The Berkshire (Hathaway) duo, none other than Warren Buffett and Charlie Munger, have been in the news this week. With Buffett at just 90 years old and Charlie Munger at a sprightly 97 years old, even TikTokkers almost feel bad when they throw the “ok, Boomer” line at these elderly statesmen of the investing community.
Boomers were born between 1946 and 1964 by the way, so neither of these fine gentlemen are boomers. In fact, they are of the Silent Generation, when children were to be seen and not heard. I’ve seen some particularly irritating TikTok analysts who I wish that would apply to.
Nevertheless, “Boomer” has become a collective noun for anyone with grey hair or old-fashioned views though, so we will just lump them in with that group for the purposes of this article.
Munger, vice chairman of Berkshire Hathaway, managed to annoy the kids (and tech entrepreneurs everywhere) by saying that Bitcoin is “too volatile” to be considered a global medium of exchange.
At the risk of painting myself as a Boomer too, I must point out that he’s right. I also wouldn’t want to be paid in an asset that could lose 20% of its value by next week. Or even tomorrow morning.
However, as close followers of The Finance Ghost will know, I spent two solid weekends researching cryptocurrency and I got my head across the line that holding some crypto in my portfolio makes sense.
I don’t see it as a currency though. I see it as a digital store of value that looks interesting alongside gold, not instead of it. In other words, I hold both. It’s worth noting that Munger doesn’t buy gold either.
Asking a 97-year-old with zero interest in gold to get excited about a digital store of value was always going to be a stretch…
However, Buffett and Munger still had the world eating out of their wrinkly palms as they sent out their annual letter to Berkshire Hathaway shareholders. With a share price of nearly $365,000 per share, I’m only a NYSE:BRK shareholder thanks to the joy of fractional share ownership.
Will we ever see a world where a Bitcoin is worth more than a Berkshire Hathaway share? Honestly, I don’t know, but I do know that the most iconic value investors in the world still have many lessons to teach to those willing to listen.
So, here are some interesting points about Berkshire Hathaway’s performance that I feel you should know:
The Berkshire Boys have beaten the S&P500 for decades
From 1965 to 2020, Berkshire Hathaway achieved a 20% compound annual growth rate (CAGR) in Dollars, which is outrageous. The S&P 500 could only manage 10.2% CAGR over the same period. The difference is even larger than first appears, as the Berkshire measure is only the share price (i.e. no dividends) whereas the S&P 500 rate includes dividends (a total return index).
Using round numbers, if you had put $1 in Berkshire Hathaway and in the S&P 500 Index in 1965, your money would be worth over $28,000 with the Oracle of Omaha and just $235 in the index.
Albert Einstein allegedly described compound interest as the “eighth wonder of the world” and I’m not going to argue with either him or Buffett. As Boomers go, they are hardcore.
The growth investing decade hasn’t been kind to Berkshire
This is where it gets interesting.
The last major global crash before Covid-19 was the banking crisis in 2008. At the end of a bull market particularly for energy companies and investment banks (who subsequently broke everything), the world changed drastically.
The baton of wealth creation was passed to the tech companies. To what extent did the Berkshire team adapt?
The answer is… not much.
If you had put $100 in each of Berkshire Hathaway and the S&P 500 on 1 January 2009 in preparation for an economic recovery, Buffett and Munger would’ve turned your hard-earned Dollar into $360 and the index would’ve grown it into $534.
In percentage terms, Berkshire achieved a 11.3% CAGR and the index returned 15.0% CAGR. Value investing has had a tough time.
The portfolio stakes are old-school
Berkshire isn’t a tech fund by any means.
Apple is $120bn of the $281bn worth of minority stakes in listed companies. Other major stakes include corporate dinosaurs like Bank of America, The Coca-Cola Company, American Express Company and various other big names ranging from Chevron and Moody’s through to General Motors and Verizon Communications.
Typically, these are value plays – mature companies that pay dividends and hold dominant market positions in certain industries.
This approach is why Berkshire has underperformed the index over the past decade or so. Growth stocks have been all the rage. Other than Apple, there is no material overlap between Berkshire and the Nasdaq stocks that set the world alight in the past few years.
