Has Buffett Lost It?

A common phrase these days, “what´s wrong with Warren”. When these ideas are floating around, it might be a good time to take the other side and bet with Buffett…but that is just speculation.

The critique likely comes from share price performance in 2019. That gives you a sense of how short term oriented some market pundits really are. The market is up 25%+ and Berkshire is only up single digits, etc. For market participants who focus on the underlying performance of the business and in long term investments, these comments are just non-sense.

If we look at the numbers, Berkshire has been performing very well. There are some businesses that are struggling, but that is expected since there are a wide array of subsidiaries. We will continue to have troubled investments, that we can be sure of. It is just part of the game.

Going back to the “What´s wrong with Warren” phrase, some arguments focus on lagging performance compared to S&P 500. Let´s look at the numbers.

We can compare the growth in book value per share of Berkshire and the S&P 500 total return, since right before the crisis. I am using this period since I think it is fair to use the whole cycle, not just the “bull” market that started in 2009.

As we can see, Berkshire has outperformed by a significant margin in this period. Very different from what we constantly hear in the media these days. During this period, the annualized growth in BVPS for Berkshire has been 10.3% while the S&P 500 TR 8.5%.

bvps spy

This is not a great comparison since book value is not as relevant as it used to be for Berkshire. Also, it is not fair to compare book value growth to total return. But at least, it is a valuable exercise and it shows that Berkshire´s underlying performance has been very good.

I prefer to use another metric, which in my opinion tracks performance more closely. That is growth per share in operating earnings (excluding insurance) and in liquid assets.

Since 2007, annual growth per share in operating earnings and liquid assets has been 12.3% and 8.2%, respectively. Those are impressive results.

opear

liq

I think over time, intrinsic value and share price will likely track the growth in these 2 figures (operating earnings and liquid assets per share).

Currently, liquid assets and operating businesses add similar value to Berkshire. Liquid assets stand at $380bn. Earnings from operating businesses ~$18.5bn, if we apply a market multiple, we get close to $330bn. That is not relevant to this discussion, it’s just a curiosity.

Other market participants make a more rational argument that cash is continuing to pile up and that might be a problem. I agree, it actually is a problem with no easy solution. Having said that, I believe 1) cash balance will almost always be higher that most would expect or prefer; 2) current cash balance won´t be a huge drag on results. I might post on these 2 comments another day.

Looking at solutions, here are some avenues to deploy cash:

Repurchases: There have been some issues 1) the stock price has not suffered a major decline since the new repurchase strategy was announced; 2) trading volume of Berkshire compared to other equities, is low so it has not been easy to repurchase large amounts of stock when price has been temporarily depressed; 3) Buffett has demonstrated a lack of appetite for repurchases of Berkshire stock in the past (that might change).

Dividends: Berkshire could do a large one-time dividend of say $50bn. That would temporarily solve the issue of a large cash balance. On the negative side, that would be a taxable event which makes it less likely.

Public Investments: Some commentators don´t realize this, but Buffett has been active on this front in the past few years. Starting in 2016, he made his largest investment ever in public equities buying close to 5% of Apple. The investment is currently worth more than $60bn and it has been close to a double so far. Berkshire also took a 10% holding in each of the large US airlines. More recently, Berkshire made a significant investment in JP Morgan.

This is an area where Buffett has successfully deployed large amounts of capital with good results. One benefit, is Berkshire doesn´t have to pay a takeover premium for these investments. In the past few years, there has arguably been better value in public markets compared to takeovers, etc.

Acquisitions:  Here is the thing, we have been in a bull market coupled with low rates. This is a difficult environment for large investments at reasonable prices. It is not easy to compete with private equity, when they can finance half of the acquisition with debt and are playing with other people´s money. Berkshire makes the investments to hold “forever” and thinks about the rate of return assuming the transaction is paid with equity.

I think we won´t see much action here unless we get some volatility and the credit markets dry up. In the current environment, Buffett won´t be the best offer as competitors are willing to pay higher prices.

I think there is less competition in large acquisitions compared to things below say $10bn. So we might get a surprise from a special situation in which Berkshire is the only real option (e.g. PG&E, Bloomberg, etc.). In general, I am not too optimistic here.

Special Situations: Berkshire has lent money when companies needed the cash quickly (GE, BAC, GS, Mars, etc). Recently, this has been a business without much activity since credit markets have been open. Buffett managed to close a deal with Occidental Petroleum offering  $10bn in exchange of an 8% preferred with warrants. He has also supported Home Capital Group, Kraft Heinz, Seritage, etc. Companies see the value of a quick yes and the approval from Berkshire. Hopefully, we will get more of these deals.

We can see why Buffett has not been able to keep cash from piling up. It is a problem with no easy solutions. That might change quickly and Berkshire will be prepared for that.

To wrap it up, Buffett has not lost it. Berkshire is doing quite well as shown by results in the past few years. I expect that results from subsidiaries and investments will be quite satisfactory in the long run.

One of Buffett’s attributes is patience. In the past, Munger has even called it “almost inhuman patience”. For example, after doing the Cap Cities deal in 1985, Buffett went 3 YEARS without buying a SINGLE stock. Then he made one of his best investments ever, taking a huge and outsized position in Coca-Cola.

Some might see the lack of action as if Buffett is losing it. I see it as discipline. As a long-term Berkshire shareholder, I am comfortable with this.

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