Right on the front of Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) latest quarterly report is a table that clearly illustrates how exceptional Warren Buffett (Trades, Portfolio) is as a capital allocator. The table I am talking about shows the securities registered by Berkshire that are available for trading on the New York Stock Exchange.
Along with the Class A and Class B shares, the company's publicly traded debt securities are also profiled. Most investors might not be interested in this data deluge, which seems like a bureaucratic requirement. However, there is an important message here.
Looking at this table, we can see that Berkshire has been issuing senior notes into the market to raise money via debt at interest rates not exceeding 2.625%. This interest rate is payable on its longest dated maturity, senior notes maturing in 2059.
Notes with shorter durations have much lower interest rates. For example, a senior note maturing in 2025 has an interest rate of 0%, and a note maturing in 2041 has an interest rate of 0.5%.
Buffett's approach to debt
Buffett has frequently said that one of the worst investment decisions people can make is borrowing money to buy equities or borrowing too much to buy businesses. He has also said that individuals should try and avoid borrowing at all costs and keep their financial profile as clean as possible.
Even though Buffett says this, he has used a different approach to his businesses in real life. On several occasions, the Oracle of Omaha has borrowed significant amounts of money when he has concluded that the potential return far exceeds the risk and cost of borrowing. In recent years, he has been taking advantage of the low interest rate environment to borrow money at near-zero interest rates and reinvest this cash into Berkshire.
This is an incredibly astute capital allocation policy in my view. Borrowing at 0.5% for several decades means that the investor only needs to achieve a return of 1% per year to repay the cost of capital.
Why not use cash?
Some might ask why Berkshire needs to raise additional debt when it still has its legendary cash pile. However, it's important to note that the continued existence of the cash pile is necessary in order to maintain the huge competitive advantages of Berkshire's insurance businesses. Having that liquidity is extremely important, so it still makes since for Berkshire to focus on issuing new debt when interest rates are low.
The corporation has repeatedly generated double-digit returns on invested capital. Therefore, I don't think we should be in any doubt that the business will earn its cost of capital with borrowings costing less than 3% overall.
The decision to borrow money at ultra-low interest rates looks even more sensible with interest rates rising higher now and inflation nearing the double digits. Debt with a nominal interest rate of 0% currently has a real interest rate of -8.5%. In real terms, the company's liabilities are shrinking.
Capital allocation decision
The table on the front of the quarterly report only shows part of the picture. Further information is contained within the report illustrating the company's borrowing in different markets. In January, the corporation issued approximately $1.1 billion of senior notes to Japanese investors with a weighted average interest rate of 0.5%. It has also been raising money in Europe, where interest rates have been held below zero for several years.
This decision to lock in low interest rates by borrowing money in different regions around the world is already generating a windfall for Berkshire as its liabilities after adjusting for inflation are falling rapidly. At the same time, its earnings are growing thanks to rising prices.
Investors spend a lot of time analyzing Buffett's investment decisions, but I believe his capital allocation decisions are just as important and can be far more influential in Berkshire's future performance. The decision to raise money at such low interest rates will generate a payoff for the company and its investors for many years to come.
