Last week, Barron’s had a piece about the attractiveness of Berkshire Hathaway (BRK.B) stock at these levels (mid-80’s per share). As with any article about Berkshire, the conclusion addressed the fact that Warren and Charlie are 82 and 88, respectively, concluding that this factor was the reason why the stock was so cheap (in terms of historical price/book). I’ve contemplated doing so many times, and decided that hearing this argument (yet again) without any discussion on the “control” Warren has as of today means that I must finally write this article. For the sake of simplicity, I will use year-end 2011 figures:
Let’s start off with the equity portfolio, and Berkshire’s four largest positions: American Express (AXP), The Coca-Cola Company (KO), International Business Machines Corp (IBM), and Wells Fargo & Company (WFC); here are the share holdings and market value of these positions:
In discussing these four holdings, Warren said the following in the 2011 annual letter: “We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects. We expect the combined earnings of the four – and their dividends as well – to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us.”
These four holdings are not going anywhere in the next decade; with that being said, there’s no question that Berkshire could sell their other stakes (as we’ve seen with PG and JNJ), meaning that we’re less sure about these remaining holdings as being out of play. Mathematically speaking, we see that these four positions accounted for nearly 60% of Berkshire’s equity portfolio at the end of 2011 ($76.99 billion); while the other $33 billion is certainly nothing to scoff at (plus billions more in fixed income securities and other securities that will need to be reinvested over time), it’s important to recognize that the four names from above are a meaningful portion of Berkshire’s investment portfolio, and will not be going away even after Warren does.
As we turn to the operating businesses, let’s start with another quote from the 2011 letter: “Charlie and I like to see gains in both areas, but our primary focus is on building operating earnings. Over time, the businesses we currently own should increase their aggregate earnings, and we hope also to purchase some large operations that will give us a further boost.” These investments are similar to our AXP, KO, IBM, and WFC holdings – once they are purchased, there’s no question that they will be part of the Berkshire Hathaway family for a long, long time; once Buffett pulls the trigger on his elephant gun, that capital investment is set in stone (the success of the investment – in terms of return on invested capital – is dependent upon the price paid, determined by the investment office; the success of the business after purchase is largely unaffected by who’s sitting in the corner office in Omaha).
Logically speaking, if the discount to intrinsic value was solely dependent upon who was making the capital allocation decision, then any deal announced by Berkshire while Warren Buffett is still with us should cause this gap to close, with larger targets resulting in increased convergence; every dollar spent today decreases the amount needed to be spent by someone other than Warren, decreasing the potential impact of their decision making.
In addition, Warren’s management style is really quite unique in that it involves limited direct involvement in subsidiary level operating decisions; in the words of Matt Rose, CEO of Burlington Northern Santa Fe (which Berkshire acquired in 2009), "I would describe it as very strange and almost bizarre the way he manages, because he doesn't manage." This isn’t to suggest he is aloof – Warren is likely involved in M&A and other financing decisions, and can be called upon when a second opinion seems prudent (there’s no question he’s ready – for example, Acme Brick CEO Dennis Knautz recently noted that he was “amazed” when Buffett appeared on CNBC and recited the company’s current production, pricing, and volume off the top of his head when asked about the state of housing); on the other side of the coin, Warren isn’t known as one to stick his nose in the day-to-day operations – he will not determine the success of BNSF under the direction of Matt Rose. Putting any sort of numbers around this is obviously difficult – but I think it’s safe to conclude that the vast majority of ongoing value creation from these businesses will come at the hands of their operating managers, not Warren Buffett.
The last issue to address is share repurchases; let’s go back to Warren’s 2011 letter one last time: “At our limit price of 110% of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower.” Regardless of who is at the helm, I would be willing to bet that anytime the stock trades below 1.1x book, the investment officer(s) of the company – whether it is Warren, Ted, Todd, or somebody else - will be in the market repurchasing Berkshire common stock. Naturally, increasing the percentage ownership of current shareholders by repurchasing common stock at a price below intrinsic value results in higher per share value for the remaining owners; when this happens, we each own that much more of the GEICO’s, Burlington Northern’s, and Clayton Homes’ accumulated over the years by Warren and Charlie. With the addition of the firm repurchase rule (set valuation metric and essentially unbounded time and quantity), Warren has effectively built-in a capital allocation decision that provides another avenue for using Berkshire’s cash pile without deviating from his investment criteria.
Collectively, the “permanent” equity holdings, the wholly-owned businesses, and the potential impact of a share repurchase, all amplify Warren’s impact on the long term success of the company – and as a corollary, diminish the impact of any new leader. Whoever takes the helm at Berkshire Hathaway will no doubt be important in allocating the billions in capital that flow through the company’s operating businesses and equity holdings over the coming years, an importance that only increases with time as new investments collectively become material; however, as we look at the starting line, much of what appears to be under their control is really locked up in securities and businesses selected over the past few decades – interests that will go unchanged regardless of how long Warren stays on as the CEO of Berkshire Hathaway.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.