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Hurry Up and Wait for Berkshire HathawayHurry Up And Wait For Berkshire HathawaySummary
Is Berkshire Hathaway really frozen? Are Warren Buffett and Charlie Munger stuck? On the surface, they appear locked down, like when Jabba the Hutt puts Solo into Carbonite. Source: Star Wars: The Empire Strikes Back First, if you're reading this and care about Berkshire Hathaway at all, I'm pretty certain you know that Buffett is bullish on the United States. Let's swing the hammer and drive the point home:
Second, if you're wondering why Buffett hasn't bought back a Godzilla amount of Berkshire Hathaway stock this is your answer:
This is a key reason why Buffett hasn't been buying stocks and companies. Berkshire's leadership isn't dumb, but they have decided to slow down to the point of inaction. And yet, the lack of action is, in itself, action because it's a clear decision Berkshire's made. Charlie Munger's already told us about patience:
In other words, investing success comes from doing nothing. And, ironically, doing nothing takes time, effort, and energy. As my father always liked to say, doing nothing is doing the hardest thing of all. This is the very nature of Berkshire Hathaway's culture. Right now, this culture is on full display, yet many investors seem to be angry that the tiger's stripes aren't changing as the wind blows. The Dice It's not about being bullish or bearish. We already know that Berkshire's leadership is rationally optimistic, that is, we know they (especially Buffett) are long term bullish. They are especially bullish long term on America, American companies, and American stocks. Yes, it's remarkably easy to say that Berkshire's lack of action, and lack of spending is a bearish indicator. The harder, and much deeper realization is that the probabilities on the dice have changed. The pandemic has thrown sand into the gears of the superb mental calculations that normally churn out a reliable range of outcomes. Buffett's mental machine is working but the inputs are terrible. It's like playing football but now the end zone has new boundaries, isn't well marked, and the goal post fades in and out of reality. It makes no sense to play a game where there's so much uncertainty. It's better to do nothing. But not playing doesn't tell us that the game is completely rotten. There are still players, a field, a ball, and more. It's just that it's a mess, and you don't know if your team can easily kick a field goal, or if they will fall through into a worm hole and end up dead and frozen on the non-planet Pluto. The Bench Warmer In the short run, Berkshire is neither a bear nor a bull; it's a rationality machine. Berkshire's a player, but it's on the bench, sitting down, while the market gyrates and gnashes. In the long run, however, Berkshire loves the game, that they can get back in, and that they can win. Until that time, they'll sit and wait.And, they don't care what I thing, or you think. Buffett is explicit that he doesn't really give a damn, and it's what's made him, and Berkshire stockholders rich: The difference between successful people and really successful people is that really successful people say no to almost everything." - Inc. Magazine In this environment, with a tremendous lack of buying due to uncertainty, I think it's pretty obvious what happens:
That's the key here. It's not so much optionality on what can be bought, but it's instead that safety increases as "nothing" increases. I think the mental calculus is simple here. You can almost see the gears of war turning in Buffett's mind here. As uncertainty increases, cash increases even more. This is to prepare for tail risk, where some of those black holes suddenly open up, sucking in even the biggest and strongest companies. Again, to be clear, Warren Buffett doesn't depend on any outside safety:
The only real fuel that any company has to escape the gravitational pull is cash. And by that, I mean cold hard cash - and true cash equivalents - on the balance sheet. I'm not talking about credit lines or easy debt issuance. I'm also not talking about any pre-existing understandings or government promises to backstop. The Blue Blanket Keep in mind that as Berkshire Hathaway's stock price drops, because of earnings, or because of stock holdings, the cash gets more valuable. In part, that's because the cash has optionality. It provides real flexibility. More importantly, it's simply there to prevent death, and escape the violence in cash flows, and held equities. Cash is life, plain and simple. Buffett's carrying that cash like Linus van Pelt from Peanuts holds his blue blanket. Even more interesting to me is that Buffett's loading up even more:
