xxvi) Warren Buffett's Company (Berkshire Hathaway)

Over 50+ years, Berkshire Hathaway has grown into a US$ 700 b financial empire.

"...has outpaced the S&P 500 (a broad index of American stocks) by almost 2.5 million percentage points..."

Robert Armstrong et al 2019

On the other hand, since 2007, he has fallen behind the S&P 500.

This firm is showing the classical S-curve, ie rapid growth followed by performance leveling and the need to reinvent itself to continue its upward growth performance (see below graph).

For decades, its plain-dealer persona has been an integral part of his success with Berkshire concentrated on the volatile sectors, such as energy and finance. 

His firm was trounced by the market during the tech boom (starting 1999) and did not predict the swing back to sensible investments. Yet in 10 years following 1999, Berkshire's shares rose by almost 80% while the S&P fell. For example, 

"...in 2008 and 2009, Buffett made a series of lucrative deals to provide capital to financial institutions, including Goldman Sachs which sold Berkshire $US 5 b. preferred shares - a debt like instrument had paid a 10% yield. Goldman's debt now deals with a yield of 4%..."

Robert Armstrong et al 2019

Recently things have changed. Buffett has had a long stretch of under-performance as competition has increased for the kind of assets he prefers, like 

"...big companies that are easy to understand but hard to dislodge from their competitive positions..."

Robert Armstrong et al 2019

Competition is increasing with the rise of private equity firms who are more "over-funded" and "debt-happy" than Berkshire. It is estimated that they 

"...have roughly $US 1.2 t. in commitments from investors that can be doubled with the use of debt..."

Robert Armstrong et al 2019

Buffett prefers to use equity than debt.

Some of his investments have gone wrong, like Kraft Heinz and IBM before that. 

The Kraft Heinz deal involved Berkshire joining with  private equity group (3G) to buy Heinz in 2013 and merging it with Kraft in 2015. Despite making excellent returns for the first few years, Berkshire took a $US 3 b. write down of its investment. The reason for this write-down was putting short-term profits over the long-term health of its business. For example, they 

- borrowed heavily, 

- laid-off thousands of employees, 

- made a failed $US 143 b. bid for rival Unilever,

- over-estimating the strength of the Kraft Heinz brand

- under-estimating the power of the retailers

- failed to anticipate a shift in the market away from big brand packaged foods, like Kraft, to ostensibly healthier options and boutique brands

This pattern was in contrast to its performance in the 1950s and 60s, Berkshire was a machine for accumulating mis-understood and under-valued shares and companies.

Thus Berkshire needs to reinvent itself and is experimenting with the following approaches:

- buying whole companies at a fair price sometimes by using low cost debt to finance it, like incoming premiums from Berkshire's vast insurance enterprise

- building a cash reserve from selling portfolio companies that are not performing (as they are under the Berkshire holding company, the transfers are not taxable)

- investing some of the excess capital in publicly traded, blue-chip stocks

- have enough cash reserves ready for the next right deal when it presents itself, ie next financial crisis

- succession planning as both Buffett and his offsider (Charlie Munger) are not young men!!!!

NB He is not keen to buy companies that need help

Some other challenges facing the company (2019)

- its sheer size, eg 

i) each working day US$ 100 m. comes in from its subsidiaries, dividends, interest, etc

ii) assets worth around $US 700 b.; with $US 112 b. in cash and cash-like investments

This means only vast investments can meaningfully improve its performance, eg publicly-traded stocks it can buy are no more than 100. Buying companies outright is not easier. For example,

"...A billion-dollar company that immediately increases in value by 50% hardly helps at all: making $US 500  m. sounds great and $US 1 b. sounds like a big investment but $US 500 m. is less than a 10th of a percent as a contribution to Berkshire's assets..."

Robert Armstrong et al 2019

Maybe a way to handle the sheer size  is to get smaller, ie pay dividends and/or sell business units and/or buy back shares, ie

"...why not get smaller, so that Berkshire can get back to producing outsized returns..."

Robert Armstrong et al 2019

Berkshire has started to reduce the company's massive pile of shareholder equity by buying back shares at the right price. It could have to buy back $US 100 b. of its shares!!!!

In mid-2018 Berkshire Hathaway modified its share repurchase criteria to when Berkshire's shares are below their intrinsic value "conservatively determined". Previously, Berkshire was only interested in buying its shares if they traded below 120% of book value (The Lek Column 2018). Thus Berkshire has the firepower for both blockbuster deals and capital returns.

Furthermore, at the start of the Covid - 19 pandemic (2020), Berkshire Hathaway had around US$ 180 b in cash ready to invest. It was therefore ready to make strategic investments, as it did during the GFC when the Bank of America Corp shares tumbled. Berkshire invested US$ 5 b. in exchange for a preferred stock and warrants.
"...The bank's share price has surged 300% since then, and Berkshire is now the largest holder of its common stock..."
Tara Lachapelle 2019