Bearish On Berkshire Hathaway? Don't Bet Against Buffett

The best mutual fund in the world carries a management expense ratio of zero. The fund’s brilliant manager, however, is 85 years old (and appears to subsist on junk food) while his partner is 92.

Of course, Berkshire Hathaway Inc. is neither a mutual nor closed-end fund, but its diversified portfolio of businesses does make it look like a fund—one that has consistently outperformed the S&P 500 for 50 years.

Along with its main insurance and reinsurance businesses, Berkshire’s subsidiaries include a railroad, fast-food restaurants, utilities, a maker of aerospace components, retailers of furniture, candy and jewelry, auto dealerships, real estate brokerages and daily newspapers. The company also owns 15.6% of American Express Co., 12.6% of Moody’s Corporation, 10.5% of Phillips 66, 9.8% of Wells Fargo & Company, 9.3% of the Coca-Cola Company and 8.4% of IBM.

With a market capitalization of US$352.68-billion, Berkshire ranks fourth among the world’s largest companies, behind Apple Inc., Alphabet Inc.(formerly Google) and Microsoft Corp.

Warren Buffett, Berkshire’s famous chairman (the “Oracle of Omaha”) still lives in the same house he bought in 1955 despite having a net worth of US$73.8-billion, accumulated entirely by making shrewd and insightful investments.

Mr. Buffett’s age and the company’s size have provided ammunition for its detractors. These pessimists say they fear Mr. Buffett’s successor might botch things up, and/or that the company has grown so large that it will no longer be able to find acquisitions big enough to increase earnings. Both concerns appear valid on the surface, but only on the surface.

Mr. Buffett’s longevity cannot be attributed to his diet. In an interview with Fortune magazine last year, he said he drinks five 12-ounce cans of Coca-Cola a day (regular Coke at work, Cherry Coke at home) often accompanied by a tin of Utz Potato Stix, a brand of shoestring potato sticks. It is not unusual for him to have a bowl of ice cream for breakfast. “I checked the actuarial tables, and the lowest death rate is among six-year-olds. So I decided to eat like a six-year-old. It’s the safest course I can take,” he told Fortune.

Quips aside, investors have serious concerns about who might replace Mr. Buffett when he’s gone.

“Essentially my job will be split into two parts,” Mr. Buffett has written about his succession plans in several recent annual reports. “One executive will become CEO and responsible for operations. The responsibility for investments will be given to one or more executives...All candidates currently work for or are available to Berkshire and are people in whom I have total confidence.”

The leading candidates are Ajit Jain, 64, president of Berkshire’s insurance group, and Greg Abel, 52, who heads Berkshire Hathaway Energy. Other possible successors are Berkshire investment managers Todd Combs, 45 and Ted Weschler, 54. Mr. Weschler was already a wealthy hedge fund manager when he anonymously bid US$2.6-million in a 2010 charity auction that gave winners the opportunity to have lunch with Mr. Buffett. Mr. Weschler, who tendered the winning bid in two successive years, so impressed Mr. Buffett that the Berkshire chairman urged him to help manage Berkshire’s money, and Mr. Weschler joined the following year.

Despite the strong lineup of successors, practically anyone could run today’s Berkshire Hathaway. The company’s portfolio of profitable businesses are so self-sustaining that a simple business journalist could sit at Mr. Buffett’s desk, drink Coca-Cola, eat shoestring potato sticks and play online bridge—and Berkshire would still outperform the S&P 500 most years. On the off chance any work needed to be done, Berkshire’s 13 owner-related business principles, first composed by Mr. Buffett in 1983 and contained in every annual report since then, provide a detailed blueprint for managing the company.

Berkshire’s huge size does make it more difficult for it to find accretive acquisitions, but there are still plenty from which to choose. The US$32-billion acquisition of Portland, Ore.-based aerospace component maker Precision Castparts Corp. in January, for example, means Berkshire will own 10.27 companies that would be in the Fortune 500 if they were stand-alone businesses. (Berkshire’s 27% holding in Kraft Heinz is the 0.27%), Mr. Buffett writes in the 2015 annual report.