This makes Berkshire an extremely useful tool for portfolio diversification and is exactly why I own it. I have a number of the tech companies in my portfolio and I get to buy into Berkshire to obtain access to meaningful stakes in the more traditional industries.
Most of the magic is in four businesses
The largest of the “family jewels” is a property and casualty insurance business, which has been the core of the group for 53 years. The incredible strength of its balance sheet allows the business to almost function as a bank within the Berkshire group, enjoying inflows from other group businesses and deploying capital into other investments.
Second and third are a “toss-up” according to Buffett: a 100% stake in America’s largest railroad (BNSF) and a 5.4% stake in Apple. Minority interests aren’t a bad idea when you get to own a decent slice of something as delicious as Apple.
The fourth most important business is Berkshire Hathaway Energy, a utilities business with $3.4bn in earnings.
Acquisitions meeting their criteria have been thin on the ground
The market has been frothy to say the least.
Against this backdrop of inflated valuations, Berkshire made no sizable acquisitions in the past year. Instead, they elected to repurchase around 5% of the shares in issue.
Share buybacks usually happen when management either believes the shares are undervalued or they have no better use for the money. In this case, it appears that the latter was certainly a driver of the decision, although the annual letter does talk to a desire to increase intrinsic value (a fancy description for trying to create value through share buybacks i.e. because the shares are undervalued).
The letter quite brilliantly describes the plague of “investment holdcos” that has hurt investors on the JSE
One of my pet hates on the JSE is investment holding companies that operate by mopping up average businesses in exchange for new shares in the listed company.
In doing so, they attempt to turn a basket of 5 P/E companies into something that is promised to trade at 10 P/E, citing “diversification” as a value creation tool. Bluntly, a fruit basket of rotten apples isn’t going to be priced like a bag of export quality apples that has just been packed.
Yet, investors lapped up that story for years. EOH, Steinhoff, Ascendis… it’s a long and sad list.
As a nod to old-style conglomerates that overpay for private companies on a continuous basis, the letter gives an example of “I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats” – a great analogy of paying too much for acquisitions and issuing shares at vastly inflated prices.
Eventually, that house of cards collapses. If you’re brave, you wait to buy the cards when they are busy being restacked in a smarter and more sustainable way, like I’ve done with EOH, Steinhoff and Adcorp.
You can’t value Berkshire Hathaway using operating earnings
Due to accounting rules, when it comes to Berkshire’s minority stakes, the company can only recognise the value of dividends received. The value of retained earnings is not brought into Berkshire’s results until the stake is eventually sold and a large capital gain is hopefully recognised. This isn’t the case for the companies controlled by Berkshire, in which full earnings are brought in (and a non-controlling interest recognised).
Without getting into technical accounting, the point is that to value Berkshire, you need to delve into the underlying portfolio and start applying a sum-of-the-parts valuation technique. If you could imagine putting a price to a car by adding up the value of all the underlying components, you’re on the right track.
Not in the letter – playing in the SNOW
There are really two important questions as we close off here:
- Can the Berkshire team adapt?
- Should they?
As already mentioned, I like Berkshire because it gives me a single access point to the best value investor team in the world. Although they couldn’t beat the market in the past decade because of their investment style, that doesn’t mean they did “badly” – they stuck to a mandate and were allocated capital by investors as a result.
However, assuming they should adapt and listen to the cries of “ok, Boomer” on social media, they have already demonstrated the power of access to IPOs.
When Snowflake listed on the Nasdaq, one of the frothiest of all frothy tech IPOs in the past year, Berkshire got involved. They invested $730m in the company at a pre-IPO price. Immediately after the IPO, the stake had doubled in value. After a further run, it’s back to where it was just after the IPO, which means Berkshire and its shareholders are firmly in the money.
The annual letter made no mention of this juicy little trade that they executed.
If Berkshire can build a powerful tech portfolio alongside its more traditional industries of interest, Buffett and Munger might even be able to create marginally successful TikTok accounts…