Can Berkshire Hathaway Get Its Mojo Back?

Under the leadership of Warren Buffett (Trades, Portfolio), Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial) has grown into a cash-generating machine. Few businesses can hold a candle to its vast cash pile, let alone its diversified and profitable subsidiaries.

Yet, for all its success, Berkshire has lagged in recent years. Indeed, the Oracle of Omaha’s flagship company has been underperforming the market for more than a decade.

Underperforming the crowd

For decades, Berkshire Hathaway outpaced broader stock market performance by a considerable margin. Its persistent compounding growth turned the company into a financial and operating behemoth. However, on a narrower time scale, things are far less exciting.

Berkshire lags the performance of the S&P 500 index on one-year, five-year, 10-year and 15-year time horizons. Only when we consider performance on a 20-year basis does Berkshire come out ahead. Buffett and Berkshire are all about the long term, but two decades is a long time to wait for a company to deliver.

Sweetheart deals are not enough

Berkshire’s underperformance is surprising in light of its numerous sweetheart deals over the past several years. Even factoring in these gains, the conglomerate has only managed to track the S&P 500 since 2002, as Albert Bridge Capital’s Drew Dickson has explained:

“Cherry picking a little, but since 2002, up to and including this year, Berkshire Hathaway has broadly mimicked the S&P (underperforming a little), and that includes the sweetheart deals.”

Such sweetheart deals offered rich rewards. For example, Buffett won highly favorable terms from both Bank of America (BAC, Financial) and Goldman Sachs (GS, Financial) in the midst of the financial crisis, deals that profited Berkshire about $15 billion and $4 billion.

A lament for the value investor

This long bull market has dented the performance of numerous value funds. Berkshire, while largely an operating company, is still a value-oriented business, as is its vast stock portfolio. As Bloomberg recently commented, this might give us reason to cut Berkshire some slack:

“To be fair to Buffett, a lot of that is due to stock investors’ continued preference for hot growth stocks, which the classic value investor like Buffett has largely avoided. These include names such as Microsoft, Amazon and Alphabet. Meanwhile, Berkshire’s management team oversees a private portfolio of companies described by the CEO as a ‘Niagara’ of cash generation...But the rest of Wall Street hasn’t been interested in hunting for value amid consumer staples companies or big banks, opting instead for flashy acronyms stocks such as the FANGs.”

Berkshire’s lagging stock performance cannot be blamed on poor execution or diminishing profitability. Far from it. Rather, it appears to be driven in large part by the market’s fixation on growth stocks and broad rejection of value investing principles.

Capital allocation blues

The longest bull market in history has served as a rising tide, lifting all boats to some degree. That has made finding bargains increasingly difficult. Some shareholders worry this will make capital allocation more difficult for Berkshire, as its valuation is predicated on using its cash pile to buy other profitable businesses. Baldwin Brothers’ Michelle Bailey recently aired this growing concern:

“We have owned Berkshire Hathaway at Baldwin for a significant amount of time and continue to incorporate it into our proprietary equity strategies to reflect that legacy positioning but also to capture the conglomerate’s earnings potential. We are, however, becoming increasingly uncomfortable with Berkshire, as we also built our position to reflect the conglomerate’s historically noteworthy cash conversion and capital allocation.”

Verdict

Buffett has acknowledged the challenges facing Berkshire several times, yet he recently sounded an optimistic tune on the prospect of acquisitions:

“2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition.”

Buffett’s reputation for ferreting out buyout bargains is rightfully legendary, but his confidence this time has not managed to convince skeptics.

As long as the bull market persists, it will be very challenging for the guru to deliver a market-beating performance.

Disclosure: No positions.

Read more here:

• The Tesla Growth Story Is Dead
• Bernard Baruch's 10 Commandments for Investors, Part 2
• Zillow's Strategic Transformation Presents New Dangers

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.