There have been a lot of headlines out of the Berkshire Annual Meeting about how BRK stock has underperformed the S&P over a ten year period. Today, I will explore some of the reasons why.
I’m sure some readers’ blood pressure readings already have spiked. How dare I criticize Buffett, right? Do me a favor and take a deep breath and give it a fair read. I think you’ll find Buffett himself would agree with a fair number of the critiques.
UPDATE: Coincidence or suspicious? The WSJ wrote a very similar story one day after this post. You decide…
Berkshire Has Gotten Too Big
This is fairly obvious. Buffett himself has addressed it numerous times. When you get to be the size of Berkshire, it is hard to find investments that really move the needle. Given the diversified accumulation of investments, you are likely to generate operating results that look like the broader market.
Berkshire Has Been Too Passive Managing Its Balance Sheet
As it has gotten larger, Berkshire has continued to follow the same playbook...invest in stocks, buy companies, don’t pay a dividend, do some buyback but not dramatic.
There is certainly nothing wrong with this approach. However, it is likely leaving dollars on the table. Buffett has been instrumental in the past at getting managements of stocks he owned to return capital if they couldn’t invest it at sufficient returns. A 10 year track record of underperformance is enough to suggest he should take a long look at his own company and realize shareholders are better off with larger capital returns.
Note, this doesn’t have to be buyback. He could pay a dividend (yes, there are tax consequences but he is all for people paying more taxes!) or he could sell or spin off portfolio companies. Certainly, some of the companies he owns could be worth more to others.
Why not get smaller so that when he finds real opportunities they can have a chance to actually move the needle?
What Worked in the Past May Not Work in the Future
We all know the boilerplate investment disclosures about past performance. Building on the last point, the old playbook of buy and hold (stocks and companies) and hoard capital may not make sense for a giant company that looks more like the broader economy.
Maybe there should be a higher bar for acquisitions? Maybe certain industries should be exited? Maybe insurance float isn’t as valuable as when there were more investment opportunities? Berkshire should at least explore these ideas and then make an evaluation.
Berkshire Should Be More Involved With Its Acquisitions
If you are buying great companies and you think it best to leave them alone, I fully understand that. However, Berkshire has bought a fair number of average companies as well in what I’ll call financial transactions (the return was good enough vs. the alternative).
While it’s part of Warren’s folksy charm to say how great all these managements are, the truth is many of them are not exceptional. There is an opportunity to add value to them through management expertise and, while synergies tend to be overplayed, they’re not folklore. They really do exist and should be pursued where it makes sense.
Managements Need Accountability to Improve
While being public has its drawbacks, one of the benefits it is provides a feedback mechanism. If you are screwing up, your stock price will (usually) reflect it. Accountability is good. It motivates. Yes, sometimes shareholders hold you accountable for nonsense but management can choose when to ignore shareholders if they believe they are right.
The point here is being an independent executive running a Berkshire sub is like management utopia. You are largely left alone to do what you wish. Some executives are clearly self motivated and won’t change their behavior as a result. Others perhaps might relax without the same pressure and see their results worsen.
One example that comes to mind is GEICO which has fallen tragically behind in telematics ceding both growth and profitability to Progressive as a result. A public GEICO would have been asked a lot of hard questions by shareholders over the years about why they refused to invest in telematics. I’m sure Buffett has asked, and maybe even pushed for it, but he didn’t force GEICO to adapt and they have fallen behind as a result.
It Is OK To Sell Long Term Stock Holdings
While long term holdings make a lot of sense, they are not a license to ignore change. If you look at the long term holdings, most of them have not aged well. The original logic for long term positions was to not be swayed by Mr. Market when he got manic given the strong franchises Berkshire held. That made a lot of sense as long as you owned great franchises with little business risk.
The problem is some of those great franchises became no longer great due largely to external factors (with the exception of Wells Fargo and its penchant for self harm). Newspapers obviously have been irrevocably harmed. Coke is in a losing battle with the sugar police. AMEX is at risk in a world of changing payment methods. Kraft has already run into trouble. And even the newest mega holding Apple faces obsolescence risk if they can’t make the transition to services given the handset business has matured.
Find Your Edge and Lever It
Buffett’s edge used to be picking stocks. Over time, he added buying successful operating companies. As I’ve illustrated, at his current size, it is harder to make that model work.
The good news is Berkshire has developed a new advantage, particularly post the financial crisis. They are the buyer of last resort. When a company is in distress (or lacks other funding options), Warren is always ready to offer a preferred investment with a high coupon and maybe a cheap equity conversion price to boot.
Most of the outsized returns over the last decade have come from this “vulture investing” (if there is such a thing as a friendly vulture). The problem is these opportunities weren’t large enough to offset the average returns from the larger conglomerate, which again emphasizes why Berkshire should endeavor to be smaller.
It’s also worth mentioning this seller of last resort approach echoes what Ajit Jain has done in the insurance business, whether it be writing catastrophe when nobody else will or selling asbestos covers. It’s the same principle and, I would argue, Berkshire’s greatest source of enduring advantage. At the risk of being repetitive, the only issue is it’s not scalable relative to the entirety of the balance sheet.
Are These Suggestions Enough to Change Performance?
First, let’s be honest and recognize that there is enough variability in stock performance that even ten years of lagging doesn’t suggest Berkshire is “broken” and will always disappoint. It mainly confirms that it will no longer always outperform for eternity like some of the true believers think. It may very well outperform for the next ten years following its current approach. It’s just there is less reason to be confident in that outcome than there used to be.
Furthermore, if Berkshire suddenly devoted its attention to corporate restructuring, returning capital, and integrating its operations, it doesn’t assure success. I do think it would improve the odds though and that’s really all one can try to do.
I’ll offer one last thought. If Buffett really wants Berkshire to persist in a form approaching what it is today long past his eventual passing, I think his successors will need to adopt some of these suggestions. Otherwise, I expect we will see enough deterioration in the performance without him that eventually shareholders will push for a painful breakup and what remains won’t look like the Berkshire that we all know.