Since his last significant acquisition in 2015 (Precision Castparts Corp.), Warren Buffett (Trades, Portfolio) has been sitting on his hands.
Even though his conglomerate, Berkshire Hathaway Inc. BRK.A BRK.B, now has more than $100 billion of free cash sitting on its balance sheet waiting to be spent, he has held back, citing high prices and a lack of attractive opportunities as the reason why he has not made any big deals during the past four years.
This lack of action, coupled with his decision to abandon book value growth as his preferred method of shareholder value creation at Berkshire and his underperformance compared to the S&P 500, has led to some media commentators and analysts starting to question if Buffett has lost his touch.
Has Buffett lost his touch?
This isn't the first time outsiders have questioned the Oracle of Omaha's strategy. Throughout its long and storied history, there have been many extended periods were Berkshire has lagged the S&P 500 and Buffett has refused to do any significant deals. The reason why is usually the same: He won't pay over the odds for any business.
The historical letters and annual meeting transcripts of the storied Sequoia Fund, which was founded in 1970 by Bill Ruane, one of the handful of successful value investors Buffett profiled in his 1984 article, "The Superinvestors of Graham & Doddsville," gives some insight into what to do when Berkshire is underperforming.
For many years, Berkshire was one of Sequoia's most substantial investments. In fact, in the early 2000s, the position accounted for around 25% of the fund's assets under management.
According to a transcript of the Sequoia Fund's 2005 annual shareholders meeting, one investor raised concerns about Buffett's lack of activity.
Citing the successful investments made by a number of other high-profile investors and funds in the years immediately following the dot-com bubble burst, the unnamed shareholder speculated if, "Buffett has sort of cornered himself by developing an investment philosophy that will not allow him to buy a stock that he doesn't intend to hold for 10 or 20 years."
Sequoia's managers respond by noting Buffett's long-term view doesn't constrain him. "Buffett has brought and sold some publicly traded stocks within a relatively short period of time," Bob Goldfarb said.
Jon Brandt went on to add:
"The leasing company in Chicago, GATX. He bought 15% of the company and subsequently sold it all. There are other ones. He bought and subsequently sold some of his H&R Block. He sold most of his Costco. He still owns a little, but he's in and out of some things."
In the early 2000s, Buffett was also trading in and out of junk bonds, which offered a yield to maturity of in the range of 20% to 30%. However, these were relatively small trades compared to the $40 billion of cash Berkshire had at the time.
On this topic, and in an attempt to answer why Buffett hasn't been more aggressive deploying this capital of the time, Ruane tried to summarize:
"You know, I don't think you have to make an investment. That's one of the problems that we have today in the investment field. People think they have to be doing something when the prudent thing might be to not do anything. And there are times when things are ridiculously high, and there are times when things are ridiculously low. And there are times when you have distortions in particular industries. At this particular time, I find in most areas where you can invest a lot of money, the prices simply are unlikely to reward you in a significant way, whether it's real estate or the bond market or stocks. And Warren has stated that over the next 15 years, and I think it will probably turn out to be less than that, he'll probably have an opportunity to put that money to work at some fairly nice returns. But you just never know when the opportunities will develop."
This is a fantastic summary of not just Buffett's investing style, but also value investing in general. Buffett has said thousands of times the best way to select investments is to stick to what you know and focus on risk reduction.
Companies that fall into your circle of competence and offer attractive risk-reward profiles are few and far between. The good news is, you never have to invest, so you can wait until the odds are well and truly in your favor before swinging at an opportunity. After all, investing is hard, successful investing is even harder and we need all the help we can get to achieve favorable results over the long term as investors.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Looking Back at Sequoia and Progressive
- Hedge Funds' Favorite Bets in 1st-Quarter 2019
- David Einhorn Roars Back WIth Value Bets
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