By: Jeff Pollock
May 26, 2017
It’s hard to get excited about buying shares of Berkshire Hathaway, perhaps even for its founder Warren Buffett. If the company went by another name, I would be surprised to see Buffett invest in the stock himself.
Over time, Berkshire’s stock performance has been exceptional. From 1965 to 2016, shares appreciated by 20.8% per annum, representing an overall gain of 1,972,595 percent for its founding shareholders. These gains were fuelled by the 19% compounded annual growth rate in the company’s book value over this period. However, as all disclaimers read, past performance is not indicative of future growth.
There’s several reasons to hesitate before purchasing shares, namely because the massive size of the company inhibits future growth, the stock valuation is not a bargain, Buffett’s successor has yet to be named, and there are looming threats to the business model as technology evolves.
With assets now totalling more than $650 billion ($160 billion of which is invested in publicly traded stocks), and more than $96.5 billion sitting in cash and Treasury bills, investment opportunities are surely harder to come by now than before. In a letter to shareholders, Buffett once wrote that:
The giant disadvantage we face is size. In the early years, we needed only good ideas, but now we need good big ideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
Beyond size, the stock trades 40% above its book value. As a rule, at or below book value is always preferable to paying a premium. However, the company is authorized to return capital to shareholders by repurchasing it own shares at or below a 20% premium to book value, suggesting that the Board too believes this valuation today doesn’t represent a bargain price.
As 86 years old, Buffett is receiving more and more questions about his eventual successor. Holding companies that trade at a premium to its book value do so for a reason. In the case of Berkshire, it’s because the company is run by Warren Buffett. Because of past success, his reputation within the investment industry is untouchable. As an example, beleaguered investment bank Goldman Sachs offered Buffett $5 billion of preferred shares and attached a 10% dividend yield to borrow his name as an investor during the financial crisis. Several years later, Bank of America also struck a similar deal. With its heir apparent unknown, it is impossible to know whether future capital allocation by Berkshire will involve the initiation of a dividend, if spinoffs will take place to unlock shareholder value, or if acquisitions will require the same kinds of business models currently sought by Buffett.
While not an imminent threat, long term investors of Berkshire will want to keep their eye on the evolution of autonomous technology. Should driverless cars develop into a success, both the insurance and railroad businesses will be affected. Together, these two operations constitute almost have of Berkshire’s earnings before taxes. When asked about driverless cars and trucks at the shareholder meeting, Buffett said “Driverless trucks are a lot more of a threat than opportunity to Burlington Northern [Railroad]. If driverless cars became pervasive, it would only be because they’re safer, and that would mean that the overall economic costs of auto-related losses would go down. That would drive down the premium income at GEICO. Autonomous vehicles widespread would hurt us.”
Rear-view mirror investing is a mistake. While the share price of Berkshire Hathaway has outperformed any other company since 1965, its future is unlikely to be as lucrative of its past. Instead, as Wayne Gretzky once said, “I skate to where the puck is going to be, not to where it has been.“
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