“That leaves just under 98% of America’s business giants that have yet to call us. Operators are standing by.”

Berkshire’s A shares (which have never split) closed recently at US$214,000 (C$277,000), putting them beyond the reach of most individual investors. Only a few hundred of the A shares trade daily. The company’s B shares, however, are a relatively affordable US$142.46 after a 50-to-1 split in 2010. (My wife and I own 150 of these).

This year, for the first time, you can see the historical record of Berkshire’s share price in the front-page table in Berkshire’s 2015 annual report. Despite not paying a dividend, the shares have registered a compound annual gain of 20.7% since 1965, compared to the S&P 500’s 9.7%, even with dividends paid by S&P 500 companies reinvested.

“Market prices, let me stress, have their limitations in the short term,” Mr. Buffett writes in the report. “Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. Charlie Munger, Berkshire vice-chairman and my partner, and I believe that has been true at Berkshire: In our view, the increase in Berkshire’s per-share intrinsic value over the past 50 years is roughly equal to the 1,826,163% gain in market price of the company.”

Over the years, Berkshire has gradually shifted away from big stakes in listed stocks toward outright acquisitions, and due to accounting rules, Berkshire must record all declines in the value of its controlled companies but not the gains.

“Today, the large and growing unrecorded gains at our “winners” make it clear that Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value,” Mr. Buffett writes. Berkshire’s book value at the end of 2015 was US$155,501, so Mr. Buffett’s remark, in effect, puts a floor under Berkshire’s A shares at U$186,600, or US$124.40 for its B shares.

Berkshire’s annual meeting will be held in Omaha, Nebraska on April 30. Last year more than 40,000 shareholders packed the city’s arena and adjacent meeting rooms, occupied all available hotels and emptied their wallets at Berkshire-owned businesses such as Nebraska Furniture Mart, Borsheim’s jewellers, See’s Candies and Gorat’s steak house. This year the entire meeting will be webcast, which means the crowds should be thinner.

“Our second reason for initiating a webcast is more important,” Mr. Buffett writes. “Charlie is 92, and I am 85. If we were partners with you in a small business, and were charged with running the place, you would want to look in occasionally to make sure we hadn’t drifted off into la-la land.”

“Viewers can also observe our life-prolonging diet. During the meeting, Charlie and I will each consume enough Coke, See’s fudge and See’s peanut brittle to satisfy the weekly caloric needs of an NFL lineman. Long ago we discovered a fundamental truth: There’s nothing like eating carrots and broccoli when you’re really hungry —and want to stay that way.”

On a serious note, one proxy proposal asks what Berkshire is doing in response to the threat of global warming, which may trigger huge property losses for insurance companies. Berkshire Hathaway companies insure government authorities against the rebuilding costs associated with major hurricanes and earthquakes. Climate change has not yet produced more frequent or costly weather-related events covered by insurance, Mr. Buffett writes, and consequently the premiums charged have fallen, which is why Berkshire’s subsidiaries have retreated from the business. Should weather-related catastrophes become more frequent, the prices charged for insurance policies will be raised to reflect the changing exposures, which would actually benefit Berkshire’s insurance business, he writes.

“As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries.”

Mr. Buffett is the main attraction at the annual meeting, but not for all shareholders. My son, who’s taking computer courses at college and who idolizes Bill Gates, glanced at the Berkshire proxy statement that came in the mail and saw that a William H. Gates III is on Berkshire’s board and will be in attendance at the meeting, ostensibly to take serious investment questions from shareholders, but more likely to be playing ping-pong or bridge with them. On the off chance of being able to meet his idol at the meeting, my son plans to use some of his summer job money to buy a few Berkshire B shares. It will probably turn out to have been an excellent idea.

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca