Is BRK time to dump?Contra Guys: Why it may be time to dump Berkshire Hathaway
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter
We are major fans of Warren Buffett and his long-time partner Charlie Munger, who are surely two of the best investors in history.
Several years ago, we went to the Berkshire Hathaway annual meeting in Omaha to get a better taste of the two gentlemen. It is definitely worth taking the trip on the first weekend of May. Be aware that accommodation will be tight.
The two men have been remarkably disciplined on how they have measured Berkshire’s success with book value being at the heart of the valuation for over half a century. Reading Warren’s annual letters year after year, this key metric of assessment has been the same.
But last year that all changed with the designated evaluation becoming the stock price. This does not make sense to Benj.
First, one should understand why book value has been nixed. Accounting rules evolve over time and there is no question that the progression does not always make sense.
Warren and Charlie suggest the recent mark-to market transformation causes “wild and capricious swings in our bottom line.” No question, it does, but is that enough to alter how the corporation values success?
In 2018, while a US$2.8-billion capital gain was realized from the sale of securities, the bottom line was dinged to the tune of US$20.6-billion by a reduction of unrealized capital gains. Ouch! Good-bye book value.
Stock markets, as we all know, vary in valuation dramatically over time. Of course, individual companies do the same.
If one assumes that the stock price is the best means of measuring a stock’s value, then one is effectively backing the efficient market hypothesis, as espoused by Eugene Fama, which suggests that stocks always trade at fair market value as the prices encompass all information. This makes it impossible to beat the market.
When Benj was taught this during his MBA studies, he had a long debate with his professor who believed this theory to be true. Benj disagreed. This likely did not help his mark.
If this hypothesis is true, how does one account for the 22.6-per-cent one-day decline in 1987? Just a rough day at the office?
It is tough to rationalize that stock prices under that scenario remained perfectly efficient. The word “poppycock” comes to mind.
This also seems to contradict that last year Berkshire started buying back shares. After all, if the principals behind this outfit are bargain hunters, why would they buy something where the stock price approximates the value?
Perhaps to understand the “why” behind Berkshire’s decision you have to start with a core investing concept Buffett has discussed for years – the idea of buying productive assets when they trade at or below what is believed to be “intrinsic value.”
This is a difficult number to calculate, but, at its core, if the intrinsic value is 25 per cent above the trading price, then a stock could be worth buying. Previously, the goal was to purchase a stock well below book value.
The Buffett methodology has changed in other ways over the last few years. Previously buying into airlines was verboten. In 2017, stakes in four airlines were disclosed. Tech was also not on the buy list. Now Apple is in the portfolio.
Benj conjectures that Charlie and Warren are less involved in decision making than previously. He believes that more of the investments are being designated by his two most likely successors, Ajit Jain and Gregory Abel.
While it certainly appears that these two gentlemen are very able, he questions whether they will be able to approach Warren’s returns as their idea of value and Berkshire’s historical idea of value differ markedly.
If Benj still owned Berkshire Hathaway, strong consideration would be given to selling. Warren and Charlie will not be the headliners for much longer, being 88 and 95 years old respectively.
Wise investors might want to go to the AGM soon and check out the company and principals more closely and do their own analysis while gathering their wisdom. Proper due diligence goes beyond Benj’s opinion.
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Book value becomes less relevant as Berkshire’s non-stock assets grow larger. I like to value the stock based on a combination of the investment portfolio and an earnings metric on the rest of the business (ie, 10X earnings or whatever you consider rational, for the railroads and utilities and manufacturing and etc. etc. businesses, including underwriting profit from the insurance businesses). There’s still potential upside from here based on that kind of assessment, I think, largely because Berkshire’s large owned businesses are better and cheaper than many of their publicly traded counterparts, but the big reason I’m willing to own a large chunk of Berkshire and am unlikely to sell is that I expect Berkshire and its $100+ billion cash hoard to outperform the market during dark days. During bull markets, probably not so much (though it has done fine over the past few years).
Here’s Berkshire over the past three years:
And though yes, Warren and Charlie are getting older and giving up more control (though investing control is almost certainly coming from the hedge fund guys they hired a few years ago, not from Abel and Jain who are more likely to succeed Buffett as operational CEOs than to supervise investments), but predicting when they will retire or what that will mean for the stock has been a mostly pointless exercise for decades now. Here’s how the stock has done (compared to the S&P) since Warren’s 75th birthday:
Thanks for your thoughts Travis.
This is one company where succession planning must be a paramount concern. I truly wonder how much strategy and tactics the 2 are responsible for.
Succession planning has been a very public and paramount concern for 15 years, with Buffett talking about it and promoting people a little more each year. The biggest shift in their absence will probably be the mindset and the speed of decisionmaking at the top, and perhaps the loss of investor “benefit of the doubt” in management decisionmaking, not so much the strategic focus of the company, which probably won’t really change.