Larry Sarbit: The critics have Berkshire Hathaway in their sights, but they’ve been wrong before
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Jul 30, 2020 • • 5 minute read
For decades, Warren Buffett has been regarded as likely the greatest investor of all time. Recently, however, many discussions about Buffett have centered around a single question: “Has Warren lost his touch?” Where do these doubts come from?
Well, Berkshire Hathaway, like many “value investors,” has slightly underperformed the S&P 500 on a total-return basis over the past decade. In particular, the critics point out, the stock’s performance this year has been lackluster. Berkshire shares are down more than 14 per cent so far in 2020, wiping out more than US$80 billion in market value, while Big Tech growth names such as Amazon have seen their valuations soar.
While it is easy to be blinded by the stock’s recent underperformance, it’s important to remind ourselves that since 1965, Buffett has produced an average annual return of 20.5 per cent. There are only a handful of investors in the world that have been able to generate such returns. Even more spectacular were the returns of his Buffett Partnership, which compounded at an amazing 29 per cent from 1957 to 1966. Charlie Munger, his partner for decades, ran a partnership from 1962 to 1975 where his investors compounded at almost 19 per cent.
Unfortunately, I would wager that most uninitiated investors don’t have a long-term perspective and likely never will. Berkshire’s loudest critics include characters such as Dave Portnoy from Barstool Sports, who slammed Buffett for unloading airline stocks as the coronavirus epidemic exploded on the world scene, calling him a “washed up investor who’s no longer relevant.”
My comeback is a quote from Lord Keynes, who said, “When the facts change, I change my mind. What do you do, sir?” The facts for the airlines changed dramatically with the arrival of the coronavirus. No one saw this global pandemic coming, including Buffett. And no one knows what will happen to the airlines in terms of survival. Thus, Buffett changed his mind because he saw nothing but uncertainty going forward. In my opinion, Buffett made a difficult but necessary reversal.
Shane Parrish from Farnam Street, a value-based investment research firm, summed up Buffett’s strategy: “You have to be willing to look like an idiot in the short term to get the best long-term results. I’d suggest that because the future has become increasingly uncertain, he’s preparing for the widest range of possible futures.”
People also questioned Buffett’s intellect back in the late 1990s when he refused to participate in the tech bubble that finally burst in 2000. I remember being at the Berkshire Hathaway annual meetings back in the late 1990s with investors trying to pressure Buffett to buy tech stocks.
After hearing question after question on the topic, framed in slightly different ways, Buffett had a rare moment of frustration — almost anger. But he always delivered the same answer: he had absolutely no interest in playing in that sandbox.
It should be noted that there are similarities between then and now. Day trading was in full swing; growth stocks went to the moon; value stocks languished. In late 1999, as Berkshire was underperforming the S&P 500, Barron’s magazine published an article entitled “What’s Wrong, Warren?” and proclaimed that he might have been losing his magic touch. “To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, even passé,” the article said. “Buffett, Berkshire’s chairman and chief executive, may be the world’s greatest investor, but he hasn’t anticipated or capitalized on the boom in technology stocks in the past few years.”
So why do we own this so-called has-been company and its 89-year-old manager? Well there are a few great reasons.
First, the company is generating about US$2 billion a month in excess cash, a staggering number.
Second, the company recently bought Dominion Energy for about US$9.7 billion, expanding its significant energy portfolio. On a simplified basis, this purchase price only amounts to about five months of current cash flow.
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Third, Berkshire has plenty of dry powder remaining. Prior to the purchase earlier this month, the company was sitting on a mountain of cash-around US$137 billion. If you are an indexer and want to buy stocks, this seems crazy. But just like he poured assets into cheap stocks in 1974 and again in 2000 when the market collapsed about 40 per cent, as well as during the 50 per cent collapse in the Great Financial Crisis of 2008, we believe that cash will be deployed once Buffett is able to find a few large bargains.
Fourth, the stock is cheap. Berkshire is now trading near book value, something we have not seen since the financial crisis. This is likely as cheap as it gets for a company which generated more than US$20 Billion of free cash flow in 2019.
The stock is especially cheap when you factor in that almost the entire gain in the market value of Berkshire since the S&P 500 bottomed in March can be attributed to the extraordinary gain derived from its Apple Inc. holding. Taking out the appreciation of its Apple shares, the value of BRK is virtually unchanged since mid-March, while the market has rallied nearly 50 per cent.
Fifth, based on regulatory filings in recent months, it appears that Berkshire has bought back a significant amount of stock in the past two to three months.
Lastly, the company remains predictable, and focused on capital preservation. Buffett, and those that follow him in managing Berkshire, will continue on the path that Warren and Charlie have laid out: find companies with sustainable competitive advantages, repeatable earnings models, room for growth, significant free cash flow, and great management teams at the helm. And if they can’t find such companies at attractive prices, they will wait.
When the crowd starts thinking that one of the greatest minds in the world has lost it, all you have to do is look back at his historical successes, which include his non-actions, as he waits for exactly what he wants.
What’s required for investors, which Buffett has demonstrated repeatedly, is the virtue of patience. As noted above, every time, that has rewarded shareholders handsomely. We believe he (and us as well) will have that wonderful opportunity.
Larry Sarbit is a portfolio manager atValue Partners Investments in Winnipeg. He can be reached email@example.com.
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