BRK 2021 Annual Meeting

So, like many of you, I watched the BRK annual meeting (replay) as usual. It was nice to have Ajit and Greg join Buffett and Munger on the stage. Buffett and Munger both looked great, and it was good to see that duo in action again. 

There were a few interesting things this time. This is by no means a summary of the meeting or anything close to it; I will just talk about things that stood out to me or things that I thought about. I know I've said that before and then sort of ran through the various topics that came up. But in this post, really, I don't mention most topics that came up.

Opening Statement 

The first interesting thing was Buffett's comments before the Q&A started. He showed a couple of interesting tables. The first one is the top market cap companies of the world as of March 31, 2021. Here is the list: 

He pointed out that the top 5 out of 6 companies are U.S. companies. People who think the U.S. is on the decline should take note of this. The U.S. has a system that works etc.  He said that in 1790, we had 3.9 million people in the U.S., 600K of whom were slaves. Ireland had a larger population, Russia had 5x more people, Ukraine had 2x more people etc...  And yet, here we are in 2021 with 5 of the top 6 companies around the world U.S. based.

And then he talked about indexing and how pros are often wrong. He asked, of the top 20 largest companies on the 2021 list, how many will still be there 30 years from now. Then he showed us the list of top global companies in 1989 and pointed out that none of them are on the list today. 

Here is the 1989 list:

This is kind of scary because at the time, there were all these books out there, like Japan as Number One and many others that basically said that Japan has the industrial / political structure, hard-working, obedient and highly educated work force and many other traits that make them an inevitable force that will take over the world. Well, that didn't quite work out. 

So it does scare me a little what might happen to the top 20 list today. Buffett meant to show the greatness of America by showing us the top 20 list of today, but I don't know if he realizes that showing us the 1989 list may actually be telling us that we are peaking in our U.S. dominance. That would be a more consistent message from looking at these two tables.

 

Being Right on Industry Doesn't Equal Easy Stockpicking

The other thing he pointed out is that being right about the future of an industry does not lead to easy investment decisions. People are all excited about electric vehicles and whatnot, but he points out that the automobile in the early 1900s was the future too, and yet, I think he said more than 2,000 companies entered that field back then, and there were only three by 2009; and two of those went bankrupt. 

He showed a slide of some of the many companies in the auto business, but since there were so many companies, he only showed a single slide of companies whose names started with "Ma" (there were too many to list even just companies starting with the letter "M").

The same argument was made in the 1999-2000 internet bubble. People (I think Buffett / Munger too) pointed out that there were many, many railroad companies that jumped on the railroad bandwagon in the 1800s, and only a few survived. 

So being right about the future in terms of industries does not guarantee success, whether it be electric vehicles, cloud, AI, alternative energy or whatever... 

 

BRK vs. S&P 500 

Someone asked what the argument is for owning BRK over the S&P 500 after 15 years of underperformance. Munger said that he prefers BRK as it owns above average businesses. Buffett said that he has never recommended owning BRK. If you can't evaluate or analyze businesses, you should just own the S&P 500 index. He pointed out that he has always said this, and even has it in his will. 

That made me think about this for a second too. Why own BRK over the S&P 500 index? 

Well, let's think about the two things that Buffett always tells you to do. When evaluating a business, you have to answer two questions:

1. Is it a good business?
2. Is it fairly valued?

We never evaluate businesses based on how the stock price performed in the past. Well, in this case, there is some need to evaluate that. But hold off on that for a second. 

If you look at BRK, the answer to question 1 is probably, yes. It's a good business. It is certainly a collection of above average businesses. And 2? Probably yes there too. Definitely not overvalued by any measure. 

How about the S&P 500 index? Is it a good business? Well, it is average, at best. Right? And then how about question number 2. Is it fairly valued? Well, this can get tricky. I tend to believe we are not in bubble territory on the index overall, and a P/E in the low 20s in the current interest rate environment is not expensive at all. 

But there are pockets, maybe even big pockets of egregious overvaluation in the index. Like, say, TSLA.  I tend to think the large tech companies are not overvalued (not cheap either). But OK, many think the S&P 500 index is overvalued. 

So where does that leave us? The BRK is an above average business trading at a reasonable value whereas the S&P 500 index is an average business possibly trading at above reasonable value, or even at best, reasonable value. 

Here, you have to be with Munger. It's BRK; no-brainer. 

What about the past underperformance? Well, Munger calls it an accident of history. He believes that a collection of superior businesses will do better than a collection of average businesses over time. That makes total sense. 

So when you put it like that, and you sort of break it down like the above, it makes sense to own, or keep owning BRK despite it's long term underperformance. Too much Kool-Aid for me?

Now, I am sure there are others here that would actually prefer the S&P 500 index; especially the tech lovers who think BRK is a dinosaur. That is not a totally unreasonable view either. It's a matter of taste, to some extent. And it's true that over time, an index will evolve (S&P survived past century) and it is not at all guaranteed that an individual company will (GE?).

Kraft-Heinz / Myths

In response to a question about Kraft-Heinz (he said he is not in a position to give advice on KHC), Buffett started to talk about the problems caused by myths created about organizations. These myths can be handed down to the next CEO and on and on. This can lead to enormous errors. It happens all the time in business and goes beyond business. This is a possible topic for a future letter to shareholders, he said. 

Munger added that when you prattle on all the time, you pound ideas back into your head even if it's wrong. One of his favorite quotes is by Sir Cedrick Hardwicke, 

I have been a great actor for so long that I no longer know what I truly think on any subject.

Munger said it happens to a lot of people, and to virtually every politician. It is totally embedded in corporate world.

It makes you wonder what you are pounding into your head every day all the time, and what of those may actually be wrong. And it makes me wonder what the cases are that Buffett has in mind, and what they might have been at KHC (although we may guess it has to do with cost management etc.). 

For me, two things stand out that I used to pound in my head early on but revised over the years. One was the aversion to technology investing driven by what Buffett always said. But I have sort of been more comfortable with technology. I would not have touched them in the 1990s (and didn't), but have been much more open to them. 

The other thing is valuation. For a long time, I was also old-school valuation, looking at P/E ratios and things like that, and insisting on things below 20x P/E. But I quickly realized that there are not that many great companies at that kind of valuation, so I was more willing to pay up for businesses I really like. The way I tempered the risk and satisfied my aversion to high values was to simply not put too much money into expensive names. This allowed me to enjoy some decent growth while not having my P/L swing wildly every day. This is not a recent thing for me, this goes way back as I have been an early investor in CMG, for example.

The other one that is making me think hard right now is buy-and-hold forever. This is also one of those hard rules that a lot of us follow, although when things get really stupid, I do sell things. In a market like today, it makes you really think hard about everything you own. 

This may not be exactly what Buffett is talking about with corporate myths, but these things popped up in my head when he talked about myths.

