This coming weekend is the annual Berkshire shareholder meeting, aka “Capitalist Woodstock”. However, like the other Woodstock, it’s been a long time since anything meaningful happened.
While Warren is obviously an unparalleled success as an investor, I think even he would admit the annual letters and meetings over the last ten years have been light on breakthroughs and are largely an exercise of hero worship and furniture sales.
If you want to learn from Buffett, don’t go to the meeting. Instead, read the annual letters from the 20th century and you’ll have most of what you need.
For anyone offended by the above, don’t be. The man is 92 (and Charlie is 99). They had incredible insights into their 80s. That is remarkable. Eventually even the most brilliant of investors run out of new things to say. There is no shame in that.
But if you really belief in the brilliance of Warren and Charlie, the only rational thing to do is sell the stock now. That’s right, sell it.
Why? It’s pretty obvious, no? They are not immortal. Eventually there will be new stewards of Berkshire and they won’t be as good as the current ones.
Even with Warren and Charlie in charge, BRK stock only matched the market over the last 20 years. What will happen when they’re gone?
Competitive Advantage
Let’s make a list of all the advantages Berkshire has under Buffett and then we can decide how many will last with a new leader.
Stock Picking
This one needs no explanation. Buffett is one of the best stock pickers in history.
Capital Allocation
I would argue this is Buffett’s greatest strength. He understands risk and reward implicitly and doesn’t get tempted by exciting stories that produce short term gain but long term underperformance.
Deal Flow
When a company is in trouble, they call Warren for help and he gets to provide relief at highly attractive terms.
On the flip side, when companies are looking to sell, they will take lesser terms from Berkshire than they could get in an auction.
Balance Sheet
Both the size and credit rating of Berkshire mean they never have to worry about finding financing for a deal. The ability to write large cash checks means they can complete deals which other bidders would struggle to finance without large dilution.
Patience
Warren and Charlie talk often about the importance of sitting hands out and waiting for fat pitches. Few investors or executives in the world have this discipline.
Deference
Warren buys companies and then gets out of the way. This would usually be a recipe for disaster, but companies are afraid of letting Warren down so they don’t abuse the freedom.
Efficiency
Because Warren is able to use such a light touch with the operating companies, combined with his aptitude for numbers, Berkshire is able to get by with extremely low overhead.
Regulatory
While Berkshire is deeply involved in highly regulated businesses like insurance, energy, and railroads, regulators leave them alone rather than demand the same level of oversight required of their peers.
Sustainable Advantage?
I probably could have listed even more strengths of Berkshire but I think I remembered most of the big ones. So how likely are these to persist with a new leader?
First, the likely replacement for Warren will be Greg Abel, whose background is in the regulated energy business. While I am sure he is brilliant and has learned a lot from Warren over the years, it is an extremely heavy lift to go from running utilities – where returns on capital are determined by the government – to running arguably the most complex collection of businesses on Planet Earth.
So let’s look at how likely he is to sustain Warren’s strengths.
Stock Picking
Extremely unlikely. While Todd Combs will remain and have most of the responsibility here, I don’t think anyone expects him to have the same success as Warren and Charlie, especially with the constraints from the size of the portfolio.
Capital Allocation
Even more unlikely. Few people in the world have Warren’s mind for this. He can calculate probabilities in his head and intrinsically arrive at the right conclusion.
But it’s not just whether someone else can do the exercise on paper. It’s also communicating with the business leaders effectively to ensure the proper balance between growth and return on capital.
It’s managing liquidity to be able to pursue deals without sacrificing returns. It’s understanding tail risk and ensuring you are in position to capitalize.
Then there’s some of the “creative” tricks like the structures on some of the financial crisis deals or insurance LPTs or having an insurance company buy a railroad.
Deal Flow
While sellers may still be willing to take a somewhat lower price from Berkshire for some period of time, it’s less likely the special deals come through at the same pace.
The trust factor corporate America has with Warren doesn’t just transfer to another individual.
Balance Sheet
This is probably one of the strengths that has the best chance to persist as long as nothing happens to diminish the strength of the balance sheet.
Patience
While it’s possible Abel has this ability, it is very rare for a corporate executive, so the odds are he doesn’t. Plus, there will be immense pressure to “make his own mark” and do something for the sake of doing something.
Deference
While the new leader may plan to stick with this approach, I’m not sure that’s a good idea. As mentioned, some of why it worked was Warren’s personality.
The business unit leaders are more likely to act independently if they don’t have the same confidence in the new chief. This will more likely than not lead to mistakes.
I would advise the new CEO to be somewhat less hands off early on to take away any temptation for the operating businesses to go astray.
