Earlier today, YouTube served me a video of an interesting presentation by Greg Warren, the Morningstar analyst who covers Berkshire Hathaway (“BRK”). Greg said something that I had been thinking about and inspired me to get my thoughts down. So, rather than write about any of the topics I had planned, I am going to share a few thoughts on Berkshire Hathaway’s cash horde and Greg Warren’s: Five Reasons to Consider Buying Berkshire Hathaway.
As you may know, people keep discussing the size of the cash balance on Berkshire’s balance sheet. Usually this is in the context of BRK’s recent underperformance relative to the S&P and the impact of the size of BRK on expected future returns. For a little primer, I’ve discussed BRK before: Einhorn Versus Buffett a Great and the Goat on Apple [that Apple tho!], Is Berkshire too Big to Succeed, Is 2019 Berkshire too Big to Succeed.
A couple of these posts have focused on the size of BRK and the impact thereof on returns. I think the basic conclusions I have reached were:
1) Buffett’s sober appraisals of future return expectations are not probative (as they have been status quo since the 50’s); and
2) the comparisons of BRK’s size to the market cap of public U.S. equities is not really the best comparison since they invest more in private businesses and the insurance markets; and
3) unique “merchant banking” type opportunities arise partially as a result of their large scale.
So basically, I think there’s still a good chance BRK outperforms the S&P over the long term (on a per share basis).
Five Reasons to Buy BRK
Here’s the video with Greg Warren:
If you have time to check it out, it is a good presentation. I also recommend that you subscribe to the valueDACH YouTube channel. They are German investors and have been putting together some great (English language) content (I studied German in college, but I mainly remember the name of the TA who taught the class, so I can’t really follow their German language stuff, though I’m sure it is wunderbar).
Overall, Mr. Warren is not highly bullish on BRK. For a more bullish take see this article containing comments from Bill Ackman detailing his recent decision to invest in BRK.
The Cash Horde
The main reason that this presentation prompted this post was Mr. Warren’s discussion of the BRK cash balance in the context of performance. At the beginning of the presentation, he says something (almost as an aside) that squares up with what I’ve been thinking about the cash balance.
First, as a number of people have pointed out, cash has historically sort of tracked the insurance float. Kyler Hasson over at Concentrated Compounding comes to mind as a guy who has posted about this (maybe more on twitter). Here’s a link to an article discussing aspects of the relationship. The key takeaway from all of this to me is that focusing on the nominal large cash balance is a version of denominator blindness.
Many investors and commentators keep discussing why WEB isn’t buying back BRK stock or paying out a dividend with that cash. They continue to furiously analyze the current valuation and the share count each quarter waiting for huge buybacks.
In the presentation, Greg (“Mr. Warren” is too confusing in the BRK context) ever so briefly mentions that Buffett may be letting the cash build with at least a partial view to what happens when he leaves the stage. He even indicated he has had some indications that this theory is accurate “from Omaha.” This might manifest itself by being conservative about buybacks (and also setting a higher return hurdle for deploying cash elsewhere).
This is the exact thought I’ve had when I read the “hot takes” about Mr. Buffett failing to buyback tons of stock here. I wouldn’t hold my breath. The most rational (and impossible for most of us) analysis of future potential opportunities/expected outcomes (and returns) would be to fully contemplate ones own age and mortality and the potential impact on the valuation of BRK around that event.
The most rational analysis would be something like, “I could buyback stock at 1.3x book, but I am 89 and when I leave BRK there is likely to be some uncertainty about the future and pressure on the valuation. Buybacks could have a materially higher expected return at that point in time and benefit those who are proving most loyal to my legacy. So I will be relatively conservative concerning buybacks and the cash balance.” I think very few of us would be able to conduct this analysis. I bet WEB can.
Even if WEB surpasses Irving Kahn’s career longevity by a bit, we’ve got maybe 20 years or so left. That huge “special situation” could be viewed as increasing the option value of the cash on BRK’s balance sheet (at least with respect to BRK buybacks).
TLDR
In sum, while I would not be surprised be surprised if BRK deploys a large chunk of cash if the right opportunities emerge, I do not expect massive buybacks at only “good” valuation levels. In my opinion, the greatest investor of all time is rational enough to analyze the potential impact of his own mortality on his life’s work (BRK) and to conclude that cash could have a higher value in the future to benefit BRK, his shareholders, and his charities, after he has exited the stage.
This could result in a higher hurdle for distributing or investing cash than would otherwise be the case. If this is true, those crying for buybacks or for lowering the hurdle rate to deploy cash will continue to be disappointed, but long-run BRK shareholders seem likely to, once again, reap the benefits of WEB’s patient approach.