Anyway, as usual, if you have time, check out the replay. It is pretty good. Mostly t he usual stuff, but it's free to watch (and fun). 

Sogo Shosha

Not quite a whale, and pretty small investment, but interesting nonetheless. As usual, people are trying to read all sorts of things into this investment, from bullishness on Japan, bearishness on the U.S., the U.S. dollar, inflation hedge / exposure to natural resources etc. It almost feels like nobody ever reads anything Buffett writes. He doesn't base investments on themes like inflation or economic views or views on foreign currency exchange rates. 

But anyway, one can only assume that Buffett feels that these Japanese trading companies are decent businesses with decent managements trading at attractive prices.

Foreign Investments 

This investment really reminds me of his Korean stock trade a while back. He said he was flipping through a Korean company handbook and noticed that a lot of stocks were trading at very low valuations. It seemed like he didn't need to dig into the details of every company to know that they were cheap enough and buying a basket would be profitable. This shosha investment kind of feels like that.

 

I remember noticing a while back in a photo or video of Buffett in his office that the Japan Company Handbook was sitting on his desk. So you knew he was flipping through that thing one company at a time looking for bargains. This may have been how he found this group. I would not be surprised if he has been reading all the annual reports of the big Japanese companies for years. Why wouldn't he, with so much capital to allocate?

First of all, I won't go into too much detail about the Japanese trading companies. They all have English annual reports on their websites, and you can just read about them on Wikipedia etc.

But I have to say my first reaction was not positive. I think many of us who are familiar with the Japanese market were a bit surprised. One pro said he was "disappointed". 

What does he see?!

Anyway, first, let's see what Buffett may be seeing. Since he bought five stocks, this is clearly not about any individual company or management. 

Let's just look at the big picture on these names. This table below is current as of early September 2020.

 

Since he has been accumulating these stocks for the past year or so, the most recent annual report he would have seen last year would have been for the year-ended in March, 2019 or more likely 2018 (as English versions of annual reports come out late). I have highlighted the March 2019 year figures, but he may have evaluated things based on 2018 figures too.

 

Prices haven't moved much (except Itochu), they are within sort of the range they have been for the past couple of years. So the table just compares everything to current prices.

 

In short, what he was seeing was a group of companies earning double-digit ROEs with single-digit P/Es and P/Bs below 1 (except Itochu).  Where can you get that combination? Maybe in some emerging markets. These are blue-chip companies with solid reputations, at least socially (banks and shosha were the two industries that parents traditionally wanted their fresh college grads to join). 

Initial Reaction

So just by the numbers, this makes total sense. No mystery here. It is exactly the sort of thing Buffett would jump into.

What about the reputation of incompetent Japanese management? That's what I would worry about most. Japanese management is and has been improving over the past few years, but I can't say I would be completely comfortable with management there, particularly in the big companies.

There are many cultural reasons why management in Japan has been so inept over the years. Things like seniority, lifetime employment, constant annual rotations of staff and the short put nature of employee positions have been really detrimental to companies there. I do have first-hand experience with this. It is getting better, I hear, but if you remember how a Korean airlines flight went down because it was culturally unacceptable for a co-pilot to point out an error to the pilot, cultural factors can be quite destructive. 

In Japan, one of the big ones is the notion of seniority. Meritocracy is increasing over there, but there is still a notion that older people know better so must be respected and not challenged. A lot of this gets mixed in with the natural tendency to defend your own turf. This combination may make it difficult for energetic, creative, competent young people to move up to benefit the company. Also, the lifetime employment 'promise' makes it difficult to make room for more competent employees. This combination of lifetime employment and seniority can be lethal in a fast changing, dynamic world.

The other big problem is that a lot of large companies tended to want to rotate people every three years to give them a broad experience to prepare them for senior positions at HQ. I remember dealing with some of these employees in NY and was shocked at how things worked. They come over to NY knowing nothing about finance, for example, and they speculate using firm capital not knowing what they are doing. Of course, by the time they start to understand what is happening, they are 'rotated' out to London or somewhere else. So they barely get to understand anything before moving on and they eventually end up at the head office, not really knowing much.

 

There were some trading companies that were close to blowing up or had to merge because they were on the verge of bankruptcy, and given my first-hand observations, that was no surprise at all. Did I tell you about one of the trading companies that would call our swap desk every day and ask for anything above a certain LIBOR spread? And they were indifferent to the risk; they didn't care. They mechanically just bought anything above a certain hurdle rate. I used to get invited sometimes to client dinners and I heard it directly too; they don't care about the risk, just give them something with this yield. They are willing to take whatever risk is implied in that given yield. Why this rate? Oh, that's our funding rate. Oh. Well, you have to take some risk, then. That's OK. Do you care what kind of risk you take? No, we just need to clear our funding rate. But structured products can be very risky. That's OK, we like structured products. etc...  You get the point. It was crazy.

 

This is one reason, by the way, why I thought a lot of the criticism against the banks during the financial crisis was baloney; a lot of these clients knew what they were doing, knew the risk they were taking. Or they simply didn't want to hear anything. They just wanted certain things regardless of the risk. Of course, I was never a salesman so would simply state facts, and they were like, OK. That's fine with us. Scary stuff. I'm sure things are better now (but I wonder. I just finished the GE book, and Immelt sounds very much like a clueless salaryman! Frightening. Except GE may have been worse; how is all of that stuff not fraud?!).

Of course, I am making all these sweeping, generalized statements, but here's another thing that you may have noticed. Some Japanese corporations do really well globally, particularly the manufacturers. If you look at Toyota, Canon, Sharp and many others, they have tended to do well in the past (although a lot of them are now under pressure from Korean / Chinese competitors). They succeeded because they mastered their craft in Japan and exported around the world and eventually built plants around the world implementing their techniques. 

But if you look at the businesses that tried to expand globally through acquisitions and / or the financial/service companies, they have failed miserably. The Japanese tend not to be great acquirers. Well, data show that this is true everywhere and anywhere; M&A tends not to work out well. But I always had the sense that it was worse for the Japanese when they venture overseas. 

As I mentioned above, I just finished the GE book, and it's funny how Immelt sort of acted like a Japanese salaryman; they just want to get the deal done no matter the price, and people are afraid to challenge the 'senior' person. In big companies, so often, things are decided by politics, so you can't afford to upset people. If you think a deal is bad, why would you risk your own career and point it out? 

This goes on to the next part of the problem in Japanese companies, and that's the short-put aspect of the employment contract. Again, there has been some change, but in general, Japanese companies are not known for paying outsized bonuses for success (well, you can argue that the Americans are very good at paying outsized bonuses for failure), so this discourages risk-taking. Why bother? If you step up and try to do something big and it succeeds, you get a nice pat on the back and maybe a small bonus. But if you fail, this can be detrimental. They may transfer you out of your job and send you to corporate Siberia. We've all read about the madogiwazoku. They can be like those empty rooms with no windows that we read about, but more often it is probably some transfer to some branch somewhere that nobody wants to go to. 