Efficiency
If the new CEO needs to monitor the operations more closely, this will require more overhead and more bureaucracy. While there are good reasons for it, there are also costs (opportunity as well as financial).
In some ways, this will be the biggest challenge. If the new CEO is too hands off, they will get played. If they interfere too much, they will lose respect and create divisiveness.
You can certainly think of some similarities to AIG here where successors to Hank had to add more and more supervision and spend more and more on modernizing systems to keep up.
Regulatory
It’s hard to imagine regulators will be so kind to Berkshire post-Warren. If anything, there may be a realization that they operated with too light a touch and become more demanding.
So there you go, pretty much every major advantage but the balance sheet size should diminish going forward. These alone are very significant challenges to maintaining Berkshire’s premium valuation after Warren and Charlie are gone.
Other Hurdles
But the challenges go beyond maintaining Berkshire’s strengths. They also face a number of other core challenges even if Buffett found the path to immortality.
Low Growth Operating Businesses
Many people still imagine Berkshire as this collection of prime brands like Coke and American Express and See’s Candies. That was forever ago.
Berkshire owns a bunch of slow growth, boring businesses with moderate returns. Insurance. Railroads. Utilities. Housing. Manufacturing.
These are low multiple businesses. They do produce a lot of cash flow but that needs to be redeployed by a capital allocation wizard. Without one, what should they trade for? 12X?
Concentrated Equity Holdings
The equity portfolio is also in a lot of boring businesses. Here are the equity positions >$10B at year end:
- Apple $155B
- Bank America $30B
- Chevron $28B
- Coke $26B
- American Express $24B
- Kraft Heinz $13B
- Occidental $13B
So Apple, Coke, and a bunch of slow growth. Even Apple is a risk. Consumer tech hardware leaders tend to change over time. Nothing guarantees Apple will be at the top in ten years.
Does this look like a vibrant portfolio certain to beat the index for the next decade?
If the new CEO wants to make changes, there is a big tax bill due. This likely leads to inaction which means being late getting out of deteriorating franchises such as Wells Fargo.
Size
Size isn’t just a challenge for the equity portfolio. It limits the ability to find attractive acquisitions. It’s hardly worth Berkshire’s time to buy a $1B business. If you’re buying $25B companies, they are likely to have less future growth, fewer synergy opportunities, and more likely to be fully valued.
De-conglomerating
It seems pretty likely there will be pressure to shrink the company to its core strengths rather than have its hand in so many different areas.
Do insurance and utilities really go together? Paint and railroads? Furniture and sugary snacks?
While normally splitting up into say four smaller companies may unlock value, that is less likely to be the case for Berkshire.
Why? First, it trades at a premium to its parts. That would get lost in sales or spins. Second, the deal flow pipeline would totally dry up if sellers didn’t believe they would stay part of Berkshire. Finally, the new entities would likely need to invest heavily in overhead to support a more traditional structure.
The Successor’s Curse
We have seen over and over when a famous CEO leaves the successor gets left with a poor hand. Apple is one of the few exceptions but certainly financial conglomerates like GE, Citi, AIG, etc. have gone through incredibly painful times after leadership change.
Ironically, in some of those cases, the famous leader wasn’t as good as their reputation. In this case, Buffett and Munger are, so the ability to maintain their level of success will be extremely difficult.
Selling Pressure
While Berkshire has loyal, long term holders with a very low cost basis, some will certainly be spooked by leadership change and sell.
Wall Street will likely feel emboldened to short the stock on the successor’s curse theory. Certainly once cracks emerge, they will short relentlessly.
Also, long time holders may realize donating their appreciated stock is a far better tax play than making charitable donations in cash.
Even in the absence of waves of sellers, the steady inflows from loyal Buffett worshippers will cease and stocks tend to go down when there is a buyer’s strike.
Add it all up and there are a lot of reasons to think the stock gets revalued for technical reasons.
The Next 20 Years
Before I wrap up, here’s the kicker. For as much as everyone admires Buffett, as mentioned earlier, Berkshire stock has only performed in line with the market over the last twenty years.
The challenges that come with size have offset the brilliance of management.
If the company is now even bigger and will have less skilled managers, how can it even match the market perform of the prior two decades?
Now is the time to get out! I could have saved a lot of words by saying “Berkshire is a legendary company led by a 92 and 99 year old. The next generation will not be as successful. Sell.” It’s really that simple.
You can try to argue with me on some of the specific points but don’t overcomplicate it. You can root for Charlie and Warren to live another ten years and listen to the meetings and buy their products, but you really shouldn’t own the stock anymore.