David Rolfe Comments on Berkshire Hathaway
Berkshire Hathaway is a good example of how we expect long-‐term value creation to drive excellent shareholder returns, provided that we do not overpay for such potential returns. Consider the Company's share repurchase strategy, which authorizes management to repurchase shares at prices equivalent to or less than 120% of book value. Berkshire currently has in excess of $40 billion in unencumbered cash on its balance sheet, relative to slightly more than $300 billion market capitalization, so there are substantial resources available for the Company to execute such a buyback strategy. Assuming book value growth falls short of our double-‐digit expectations, we expect shares to simply not appreciate, rather than depreciate, as we estimate shares currently trade near 120% of book value, with buybacks effectively providing a valuation "floor." So we could be wrong about Berkshire's upside, but we think we have accounted for that risk by ensuring relatively limited downside. We conclude by reiterating that any business can sell $100 bills for $95 to generate billions of revenue. But that is not a true value proposition. We believe that profitability represents the existence of value creation and capture – the higher the sustained profitability the better. Further, as these profits are retained and successfully reinvested back into the business at continued high levels of profitability, the ensuing earnings growth is what drives long-‐term shareholder returns. While not all businesses have such an explicit (and accretive) buyback strategy as Berkshire, it is a good example of why we look for businesses that not only have ample profitability and per-‐share earnings growth but also trade at attractive valuations. We like the rewards of a rapidly appreciating stock just as much as any investor, but we also like to maintain those rewards by recognizing the ever-‐present risk that we could be wrong.
These risks are certainly higher today and very much at the forefront in our minds as the current bull market just passed its 5-‐year anniversary. Prudent, repeatable investment "process" implies investment "discipline." Our focus on value in the current bull-‐run environment requires more rarified investment "restraint."
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners first quarter 2014 commentary.