 

Although the long-call nature of U.S. business can create problems, the short-put structure of Japanese employment can be troublesome too.

Anyway, enough of this. Things have probably changed a bit. The above problems usually manifested itself in low profits, low margins and low ROE in Japan, as businesses pursued market share at all costs, spent money building facilities for their employees, created companies where the main company can dump unnecessary workers etc. 

But at least in the above table, we can see that ROE has been decent in these trading companies in the recent past. 

BPS Growth

OK, so we see that the stocks are cheap on a P/B basis. If we are going to evaluate something on a P/B basis, unless we are expecting liquidation, we have to look at how BPS has grown. So here is a quick table that shows the BPS of these companies; most recent, 2015 and 2010 figures, so we can see how BPS has grown for these companies in the past 5 and 10 years. I also added stock prices for the same time frame so we can compare.

BPS Growth of Buffett's Shoshas

 

Itochu is pretty good; they have grown BPS 11.2%/year over the past decade and 5.5%/year over the past five. This may even be better than BRK! (I didn't look). Stock price returns are not bad either. The other ones? Not so impressive, but including dividends, most of them look decent on a 10-year BPS growth basis, actually.  (Stock price change excludes dividends).

 

Anyway, moving on...

Itochu

I will spend some time over the next few weeks reading the annual reports of these companies, so maybe I will post more about them if I find anything interesting. 

But first, I took a quick look at Itochu. Itochu has been one of the top trading companies for years, and has a reputation of being a little more modern and 'hip' than some of the others which were part of a zaibatsu. Shosha as part of a zaibatsu makes you wonder where their real interests are; are they trying to make money for the shareholders? Or do they have a specific role to fill as part of the industrial group which would force them to do things that might not be economically rational? They also might seem a little more traditional / conventional, which is not a complement when it comes to Japanese business.

 

 

This is a great chart from the 2020 annual report. But this is illegible, so I cut it up below so you can see the tables below. 

 

It's hard to see, but the below tables are what's at the bottom of the above table. They show the stock price and valuation of the stock every year from 2011 through 2020. And you can see that the stock has always been really cheap; single digit P/E's and trading at around BPS. 

Despite this, their historical returns are pretty decent.

A cheap stock that has grown nicely over time is sort of a no-brainer, if you believe in the quality of the earnings and accounting values of book.

 

Trading companies are hard to analyze. I have spent time on them in the past, and they were usually just big, black boxes. They have evolved over the years from a purely import / export business to more of an investment business. A lot of investments, though, are related to their client businesses. For example, a company might buy a farm that produces products to export to Japan, or may invest in an oil field that will export oil to Japan etc.

There was a little block in the 2020 annual report explaining how they differ from private equity funds.

 

Here's another snip showing the ROE of Itochu going back to 2011. This is very unJapan-like, with double-digit ROEs for the whole period.

...and here's a nice snip showing labor productivity. But I am not so sure how relevant this is as they are investing more. Investments will increase profits and may not necessarily increase number of employees. Kind of like Berkshire Hathaway; not all employees are directly related to the revenues the holdings produce. 

...and here is a snip of all the medium-term plan targets and results in the recent past. They have achieved most of their goals. 

As Buffett explained about his IBM and Petrochina investments, he likes it when managements say they will do something and they accomplish it. IBM used to succeed in hitting all their goals too, which was one reason Buffett was attracted to the stock (which didn't work out in that case).

 

 

 

 

So Itochu looks very interesting. This doesn't count as much of an analysis, though, as you would have to go and dig into the balance sheet and see what's in there and how they're valued. Buffett said the accounting is good, but I think he means that many of these companies report under IFRS or GAAP standards and are audited by major accounting firms (well, this was true with GE and Enron too, not to say shosha are either of those). 

Marubeni took a big writedown in 2020, so you never know when these things will happen. I don't think we have enough information to make our own estimate of what these things are worth. So you have to just look at and use what we have. And I guess that would be cash flows and dividends. You can't really fudge those.

 

Conclusion

This is kind of interesting, and as I said, I will spend some time looking at these companies. But I am not at this point jumping with excitement about buying these names. If any, Itochu is certainly interesting. The others? Not sure.

A lot of these companies talk about wanting to invest for the future, but you can't just wake up one day and decide that you are now suddenly a venture capitalist. Marubeni has a fixed amount they said they want to invest in new businesses, which is kind of frightening. When you say you want to invest X in a certain sector, it makes management want to fulfill that regardless of the opportunity. Why would you want to do that? Maybe 0 is the best course of action. 

 

I probably told you guys about a supplier in Japan who told me that certain period-ends, they get a big influx of new orders. Why? Clients say they have money left over in their budgets and if they don't use them up, it will be cut next year. Nobody wants their budgets to be cut! Makes sense for the division, but a nightmare for shareholders!

Some of these annual reports eerily resemble Immelt's nonsensical ramblings about investing in the future and technology too. Scary.

Shosha investments in the past have been related to their clients; buying a factory that manufactured goods for them or a client, buying mines, oil fields, refiners, processors or farms that exported supplies to Japan etc. So there was this expertise and some proprietary knowledge behind those investments. 

But venture capital?  I'm not sure how that would work. It might work!  But it might not. Who knows. 

Anyway, I will probably follow up with more posts because this is sort of interesting. 

Is Buffett Really Bearish?!

So, with Buffett dumping airlines, JPM and not jumping into the markets in March, is he really all that bearish? His cash keeps piling up to the frustration of long time Buffett fans.

March Decline

First, I would have to say that the March decline was pretty quick. It crashed, and the market bounced back pretty quickly. Plus, what crashed are the stocks that are going to have a lot of problems. What rallied are beneficiaries. I would have loved to buy MSFT, GOOG, AMZN or whatever, but those didn't really tank all that much. 

 

Plus, for a company like BRK, you would want to take advantage of any distress to get involved, but as Buffett said, with the stimulus package, the phone wasn't ringing all that much. There may be opportunities within each of the private holdings too, and we know there is a lot of pain in just about every wholly owned business at BRK.

 

Buffett Bearish? 

A while back, I argued that this increase in cash does not necessarily reflect a bearish view on Buffett's part. OK, maybe it's not super-bullish. But it's not outright bearish, either. 

 

First, I said the accumulated cash pretty much corresponds to the rise in float; since the mid-1990s, cash and fixed income investments always approximated the amount of float. Also, just because Buffett doesn't buy stocks doesn't mean BRK is not fully exposed; some of his former stock holdings are now wholly-owned subsidiaries. Just because they are no longer publicly listed equities doesn't mean we can't participate in intrinsic value growth of the business. We still own the equity. Same with outright purchases of other listed and unlisted businesses.

 

To show this, a while ago I posted how BRK is fully exposed despite the high cash balance. First, I added up the stock holdings, and then to that, I added the net worth of our subsidiaries; the railroads, utilities, and manufacturing, services and retail, and it all added up the the full value of BRK's shareholders' equity.

 

I showed that the high cash holdings of BRK is not a drag on future potential returns as it would be in a mutual fund. If a mutual fund had a high cash holding, yes, then it would lag in a bull market. Not so BRK. 

 

Since manufacturing, services and retail is no longer itemized on the balance sheet, I can't do this, but if you net out the cash, cash equivalents and fixed income securities with float, you will see that what you have left is still equity ownership in the various businesses; the cash is not necessarily a drag on returns on this basis. Of course, if the cash was invested in higher returning securities, future returns would be higher.

 

But it's still fair to say BRK has 100% equity exposure.

 

Here are a couple of tables to illustrate this. 

Liquid Assets = Float

First, check out the liquid assets (cash and cash equivalents plus fixed income investments) against float. This is just an approximation of float using the 2 or 3 items shown on the consolidated balance sheet so may not match what Buffett calls float, but it is close enough.

This ratio is on the far right of the below table labelled, "Liquid / float". Since 1999 or so, it's been remarkably stable at around 1. Someone asked about this at a recent annual meeting and Buffett said there is no relationship. It is a head-scratcher because it seems to match perfectly over time.

By the way, the cash and cash equivalents include only what is at the top of the balance sheet and excludes cash held in railroad / utilities (for simplicity, and most cash is in the insurance segment anyway).

 

Stocks to Total Shareholders Equity

Some insurance companies like MKL and Y use their equity portfolio to shareholders' equity ratio to show how much stock market exposure they have. This, for BRK, is in the column labelled "Stocks to sheq". It is amazing to think it was above 100% before the Gen Re merger. BRK back then was a leveraged play on Buffett's stock-picking skills, and any investment in bonds offered free incremental points on ROE above all that. No wonder why returns were so high back then. 

 

Since then, the stock portfolio (including equity method investments) has averaged 52% of BRK's total shareholders equity.  Despite the huge cash holdings, note that the year-end figure was 62%, and at the end of the 2Q2020, it was 56% despite the portfolio taking a big hit this year. This is higher than the 52% average since 1998. I use the average since 1998 because the beast was a different animal pre-Gen Re. 

So, this piece of evidence doesn't really show any bearishness on Buffett's part, or at least compared to the last 20+ years.

 

BRK Balance Sheet Stuff

 

This next table shows some other ratios. Investment leverage is used by insurance companies too, total investments versus total shareholders equity. This is not really all that relevant for BRK because insurance is only one part of the business. 

 

Investment Portfolio

But let's look at the portfolio in a conventional way. We will add the cash, cash equivalents and stock portfolio and see how that breaks down. 

 

The column labelled "equity %" shows how many percent of total investments was invested in stocks (including equity method). 

 

And, check it out! This also averaged 52% since 1998, and at year-end 2019, this was 65%, and was 58% at the end of 2Q2020.  

Buffett bearish? Well, according to this piece of evidence, not really. Or, at least, not all that much more than in the past 20 years.

Maybe this is a little tautological but liquid assets as a percent of total investments is also below historicals, and also liquid assets vs. total shareholders equity is also lower: 51% average since 1998, but 34% and 41% at year-end 2019 and 2Q2020, respectively.

 

 

 

AAPL

By the way, for those who say Buffett has lost his touch, what do we call AAPL? At $470/share, the gain to BRK on this buy is $83 billion! This is not how much it's worth now, but how much BRK has gained on the position of around 250 million shares. That's as much as the total shareholders equity BRK had as recently as 2004, and also as much as the gains on all of the other holdings as of the end of 2019 (so before the recent decline in most of these holdings). 

This is the table from the annual report, excluding AAPL.

I admit I have been an AAPL naysayer for years. Part of this multiple expansion is probably due to a shift in the business model from a hardware, consumer electronics business to more services. I have no idea how this will pan out over the years, but I do notice more and more people living their lives in a very Apple-centric way.

Conclusion

People are frustrated that Buffett continues to accumulate cash. The cash just gets bigger and bigger and it makes Buffett seem more and more bearish. But as you can see from the above, the cash balance may grow, but so does BRK. So on a relative basis, the cash balance hasn't really been growing all that much. Judging from this analysis, you can't really conclude that Buffett is any more or less bearish than he has been in the last 20 years. But that won't stop people and the press from obsessing over this 'nominal' figure. Oh well... 

Wow!

It's been quite a few weeks since my last post. I haven't really changed my thoughts since then, but maybe the economic impact of this will have more than a blip on the long term charts after all.

So far, the economy seems to be doing much worse (or will soon) than the stock market. The initial decline was shocking, but not at all unexpected. The recovery rally is kind of incredible too.

As I watch all these commentators, I realize nobody really has any idea. The commentators / pundits that survive a long time are masters at saying things that will make them look 'correct' in hindsight later on. You make enough calls and predictions, you will at least be able to pick one and say you were right. Also, they are very careful to word their comments so that they can't be called out for being wrong. 'If this happens, then this will happen, if that happens, then that might happen...' etc. You say enough of that, and you will be right about something, eventually... It's kind of a joke, but whatever.

Buffett and Airlines

A lot of things have happened since my last post, including the virtual BRK annual meeting. Nothing really new or unexpected, as usual, but one thing that may have shocked people was how Buffett dumped all his airline stocks. We are supposed to be long term investors, and are not supposed to be reacting to headlines, however scary.

But if you look at their income statements and realize that their revenues are down 90% and may be down for a year or more, it's hard to imagine them surviving. Most of them will be out of business by the end of the year or long before that. The government will have to bail them out, but that will be costly. Either they will have to take on a lot of debt that will take years to pay off, or they will have to issue a lot of equity, basically wiping out current shareholders.

Many businesses will not survive this, and even if they do, there will be big losses to equity investors.

A lot of restaurants will go out of business too, but mostly the independent ones. Major chains, especially fast food and fast casual should be fine.

Retailers are out too, for the most part. A lot of retailers should probably not even exist, and this pandemic is just accelerating what is going to happen anyway. The Micrsoft CEO, Nadella, said that there was two years worth of virtualization in two months since the pandemic. I think that's the case with retailers. This will just accelerate the demise of retailers with flawed (or out of date) business models.

No Bargains?

One thing Buffett said was that he didn't really see any bargains during the decline in March. We know from the 2008-2009 crisis that Buffett is not really a trader, so he is not going to be buying the lows on big down days, necessarily. So on fast declines with quick rebounds, he is not going to get much done.

If you look at what's going on, the stocks that were really hit are the ones that you don't really want to own, necessarily. Airlines, real estate, retail, travel-related stocks etc. And the ones you want to own didn't really get cheap. I can see Buffett piling into things like Amazon or Google if they were dumped with the bath water, but they weren't, really. Neither was Microsoft. Not sure what he thinks of Netflix, but that wasn't dumped either.