Obviously some of this selling comes from Todd Combs and Ted Weschler. And, of course, some of this selling is because of compliance and regulations. Nevertheless, adding it all up, and it appears Buffett's hunkering down. But again, I see this as a way to avoid uncertainty, not as a bear call, or any kind of screaming to short the market. Putting it another way, the first order decision is to avoid uncertainty while the second order implication is a bear call. Buffett seems to see a greater range of outcomes, and many of those outcomes are unknown but likely to be very bad. That's still not literally a bear call, especially in the long run. The Duck So, for my own sake, I want to summarize again. I think it's clear Buffett's a long term bull, but short term, and even medium term, he's something entirely different. Maybe he's a cash rich duck, floating on the pond. Just floating around, with some wealthy little ducklings paddling behind. Now, enough about Buffett's investing. Let's talk about investing in Buffett and Berkshire Hathaway. While I admire the efforts of those who endlessly crank through the exact numbers to obtain perfect valuation I'm a bit more simplistic about Berkshire. I just look to see if there's a fat man and a fat pitch. The Fat Man I would like to protect my downside with some option to enjoy gains over time. Cash is fine, and I'm holding more and more all the time. But, I do keep investing, mostly in what the market hates. I also look for obvious bargains. I've recently bought Altria (MO), Philip Morris (PM), and Wells Fargo (WFC) for example. Back in March, I grabbed General Dynamics (GD), Sysco (SYY), Franklin Resources (BEN), and Prudential (PRU). Now, I didn't buy a lot. I'm adding very slowly. I don't trust this market, and like Buffett, I'm extremely worried about the range of outcomes. And, like Buffett, I think in the long run, we're going to be just fine. I added a little bit of Berkshire (BRK.B) on March 18th @ $170 and then again on March 23rd @ $163 it looks like. I didn't go crazy. I just added to my holdings, as the world seemed to be on fire. Like many others, I thought we could easily drop down a whole lot more. But, we didn't. So, in any case, unlike so many others, I don't mind all the cash that Berkshire's holding. It's around 30% right now: It's interesting that the Cash-to-Market Cap hasn't gone totally bonkers. Sure, there's more and more cash rolling in, and it's being held. But, you can see that 30% isn't absolutely crazy. It's maybe elevated and wee bit above average looking back 10 years. In any event, I like how "fat" Berkshire is right now with cash. I like how it translates to a wonderful Price-to-Book ratio: I know, I know. Fundamentals are a mess right now, for so many reasons. So, I added Price-to-Tangible Book too. There's value here, and the cash is making "The Man" obviously fat, at least that's how I see it. It's part of the reason I took a couple of shots in March, per my trades noted earlier. Roughly speaking, Buffett's in command of $137 billion. Even if he never, ever uses $50 billion of that, we're looking at well over $80 billion to weather the storm, and eventually invest, buyback or pay a dividend. Naturally, that last bit about a dividend was added for comic relief. To summarize again, Buffett's looking to protect the business with more and more cash as the uncertainty rages. The bull can wreck the China shop and the bear can eat the salmon swimming up stream, while Buffett simply floats, waiting for better probabilities to emerge. The Fat Pitch I'm going to come back to Price-to-Book in a moment. First, let's look at how far the stock as dropped: Source: FASTgraphs Nasty! And BRK.B has gone from about $226 down to $169, as I write this. So, we're looking at a 25% drop. That's not fun at all. It's better than what we're seeing with retail, oil, and so on. But, it's still ugly. However, lower prices are a gift for long term investors who are still adding. That's the key here. If you're retired or otherwise not adding to Berkshire, it's unfortunate to see wealth evaporate by 25%. However, if you're adding, and the price is fair, or there's even a discount, then it's nice little gift. There's been plenty written about valuation of Berkshire but I do admit that I like to track success with Berkshire in terms of Book Value. It's a worse and worse approximation of value over time. Even Buffett thinks so:
(Sorry Warren, I still like it when looking at Berkshire Hathaway.) Richard J. Parsons does a wonderful job explain this in his article: A Review Of Berkshire's Price-To-Book History, written in 2017. Here are some things to keep in mind:
There's more in the article, and there are more articles like this, talking about Berkshire's Price-to-Book. In short, there's a lot of certainty, to the upside, in buying Berkshire when Price-to-Book is below 1.4x and as that drops to 1.3x and lower, the probability of success increases. It's not certain, and losses are possible, but you load the dice in your favor, and you stack the deck when you're buying down below 1.2x. Being near 1.1x right now is quite favorable in terms of positive outcomes and positive probabilities. The Buyer I'm a fan of Berkshire below $170. I'm a bigger fan at $160 and down from there. The price right now is at worst fair. I don't think I'm overpaying. And yet, Charlie Munger nags at me. I literally hear him in my mind:
