Judging from the lack of market reaction, many people seem to think Berkshire Hathaway will do just fine without Warren Buffett overseeing every significant decision. Mr. Buffett during a Berkshire annual meeting weekend in Omaha, Ne. on May 3, 2015.Rick Wilking/Reuters
After Warren Buffett surprised markets earlier this month by announcing that he was stepping down as chief executive of Berkshire Hathaway Inc. BRK-A-N BRK-B-N, a funny thing happened to the company’s stock price.
It barely budged.
Those who had predicted a stampede out of Berkshire once Mr. Buffett left the scene will have to think again. Despite the imminent retirement of one of the greatest investors of all time, Berkshire stock remains up about 13 per cent this year.
Judging from the lack of market reaction, many people seem to think the company will do just fine without Mr. Buffett overseeing every significant decision. Perhaps that reflects confidence that he has built a top-notch team to replace him. Or perhaps it simply reflects massive inertia.
If you’re worried about the latter, this is a good time to ask whether Berkshire is still worth buying or owning.
Full disclosure: I’m grappling with this question in my personal portfolio. I’ve owned Berkshire shares for just over 20 years and have done well with them – in fact, I’m up about 900 per cent on my investment.
My problem is that I’ve never fully bought into the adulation that surrounds Mr. Buffett. A decade ago, I grew skeptical about his ability to keep pace with the broad market and sold half my initial Berkshire stake. No insult to the great man: My doubts were rooted in how big Berkshire had grown. Mr. Buffett himself warned that he was finding it difficult to turn up attractive investments that were large enough to meaningfully affect the company’s share price.
As it turned out, his misgivings and mine were misplaced. Over the past 10 years, Berkshire managed to keep up with the red-hot S&P 500 index. That is an impressive feat.
However, it’s not that impressive. Berkshire and the S&P 500 have produced nearly identical results over the past decade – a 246-per-cent gain for Berkshire versus a 237-per-cent total return for the S&P 500 with dividends reinvested. All things considered, I did just about as well on my non-Berkshire U.S. index investments as I did on my remaining Berkshire shares.
So why not just shun Berkshire and buy a plain-vanilla S&P 500 index fund instead? This is where we get into matters of faith and speculation.
Being a Berkshire shareholder involves a belief that the company has discovered a better way to invest. There is some evidence for this happy conviction.
A 2013 research paper by Andrea Frazzini, David Kabiller and Lasse Pedersen of AQR Capital Management probed Berkshire’s track record under Mr. Buffett. After an impressive amount of mathematical analysis, the researchers concluded that the company’s secret sauce consists largely of leveraging safe stocks.
This is not quite as simple as it sounds. Berkshire’s strategy involves three major components.
First, it avoids speculative long shots. It focuses instead on dependable, boring companies – what the AQR researchers call “cheap, safe, high-quality stocks.” Coca-Cola Co. KO-N, American Express Co. AXP-N and Moody’s Corp. MCO-N are fine examples.
Second, it uses the float generated by its insurance operations to magnify the returns from those safe stocks. (Float is the money that an insurer controls between the time that customers pay their premiums and the time that claims are paid out. The insurer can invest that money, which amounts to free financing for its portfolio so long as the insurer manages its risks properly.)
Finally, Berkshire benefits from a corporate structure that insulates the company from fickle investors. Unlike the situation at a mutual fund or a hedge fund, nervous investors can’t pull their capital during rough patches. This allows Berkshire to stick to its strategy through even the maddest market turmoil.
These structural advantages seem likely to persist at Berkshire even after Mr. Buffett is gone. Granted, it will not be an exciting company, but that is precisely the point: By adding a modest amount of leverage from its insurance float to a portfolio that tilts toward reliable, high-quality stocks, it should remain capable of producing decent returns without undue risk.
So does that mean it’s a buy? Opinions will differ. Greggory Warren, a Morningstar analyst, figures Berkshire is slightly overvalued. He puts a US$487 fair value on its Class B shares, slightly below the US$510 they are now trading around.
I can understand why Mr. Warren is underwhelmed. Based on price-to-book value – the time-honoured way to value Berkshire – Mr. Buffett’s empire looks to be at the expensive end of its trading range over the past decade.
However, Berkshire still possesses unique advantages. Most notably, it has amassed a cash pile of US$333-billion. That gives it a huge amount of firepower if the market should tumble and buying opportunities emerge.
If you’re like me and think that the U.S. stock market rests on a shaky foundation of massive deficits and turbulent politics, Berkshire offers comfort. It is cash-rich, managed by smart people and tilted toward value and quality. For now, I’m holding on.