So crappy stocks got cheap, but as Buffett said, the way to succeed in the stock market (or at least not lose money) is "don't buy crummy businesses". And there are a lot of them out there now.

People also view Buffett as being 'bearish' because he sold stocks, and he is still sitting on a growing cash balance. He did mention during the meeting that he has a lot of cash, but he has a lot of equity exposure too. I wrote about it a while back, but his equity exposure is not limited to his listed equity portfolio. Kraft is not included in his list of stock holdings, but he still owns it. Same with Burlington Northern, and his many other operating companies (some of which were listed until recently).  If you add it all up, BRK is still fully exposed and is not as conservative as it seems if one were to look only at his listed equity portfolio and cash balance.

Which leads to the next thing being talked about a lot these days (as it has been for the last few years).

Value Investing is Dead?

One thing people need to keep in mind about value investing is that the way the general press talks about it and the way investors talk about it are completely different. The press just looks at nominal valuation and that's it. There is no concept of what something should be worth, and whether it is trading above or below that. They don't understand the concept of intrinsic value. Indexes split between growth and value don't help either.

Value investing used to be about low P/E's and things like that, I suppose, but the more modern approach is what something is trading at versus intrinsic value. This is not that modern, actually, as Buffett has been saying that for many decades.

Here is something from the second edition of Graham's Securities Analysis. This is in the section where he discusses the difference between investment and speculation.

It may be helpful to elaborate our definition from a somewhat different angle, which will stress the fact that investment must always consider the price as well as the quality of the security. Strictly speaking, there can be no such thing as an “investment issue” in the absolute sense, i.e., implying that it remains an investment regardless of price. In the case of high-grade bonds, this point may not be important, for it is rare that their prices are so inflated as to introduce serious risk of loss of principal. But in the common-stock field this risk may frequently be created by an undue advance in price—so much so, indeed, that in our opinion the great majority of common stocks of strong companies must be considered speculative during most of the time, simply because their price is too high to warrant safety of principal in any intelligible sense of the phrase. We must warn the reader that prevailing Wall Street opinion does not agree with us on this point; and he must make up his own mind which of us is wrong.

Nevertheless, we shall embody our principle in the following additional criterion of investment:

An investment operation is one that can be justified on both qualitative and quantitative grounds

I would look at the opposite of this example and say that many cheap stocks may not necessarily be safe. Would you buy junk bonds just on yield? Nope. Someone showed me years ago a quantitative report basically showing that the valuation of a stock is pretty much determined by it's credit quality (I don't know if there was an adjustment for long-term growth or returns on capital), but it made sense to me. The industrial cyclicals were always 'cheap', like steel, auto manufacturing etc. And consumer stocks were always expensive.

Anyway, today, I think a lot of this gap between value and growth just may be reflecting huge secular changes in the economy. You can say AMZN is overpriced and BBBY is cheap. But really, who would short AMZN and go long BBBY?

MKL Dumping Stocks

On the 1Q earnings call, MKL said they dumped a few stocks they thought would be hugely affected by Covid-19. Here are the stocks they dumped:

Anheuser-Busch Inbev ADR	0	0.00%	13,000	-13,000	-100%
CDK Global Inc	0	0.00%	176,897	-176,897	-100%
Discovery Communications	0	0.00%	117,000	-117,000	-100%
Dollar Tree Inc	0	0.00%	123,100	-123,100	-100%
Hasbro, Inc	0	0.00%	364,000	-364,000	-100%
Kraft Heinz Co	0	0.00%	68,000	-68,000	-100%
Rockwell Automation Inc	0	0.00%	140,100	-140,100	-100%
Scotts Miracle-Gro Co	0	0.00%	422,000	-422,000	-100%
Unilever PLC ADR	0	0.00%	1,527,600	-1,527,600	-100%
United Health Group Inc	0	0.00%	599,000	-599,000	-100%

This is as of end the March, and they may have dumped more things in April. Buffett dumped airline stocks in April, so that dumpage doesn't show up on his 13-F, which is here, by the way:

BERKSHIRE HATHAWAY INC

Filing Date: 2020-05-15

Name	dollar amt	%port	#shares	change	%chg
APPLE INC	62,340,609	35.52%	245,155,566
BANK AMER CORP	19,637,932	11.19%	925,008,600
COCA COLA CO	17,700,001	10.09%	400,000,000
AMERICAN EXPRESS CO	12,979,391	7.40%	151,610,700
WELLS FARGO & CO NEW	9,276,210	5.29%	323,212,918
KRAFT HEINZ CO	8,056,205	4.59%	325,634,818
MOODYS CORP	5,217,658	2.97%	24,669,778
JPMORGAN CHASE & CO	5,196,030	2.96%	57,714,433	-1,800,499	-3%
US BANCORP DEL	4,563,233	2.60%	132,459,618
DAVITA HEALTHCARE PARTNERS I	2,897,549	1.65%	38,095,570	-470,000	-1%
BANK OF NEW YORK MELLON CORP	2,686,487	1.53%	79,765,057
CHARTER COMMUNICATIONS INC N	2,367,684	1.35%	5,426,609
VERISIGN INC	2,307,964	1.32%	12,815,613	-137,132	-1%
DELTA AIR LINES INC DEL	2,050,935	1.17%	71,886,963	976,507	1%
SOUTHWEST AIRLS CO	1,910,218	1.09%	53,642,713	-6,500	0%
VISA INC	1,701,823	0.97%	10,562,460
GENERAL MTRS CO	1,551,872	0.88%	74,681,000	-319,000	0%
LIBERTY MEDIA CORP DELAWARE	1,446,433	0.82%	45,711,345	-240,000	-1%
COSTCO WHSL CORP NEW	1,235,572	0.70%	4,333,363
MASTERCARD INC	1,192,040	0.68%	4,934,756
AMAZON COM INC	1,039,786	0.59%	533,300	-4,000	-1%
PNC FINL SVCS GROUP INC	880,431	0.50%	9,197,984	526,930	6%
UNITED CONTL HLDGS INC	699,073	0.40%	22,157,608	218,966	1%
SIRIUS XM HLDGS INC	654,149	0.37%	132,418,729	-3,857,000	-3%
KROGER CO	570,475	0.33%	18,940,079
M & T BK CORP	556,665	0.32%	5,382,040
AMERICAN AIRLS GROUP INC	510,871	0.29%	41,909,000	-591,000	-1%
GLOBE LIFE INC	457,278	0.26%	6,353,727
LIBERTY GLOBAL PLC	434,229	0.25%	26,656,968	-481,000	-2%
AXALTA COATING SYS LTD	415,689	0.24%	24,070,000	-194,000	-1%
TEVA PHARMACEUTICAL INDS LTD	384,248	0.22%	42,789,295	-460,000	-1%
RESTAURANT BRANDS INTL INC	337,782	0.19%	8,438,225
STORE CAP CORP	337,425	0.19%	18,621,674
SYNCHRONY FINL	323,860	0.18%	20,128,000	-675,000	-3%
STONECO LTD	308,410	0.18%	14,166,748
GOLDMAN SACHS GROUP INC	296,841	0.17%	1,920,180	-10,084,571	-84%
SUNCOR ENERGY INC NEW	236,195	0.13%	14,949,031	-70,000	0%
OCCIDENTAL PETE CORP	219,245	0.12%	18,933,054
BIOGEN INC	203,440	0.12%	643,022	-5,425	-1%
RH	171,638	0.10%	1,708,348
JOHNSON & JOHNSON	42,893	0.02%	327,100
PROCTER & GAMBLE CO	34,694	0.02%	315,400
MONDELEZ INTL INC	28,946	0.02%	578,000
VANGUARD INDEX FDS	10,183	0.01%	43,000
SPDR S&P 500 ETF TR	10,155	0.01%	39,400
UNITED PARCEL SERVICE INC	5,549	0.00%	59,400
PHILLIPS 66	0	0.00%	227,436	-227,436	-100%
TRAVELERS COMPANIES INC	0	0.00%	312,379	-312,379	-100%
Total	175,485,996