Charlie is talking about the market, not Berkshire. Then again, Berkshire has fallen well over 35% several times over the years. That's straight from the 2017 Berkshire Hathaway Annual Report. You can argue this time it's different, but there's a deeper point here. There's no clarity on the duration of any drop. It can happen fast like in 1987, or it could grind lower over months and years. Again, the keyword is uncertainty, with a dash of murky probabilities. Put another way, 50% of Berkshire's recent top price of $226 is a paltry $113 per share. In effect, it wouldn't be insane to look at the uncertainty and think that BRK.B could hit $160 again, or $150, or even down to $120, $110 or even $100, or lower. Buffett isn't worried because he's holding cash. He doesn't like the uncertainty, but he certainly knows how to tell everyone to kiss off. And, I don't mind adding more shares when I see the stock go deeper and deeper on sale. The other side of this is bright, and perhaps very bright. The Question (On Everyone's Mind) What happens with all that cash? The simple answer is the obvious answer. Eventually, the cash will be used:
I'll tell you what the cash on the books is buying right now: Peace of Mind in times of uncertainty. Cash is clarity when there's fog. Cash is a lighthouse, guiding the way. It doesn't need to "do" anything at all to provide safety during the storm. And if the sky clears suddenly, all the better, because it's extremely unlikely that cash will rush into Berkshire from investors, driving up the price. Also, with more clarity, there will still be dislocations in the market, and Buffett can swoop in and take advantage. To summarize yet again: If you don't like a company with $130 billion of cash, if you don't like a company with a CEO with an eye on uncertainty and probabilities, if you don't care about a company selling at a fair price, then do not invest in Berkshire Hathaway. It's a weird company; not average. If you want average results from your investing, Buffett thinks that's great. Go ahead and buy index funds and move on. However, if you want Weird Fat People, Strange Ducks and Oddball Buyers then join the club. You'll sit and wait, all that cash stacking up, until it's time to strike. If that's failure in your mind, chase something else because it might be years. I don't mind safely sitting on a pile of money, waiting to pounce. Looking Forward I don't want to predict. However, eventually, the money will be spent or given back. I think that more buybacks are going to happen before dividends ever happen. For one thing, there's Buffett's "hate" of corporate tax and he's clear that he's working for shareholders. So, using buybacks is more tax efficient than sending out dividends. That's only true, of course, when you're doing buybacks below intrinsic value otherwise you're destroying shareholder value. The counterbalance right now is that buybacks have become a political hot potato. In any event, going forward, I think we'll see more buybacks before we see dividends. With that out of the way, we know that Berkshire's having problems competing against cheap money (e.g., private equity), and of course, The Fed. Under most circumstances, Berkshire Hathaway would be a lender of last resort. However, with The Fed jumping in, the phone stopped ringing. All of this being said, Berkshire will continue to hoard cash, but they will continue to spray money out over several capital intensive businesses (e.g., BNSF, MidAmerican), and they will look for more. They will very likely not seek out capital light businesses to buy; they desire capital intensity for precisely the reason that these business need Berkshire's cash and they can earn a fair return. Expect something more like a utility, energy company, or some other kind of infrastructure company (e.g., construction, healthcare). Do not expect anything like a Coca-Cola (KO) or Dunkin Donuts (NASDAQ:DNKN), because they are too capital light to buy outright, but also they are known, and too expensive. I've gone on too long, so to really wrap this up, I'll just say that we're still probably 6-12 months away (i.e., 2021) from anything outsized from Berkshire Hathaway. Uncertainty first has to drop, then we'll see Buffett and leadership ease back into things, or make rapid buys if things go to hell and the phone is ringing but The Fed doesn't pick up. I doubt Berkshire will get any fat pitches any time soon, no matter what. This is going to be a wait-and-see game. I do not predict much action at all. I predict a slow grind. Disclosure: I am/we are long BRK.B, MO, WFC, PRU, SYY, PM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. |
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