The evolution of Berkshire Hathaway

Warren Buffett at the Woodstock of Capitalism

The annual general meeting of Berkshire Hathaway Inc. (NYSE: BRK.A) took place in early May, virtually of course, due to Covid 19 precautions. It has often been described as the “Woodstock of Capitalism,” where in normal times, thousands of shareholders in Berkshire gather in Omaha, Nebraska for several days of meetings and jollity. The event is capped when Berkshire’s Chairman and CEO, 90-year-old Warren Buffett, and at age 97, his even more mature partner, Vice Chairman Charlie Munger, take questions for three-and-half hours. This year, as last, it was all done online. So what did we learn this year about the venerable conglomerate and its equally venerable founders?

Warren Buffett’s track record as investor commands respect. On page 2 of the Berkshire Hathaway annual report, Buffett always includes a graph comparing the performance of Berkshire, which doesn’t pay dividends, with an investment in the S&P 500 with dividends included. Over the 55 years since he took over a failing New England textile business and took on its name, Berkshire Hathaway has delivered a 20% annual compounded rate of return, almost double the 10.2% for the S&P 500 in the same period.

Long-term performance doubles S&P 500

There have been years when Berkshire’s stock has underperformed the index, and several of them have come in the last few years as Berkshire’s enormous size has made it increasingly difficult for Buffett to find investments that he describes as “elephants” – thost that are, as he puts it, big enough to move the needle for Berkshire as a whole. At US$641 billion, Berkshire’s market capitalization makes it one of the 10 largest companies in the world, exceeded only by Saudi oil giant Aramco and five of the six FAANG+s (Apple, Microsoft, Amazon, Google-parent Alphabet, and Facebook), Chinese ecommerce giant Alibaba, and Tesla.

Despite lagging the S&P 500 by 20 percentage points in 2019 (up 11% against 31.5%) and by 16 points in 2020 (up 2.4% vs. 18.4%), Berkshire has still almost doubled over the last five years, and only slightly lags the S&P over that period, up 97.4% compared with 104% for the index.

While Berkshire is not regarded as a technology play, one of its largest holdings, which Buffett described in this year’s annual report as one of the four crown jewels for Berkshire, is a 5.4% stake in shares of Apple Inc. (NSD: AAPL), worth $120.4 billion at year-end 2020. He admitted he was mistaken in selling some Apple shares last year, realizing an US$11 billion capital gain, but given that Berkshire’s cost base for Apple, which it began purchasing in 2016, is only $31.4 billion and it generates $775 million in dividends annually for Berkshire, he may be forgiven his error.

Apart from its long-established property/casualty insurance operations, which are consistently profitable at the operating level and which give Berkshire US$138 billion in free “float” (premiums which Berkshire has received but which does not have to pay out on for many years, if ever) to invest, the other two crown jewels in Berkshire’s group of businesses are wholly-owned Burlington Northern Santa Fe railroad, the largest U.S. railroad by freight volume, and Berkshire Hathaway Energy (BHE), whose earnings have grown to US$3.4 billion from US$122 million during Berkshire’s 21 years of ownership.

Both of these businesses are ones that should appeal to investors looking for exposure to environmentally friendly “green” industries, as railroads are by far the least carbon emitting of any means of transport available, and BHE is one of the largest wind power and solar operators in North America and Europe. Yet Buffett faced criticism this year for his failure to embrace the current fad for codes specifying diversity and environmental principles. He replied by pointing out that a box-ticking exercise, especially for what is an old-fashioned conglomerate, inevitably fails to take account of the very different circumstances of the underlying companies. In total, companies in Berkshire’s portfolio employ 360,000 people in a wide variety of industries ranging from candies through furniture stores, manufactured housing, aerospace parts, energy, insurance, technology, railroads, and newspapers.

Focusing on business and creating wealth for shareholders, Buffett and Munger devoted a lot of time attacking the phenomenon of Special Purpose Acquisition Corporations (SPACs). Buffett pointed out that almost all SPACs required their managers to buy an operating company within two years or they would have to return the investors’ money. As Buffett observed, “If you put a gun to my head and told me I had to buy a company in two years, I could do so, but it wouldn’t be a very good company.” They attributed the popularity of SPACs to the high fees they generated for the promoters and the investment banks who listed them. Likewise Munger felt that the retail investor craze using zero commission brokerages like Robinhood was nothing more than gambling, as it encouraged retail investors to focus on short-term attempts to game the market.

Succession plan

Some critics claimed that Buffett and Munger were essentially too old and out of touch to appreciate the changes that were happening in finance. Others believe that someone with Buffett’s long-term track record that has weathered many storms should not be underestimated or discounted. These have included the Financial Crisis of 2008-09, where Berkshire’s massive cash positions enabled it to act as lender of last resort to mega banker Goldman Sachs! And Buffett’s prescience in buying BNSF in its totality while it was temporarily depressed in price is proof that as Buffett has famously observed, “It’s only when the tide goes out that you get to see who’s been swimming naked.”

While investors should consult their financial advisors before making any important investment decisions, they could do worse than follow the example of Warren Buffett and Charlie Munger who had Berkshire repurchase $24.7 billion of Berkshire stock in 2020. That shrank the float by over 5.2%, but increased the value for remaining shareholders commensurately without their having spent a dollar of their own money.

While Buffett’s and Munger’s age means that they will inevitably be replaced in the next few years, they have been preparing a succession plan for years now. Buffett’s chosen successor for the job of Berkshire’s CEO will be Greg Abel, currently Berkshire’s Vice Chairman of Non-Insurance Operations, while Ajit Jain, Vice Chairman of Insurance Operations, will continue to run the insurance businesses. Investors have always worried about succession at Berkshire, but that too now appears to be an issue that has been addressed.

Gavin Graham is a veteran financial analyst and money manager and a specialist in international investing, with over 35 years’ experience in global investment management. He is the host of the Indepth Investing Podcast.

Notes and Disclaimer

The commentaries contained herein are provided as a general source of information based on information available as of May 6, 2021, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.