Insurance Companies

By the way, insurance companies are going to hurt for a while. People keep saying that business disruption doesn't cover pandemics, or that it requires physical damage etc. But the way things work in this country, that doesn't matter. We have enough lawyers with a poorly structured incentive system so insurance companies can get bogged down in years and years of lawsuits. Even if insurance companies win, who knows how much all of that is going to cost.

Plus, interest rates are now 0% all the way out to 5 years, and 1% to 20 years. That's going to be painful, and makes BRK's float basically worthless. Yes, this may be temporary, but we have been saying that for more than 10 years now. I have always suspected we will follow Japan in terms of interest rates. I didn't expect a pandemic to cause rates to go to zero, though.

I still think BRK, MKL and others are great investments for the long haul, but there are serious issues for them out there for sure.

Banks
JPM and other banks are going to take some huge credit losses. There is no way around that. One rule of thumb is that credit card losses will follow the unemployment rate. Unemployment got up to 10% during the financial crisis, and sure enough, JPM's credit card charge-offs peaked at 10% or so. Total charge offs were 5%, I think, back then.

Unemployment is now over 15%, and headed to 20%. JPM has $160 billion in credit card loans, so credit card charge-offs can get over $30 billion. Total credit losses may get to 10% and they have around $1 trillion in loans outstanding. Who knows, really.

JPM is still the best managed big bank and they will get through this for sure, but they face some very serious problems. I think the view expressed during the 1Q conference call (expecting rebound in second half of the year) is way too optimistic.

Even if we start to reopen the economy, we can't really have a real recovery as a lot of events won't come back, and restaurant / bars / retailers will run at 30-50% capacity.

An interesting thing to look at is Sweden. They didn't have a hard lockdown like the U.S. and European countries, but their economy is taking a hit anyway. Reopening the economy doesn't mean we are all going to go back to the way we were right away. Many people tell me that they won't change anything even if the economy reopens until they get a vaccine. This could be years away.

I tend to believe things will normalize when we get a treatment that makes Covid-19 far less fatal. If we take that off the table, people will start to get back to normal.

I have no idea about these things, but I tend to think the odds of us finding a treatment is far higher than us finding a vaccine (there is a chance we may never find a vaccine).

Anyway, the mitigating factor to the above bank credit disaster is the amount of money being injected into the economy. I don't know if people are going to use their stimulus / Covid-19 help checks to pay off their credit card (they seem not to be paying their rent), but it will have some positive impact on bank credit, I assume (and hope).  Well, but don't assume because...

Is the Market Being Rational?

So, people are saying that the market is being too optimistic about a return to normal, but it's hard to tell. The market is full of stocks with different exposure. If the airline stocks got back to their highs, I would agree that the market is being too optimistic. But that hasn't happened; not even close. Same with retailers. And restaurant stocks.  OK, Amazon, Netflix, and others are going to new highs, but I doubt that is reflective of the market's optimism about a return to normal.

So when the markets move, I think we have to look by sector, and by stock, to see what they're expecting. It makes no sense to look at the index itself.

What to do?

When this started, I told people the same thing I always told them. Ignore the headlines and just think 3-5 years ahead. This works, though, for people with diversified portfolios. I wouldn't know what to say if they owned a lot of airlines, hotel and other travel related businesses, or other areas that may not recover so quickly. I have no idea.

I haven't owned any retail stocks in a long time (except BRK, which is the closest thing to a retailer I own), and the only restaurant stocks I own are CMG, QSR and SHAK.  Well, SHAK was never cheap so it's a token position that is not significant; it's more of a moral support, I like this company, kind of position. CMG was a large position that I scaled back and had to do again as it went over $1,000. It's not a cheap stock, and I have no idea why it's above $1,000; maybe they are going to take market share after many of their competitors go out of business within a few months). Oops, after writing this, I just realized I do own Costco. So I lied. I own Costco and have no problem with it. I will hold on to it. Yes, it's expensive, but I really like the business for all the reasons we've all heard already a gazillion times.

If you own the S&P 500 index, it doesn't really matter. Many companies will go bust, but that happens all the time. Some big banks, AIG and FNM went bust (or was massively diluted) during the financial crisis and yet the S&P 500 index was fine. It should be fine over the long term this time too, but many of the components won't be.

As usual, just don't invest based on the headlines. OK, evaluating your holdings on long term potential incorporating Covid-19 might not be a bad idea (like Buffett's dumping of airlines), but I would be careful about that too.

One thing is for sure. You really don't want to go chase Covid-19 stocks. You can buy AMZN, NFLX, MSFT thinking these are the pandemic-proof stocks, but the worst time to buy stocks is when everyone piles into them for the same reason (I wouldn't short them either!). For example, I wouldn't touch Zoom stock, of course.

Things are Interesting

I have to admit I have sort of been lazy about my investments over the past few years, kind of just let it go... Looking for things to do wasn't all that interesting as things got expensive.

But things are getting interesting again. I haven't read through so many conference calls and 10-Q's in a long time, and it's been fun. I have to say, though, that the 10-Q's only reflect a small portion of what's happening as the 1Q included the relatively healthy January and February. NYC shut down in mid-March. So there was only 2 weeks of really bad data included in 1Q. The 2Q reports are going to be really scary, but I can't wait to sift through that stuff.

Maybe this will lead to more blog posts. That would be fun, as I do enjoy this process. Until now, though, things are more interesting, but nothing really stands out to me. The really devastated industries are just 'too hard' for now, like cruise lines, airlines, casinos, and the solid businesses that you want to own are not cheap (AMZN, MSFT, COST etc...).

