? Triple entendre right there – interest rates being the point, no return being the yield for the indefinite future, and the point of no return being the inability of central bankers and policy making legislators to ever walk back the path to financial ruin laid by their own hands. The job description reads capital allocation with professional worry skills required. I try to have fun with the annual letter, making light when possible of dry finance, accounting and economic theory. The “intelligent investor” is conditioned to focus on the first two, ignoring the dark art of economics for the betterment of the investment result. The process at Semper is very bottom up with a majority of time spent under the hood and in the footnotes of businesses, trying to mesh business quality and price. A dual margin of safety approach we call it. The majority of my career spent ignoring the “macro” has proven the wise course. However, a wary eye on a growing debt bubble compels worry and forces strategic thought on how to best deal with the issue that’s now front and center. The Point of No Return examines the history of how we got to this point and the likelihood of dealing first with deflation and ultimately hyperinflation, perhaps…2021 marks the 40th anniversary of record high interest rates in the United States. For four decades we have become a society conditioned on immediate gratification. The entirety of the industrialized global economy is in the same boat. We are a society living beyond our means, governed by none willing to sacrifice today for a better tomorrow. A willingness to spend with no governor and a false belief that no level of debt is too great if interest rates can be set at a low enough level comes with consequences. The role of central banks is apparently to finance unlimited deficits. Whichever direction the monetary and fiscal paths take us, austerity is coming. Our role as stewards of capital only grows more complicated. Owning proper assets, at the right time, will require every ounce of focus and every bit of cumulative experience. COVID-19 pulled forward in a short span so many trends and disruption already unfolding, accelerating the timeline on dealing with the coming fallout of the debt bubble On a cheerier note (thank God), the portfolio trades at a wide discount to intrinsic value. The section in the letter titled Intrinsic Value Update – Opportunity Knocks and Opportunity Cost is a portfolio-specific discussion of portfolio activity and rationale for prospective expected returns. Despite stock market returns outstripping underlying business fundamentals, our ability to shift capital around – adding and eliminating a few positions from the portfolio and adding to and trimming others – kept quality high and 5 price low, yielding substantial earning power and prospective accretion to fair value. The quality and valuation gap between world markets and the Semper portfolio widened considerably, and we again compare fundamentals and valuation against the market. Regarding the market, valuations are consistent with those seen at major historical secular peaks. Expedition Everest, a nod to Disney’s famous rollercoaster, compares current valuation and economic yardsticks against those at various inflection points in the past. By several measures, prices have never been more expensive. Others, such as durably higher profit margins than in past cycles and low interest rates perhaps temper some of the excesses. But in the context of a debt bubble, overall capital market valuations are troubling. TAMs are the New Eyeballs continues the valuation discussion and specifically drills down on price-to- sales as a valuation metric. A working hypothesis that paying high prices portends weak investment returns is tested. The investment derby in 2020 was led by unprofitable companies, stocks with a high proportion of shares sold short and those with prices at more than ten times sales. The number of companies trading at very high multiples ballooned, bringing back memories of the late 1990s. A brief discussion about Tesla is included in this section. The reaction by Tesla shareholders to a fundamental case that future returns stand to be poor because the stock is way ahead of the business is the same visceral response we confronted when making the same case about many tech and Internet stocks in 1999 and early 2000. One chap suggested I return my degrees and CFA charter because clearly, I learned nothing. Social media provides endless entertainment value. A great privilege is spending time on campus with aspiring investors each year.