So to those who feel that ETFs and the indexing bubble has lead to a lack of differentiation in the evaluation of individual stocks, it is quite obvious that this is not the case at all. I've always maintained that this is not the case. Sure, there may be excess valuation in some large cap index stocks where index funds are 'forced' to buy regardless. I think overall, crummy stocks are cheap and higher quality stocks are expensive.

OK, banks and insurance companies are cheap now, and not all of them are crummy. But there are massive uncertainties they are facing now. The market is probably wrong and these stocks are probably too cheap.

Why BRK?

Every now and then, BRK comes up in conversations with people (and often with people not in the business) and the topic becomes, what to do with BRK post-Buffett. I tell them I own BRK and plan to own it for a long time, and sometimes I wonder why myself.

Too Big
First of all, it's really big now so it's going to be hard to grow the way they used to. With a market cap of more than $500 billion, it's going to be hard to keep growing at a high pace. This used to be sort of the cap in big company capitalizations; a lot of the bit techs went to $500 billion in 1999/2000 before they all came crashing down. The barrier today seems to be $1 trillion; Maybe these $1 trillion companies hit that wall and come crashing down. Who knows.

In any case, BRK is just too big to get too much alpha going forward.

Buffett
Buffett is not so young anymore, so the historical performance is getting increasingly less relevant; Buffett created the performance of the last half a century, but he is clearly not going to lead the charge for the 50 years. This doesn't mean BRK can't outperform.

Buffett hired some great managers to help manage the equity portfolio, but their historical performance is sort of irrelevant too.  Those guys posted great returns with a much, much smaller capital base. They will eventually inherit a $200 billion+ equity portfolio. If they want to stay focused, they will need to invest in companies they can buy $10-20 billion worth of. And there aren't a lot of those. Their universe will be no bigger than the one Buffett is fishing in now, so it's hard to imagine they will improve on what Buffett can do with this size.


Returns Not So Great Lately
And people say that BRK hasn't even been performing all that well lately, underperforming in the past five years. The rolling five-year BPS growth vs. the S&P 500 index total return has been negative for the last five years in a row (through 2017):

2013  -4.0%
2014  -3.9%
2015  -2.3%
2016  -3.2%
2017  -2.7%

People often point to this to show that the era of BRK outperformance is over.

But this sort of misses the fact that back in 2008, the S&P 500 was down -37% while BRK's BPS declined only -9.6%. So in a sense, the S&P 500 index had a lot of catching up to do compared to BRK. Looking only at the above table of the last five years misses a lot of crucial information.

Having said that, it's true that the supergrowth of BRK ended back in 1998, but has been a steady grower since then.

Check out the below log chart since 1980. You can see two clearly different eras in terms of performance. 1980-1998 was just amazing, but 1998-2018 has been much more modest (data just happened to be available since 1980 as I was playing with daily data; no cherry-picking start/end points. Good enough for this analysis).

BRK, Log Scale Since 1980

BRK's BPS grew +28%/year from 1980 through 1998 vs. +18%/year for the S&P 500 index for an outperformance of 11%/year. BRK's stock price rose +33%/year in that period, beating the index by 15%/year.

Since then, things have flattened out a little, but the returns aren't that bad at all. 

BRK vs. S&P 500
I haven't updated this table in a while, but let's take a look at BRK's performance against the S&P 500 index (total return) in various time periods.

BRK vs. S&P 500: Various Time Periods

Of course, we know how great the performance has been since 1965. But check out the past five years. On a BPS basis, BRK underperformed the S&P 500 total return, but outperformed based in BRK's stock price.

If you look at all the time periods, though, BRK has outperformed both on a price and BPS basis in most time periods.

This year, it just so happens that the 2007-2017 is the same as the 10-year comparison so be careful to not double count...  

But to me, more interesting than looking at the past 5 and 10 year returns (which are no doubt important), is to look at 'through-cycle' performance.

The lower part of the above table shows returns from various market peaks (year-end basis). You will see that on a BPS basis, BRK has outperformed the S&P 500 index since the 1989, 1999 and 2007 market peaks, and also on a price basis in most of those time periods.

The 1998-2018 BRK log price shows a more modest pace of growth than the 1980-1998 period, but you will see that BRK has still grown 10%/year since then, bettering the S&P 500 index (including dividends) by 3%/year on a BPS basis and 2%/year on a price basis. Not like it used to be, but not bad! (How many funds can you name that has done as well?)

So all this talk of Buffett not performing well is not so relevant to me.

It looks funny to have both 1998 and 1999 in there, but 1999 is there as a market peak, and 1998 for sort of a momentary peak in relative performance of BRK, and sort of the end of the high-growth era for BRK.

Why BRK?
Despite the size, and the potential risk of a post-Buffett BRK, why do I still like BRK? First of all, the recent performance, I don't think, is as bad as people make it out to be. They are still outperforming in most time periods, especially from various market peaks.

There is something about BRK that makes me more comfortable than owning the S&P 500 index, even with the post-Buffett risk. The first thing is that BRK will probably not do anything irrational or stupid. This is not an assurance we get when investing in the S&P 500 index. The index committee will add bubble-ish stocks at bubble-ish prices. BRK will not be 'forced' to buy stocks just because they are 'big'. They will only buy stuff when it is high quality and is priced rationally. These are two things that the S&P 500 index committee do not seem to care about too much.

Sure, this inflexibility with regard to price and quality will be a drag on performance during certain time periods (like now, and back in the late 1990s), but I would feel more comfortable when my money manager is not chasing big stocks.

Also, check out the below chart. It's just the S&P 500 index since 1980 along with the BRK/S&P 500 index ratio. I just wanted to see, visually, how BRK has performed (price-wise) versus the index over time.

And what I see is kind of interesting.

S&P 500 Index and BRK/SP500 Ratio Since 1980

BRK seems to not do too well in late periods of raging bull markets (like the late 1990s) but seems to pick up a lot of relative performance during rocky times. This is kind of important for conservative investors. Whatever you think of the stock market now, there are pockets of bubbliness, and if that pops, it wouldn't surprise me if BRK has another big step up in relative performance like in the two circled periods above.

This sort of makes sense, right? As BRK doesn't have a whole lot of exposure to FANG/FAANG stocks. And if the market does decline a lot, that will provide a lot of opportunities for BRK to deploy cash so you are kind of sitting on cash optionality by owning BRK.

Yes, BRK declined 50% during the crisis, no better than the S&P 500 index, but if you look at the above table and charts, you will see that BRK does ratchet up relative performance during tough times. So just comparing peak-to-trough drawdowns sort of misses some important information.

By the way, here are some large declines in BRK stock over their history (from the 2017 Letter to Shareholders):

Stunning Discovery
OK, maybe not. But I just noticed something. Look at the above chart again; BRK price / S&P 500 index ratio. If you look at this chart, you will notice that the uptrend is pretty consistent and linear. OK, I am not going to go back and put a regression line on it (too lazy), but you can sort of imagine a straight line going through it from the mid-90's even through today.

Here is the chart again with the line I sort of see (this is not a regression line, but one I just drew by hand). The lower chart is the BRK/S&P index ratio:

And, importantly, there is no kink, bend or flattening after 1998!.

What does that mean?! It means the rate of BRK's outperformance against the index has been pretty consistent and hasn't tapered off at all! 

The ratio will measure the 'rate' of outperformance, not the absolute difference.

Here's what I mean. The above chart is based on prices, but I will look at BPS growth instead as the prices data is a little too spikey (and too sensitive to start/end points). As we saw above, in the period 1980-1998, BRK's BPS grew at a rate of 28.2%/year versus 17.7%/year for the S&P 500 index (total return), for an outperformance of 10.5%/year.  Since then, BRK's BPS grew 9.5%/year vs. 6.2%/year for the index for an outperformance of 3.3%/year. Looks like big degradation in relative performance.

But the linearity of the above ratio chart made me look at this another way. The 1980-1998 28.2%/year is 1.6x the index return, and the 1998-2017 BPS growth of 9.5%/year is 1.5x the index return! 

So, from now on, I am inclined to answer the question, "How do you think BRK will perform vs. the S&P 500 index in the future?" with, "I think it will do 1.5x better!".

Nonsense? Maybe. But it looks interesting to me. This is the danger with playing with charts.

Optionality at Low Cost
Moving on. This is not a new idea, but we can see all the cash at BRK as optionality (even though I have long said that the cash is matched pretty closely to float so wonder how much of the cash is actually immediately deployable. Some of the float might be 'fast', meaning maybe they actually can deploy a lot of that cash and run down the float if necessary).

A lot of funds held a lot of cash since the crisis and have severely underperformed the index. The worst fund managers have actually been net short since the crisis and have catastrophically posted negative returns for years on end. Sure, these guys had plenty of opportunity because they were short; if the market went down, they could profit on the decline and then use the profits to go long and make even more money! But, those guys were neither prudent nor rational, and it is unlikely they will ever be able to make up the damage as it is just too big to overcome.

And yet, here, we have BRK with all that cash and it seems like they haven't sacrificed all that much in terms of performance. That is really amazing when you think about it.

Leverage
By the way, BRK has $97 billion of cash/cash equivalents on the balance sheet just looking at the Insurance and Other segment.  This makes people say that Buffett is bearish the stock market. Well, it's true that Buffett has been having trouble finding stuff to buy, but that doesn't necessarily make him 'bearish'. There is a difference between not finding things to buy, and being bearish (and expecting a market decline).

One thing that occurred to me when thinking about this huge amount of cash and short term investments on the b/s is how small the investment in fixed maturity securities is: $18 billion.

So first of all, the amount of cash/cash equivalent sort of seems to me like more of a bearishness or unwillingness to buy bonds than stocks. There is only $18 billion worth of bonds in the insurance segment versus, what, $200 billion in stocks? That's not bearish stocks to me, that's more like, bearish bonds!

Not to mention BRK has been net purchasers of stocks; not the act of a bear.

Here's the other thing. When we look at insurance companies, we often look at investment leverage. For me, since I like risk, I look at the percent of shareholders equity invested in stocks. Markel looks at and talks about that, as it's a big source of their expected BPS growth.

So I think about BRK in the same way. Forget about cash vs. float and all that stuff for now.

Let's just look at how levered BRK equity is to 'equity'.

First of all, the portfolio (including KHC) is $219 billion at the end of 3Q 2018. That's against $379 billion in total shareholders equity (including minority interest). So the ratio of shareholders equity invested in stocks is 58%.  That's a lot higher than any other insurance company, and I think higher than MKL has been recently (maybe they are much higher now; too lazy to check now).

Of course, this is not like the old BRK, but not at all overly conservative either.

Now, keep in mind that BRK has a lot of unlisted businesses. For example, the various businesses in the railroad, utilities and energy used to be listed companies. If these were still listed, they would be included in equities. As far as growth potential is concerned, other than not having to mark to market, these businesses are basically no different than the equity portfolio (ignore the advantages of wholly owned businesses etc.).

So from the 'leverage' point of view, we can add this to the equity portfolio. The book value of this segment is $96 billion. With a similar argument for the Finance and Financial Products segment, we can add another $24 billion.

Sum that up and you get 'equity investments' of $339 billion.  That's against total shareholders equity of $379 billion. So that's already like 90% of BRK's shareholders equity invested in equity of businesses. That's really not all that bearish!

This, by the way, doesn't even include the other unlisted businesses, the Manufacturing, Service and Retailing Operations (MSR), which is the 'other' in the Insurance and Other segment. BRK doesn't disclose the balance sheet in detail for this segment, but in 2016, BRK equity in the MSR segment was $92 billion or so. Add this to the above $339 billion and you get $431 billion worth of equity investments at BRK against it's shareholders equity of $379 billion.

This is why you get equity-like returns on BRK despite BRK having so much cash/cash equivalents on the balance sheet. This is hardly the balance sheet of a bearish CEO.

Conclusion
I haven't even touched valuation here, but from all of the above, I like BRK a little more now than I have liked it in recent years.

I don't want to time the market and call a peak or anything. I have made it clear that even though we may enter a bear market or have a severe correction at any time, there doesn't seem to me to be a strong case to be made for an extended bear market in the U.S. at the moment (famous last words... I know!)

But the more frothy things seem (well, less so now with the October/November corrections), the more interesting BRK becomes for the above reasons.

AND, it is possible that you won't give up much in terms of performance to buy this 'optionality', with, of course, the greatest investor of all time ready to pounce if we have any big disruption in the market. And we can't forget that BRK has a lot more levers to pull than most conventional funds or even hedge funds; they can buy private businesses too, or do add-on deals to augment the many businesses they already own.

Plus, all that cash on the balance sheet doesn't mean it's as much a drag on BRK's performance as people make it out to be.

As for a post-Buffett world, I think what we need is intense rationality and discipline not to do stupid things. We know BRK is not going to jump into Bitcoin, or buy into bubble stocks (I fear we may find AMZN in the 13-F at an entry price of $3000 some day; that may be a sell signal!), panic and sell out stocks during a crisis or anything like that. And they will not be subject to quarter-to-quarter performance pressure in fear of redemptions. Many of these (and other) advantages are enough to keep me comfortable with BRK for a long time.

Also, even though BRK is not growing the way it used to, and it doesn't look like they are outperforming as much against the index, it looks like a lot of this is due to lower returns in the market in general as the rate of outperformance has been remarkably consistent even after 1998.

By owning BRK, you sort of get paid at least market performance while you wait for the optionality to be exercised!