Thursday, August 20, 2020

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... 



23 comments:


  1. My conclusion with Buffett's ever increasing cash pile is that Berkshire is too big so it should return some of this cash to investors.

    If the recent crash and current economic environment is not enough to for him to spend, then what would it be?

    His misjudged both WFC and IBM. IBM could be excused, but WFC? People were pointed out the obvious long, long time ago so NOW he sells it?

    Additionally, is BRK actually safer than S&P500? Its recent failures show otherwise. People point out the Apple investment. That's actually high risk. Significant part of Apple's revenue and growth come from a certain market that can be turned off with a flick of a switch. Every passing day increases the chance that this would happen.

    As long as Buffett is at the helm and BRK does not return money to its investors, it's not going to outperform the S&P500.



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    1. It will be hard to outperform regardless of who runs it, just based on size.

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  2. My conclusion with Buffett's ever increasing cash pile is that Berkshire is too big so it should return some of this cash to investors.

    If the recent crash and current economic environment is not enough to for him to spend, then what would it be?

    His misjudged both WFC and IBM. IBM could be excused, but WFC? People were pointed out the obvious long, long time ago so NOW he sells it?

    Additionally, is BRK actually safer than S&P500? Its recent failures show otherwise. People point out the Apple investment. That's actually high risk. Significant part of Apple's revenue and growth come from a certain market that can be turned off with a flick of a switch. Every passing day increases the chance that this would happen.

    As long as Buffett is at the helm and BRK does not return money to its investors, it's not going to outperform the S&P500.



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    1. People were saying the same thing at all the previous peaks where we saw overvaluation and Buffett was holding out and not buying things because he didn't see any deals. When market comes down, he will go on a spending spree, just like in prior times.

      Key with Apple is he bought a strong moat with incredible cash flow at a significant discount, which you definitely can't say with what people are buying now (i.e., Tesla, Amazon). Buffett has outperformed everyone for decades. Incredible how many people are shortsighted, which seems to be fueling what looks just like previous bubbles.

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  3. Thank you for the thoughtful analysis on BRK. I always look fwd to your candid and quality research on Brk.
    I would not go so far as to say Buffett is bearish as he has inertia and lack of action. He bought back stock fairly aggressively near the end of Q2 but bought none at the brk bottom in Q1. I am not saying to blow everything but say putting $5bn to work when brk was crashing and hit 159 would not have risked the franchise and also would have been a good way to put cash to work.

    He said his phone didn't ring which makes sense given the govt action money in private equity now. I don´t think this will change much in the future. So what is the plan? Is he gonna keep saying the phone isnt ringing. Maybe you don´t want that call, why are they calling you when they can get it cheaper somewhere else(see oxy, pcp, khc). Concerned that there may be a negative selection bias in companies that decide to work w brk. So we are left with subpar deals. I would rather buy good shares of companies at discounts during mkt sell offs than buy bad companies because they decide to sell the whole thing.

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    1. The US government was essentially competing against Buffett.

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  4. Forgot to add that I think Buffett should have a serious conversation with whoever bought the gold miner. Truly horrible business. Look at the 20 year chart of GOLD, price has gone from 250 to 2k and the stock is essentially flat. That is all you need to know about the gold business. I really concerns me that this idea even entered their watch list much less putting $500mm into it. I could give you a list of great 25 s&p 500 companies would have put 500mm into easily during the sell off. My bet its Weshler. He made his career on 2 names; wr grace(where he worked for many yrs and was an asbestos litigation play) and DVA which is essentially a reimbursement scam.

    The whole T&T experiment is a waste of time and resources. These positions have almost no impact on brk. Put surplus cash in the s&p and have them work on portfolio companies and look for companies to buy. Really does not make sense to me.

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    1. Why in the world do you think the past is the future? We invest in real-time. The past is 100% irrelevant.

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  5. Not sure why your analysis on Berkshire's cash levels as % of investments are so different than Bloomberg's [https://www.bloomberg.com/opinion/articles/2019-08-26/warren-buffett-s-quiet-but-his-philosophy-still-speaks-volumes]?

    Also, one key metric Berkshire keeps an eye on is US Stock Market Cap to GDP, which is now higher than dot com levels from 1999 (also see Bloomberg chart).

    He could be strengthening his fortress ahead of the coming storm.

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    1. Could be. My point is that his cash has been building up for years. I even argued (a while back) that he doesn't even have all that much cash to put to work as it seems like all that cash backs up float. But that's a separate argument.

      I'm sure if there is a really great, gigantic 2 foot hurdle available, he would shoot, but that just hasn't been the case for years with all this private equity cash looking for deals.

      All these indicators show all sorts of stuff, and the markets will go up and down, but I still think if people focus on the names, they will be fine regardless. Value investors did fine after 1999-2000, and they will probably fine in the next correction / bear market.

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    2. A lot of these general mkt valuation metric are not so valid anymore. A lot of these American companies are global companies so measuring against just the us gdp doesn't make much sense. I find it interesting that there are so many theories out there but they never seem to adjust their theories for what the mkt is telling them. We have been hearing about hyperinflation etc for 30 yrs, hasn´t happened. But there is always some reason it will start to happen now. They never say maybe our theory or model is wrong.

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  6. Come on Roy.. Hate the game, dont hate the player, you want you money you sell your BRK shares but please do not judge Buffett on this minor stuff.
    Be honest.

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  7. 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.

    This has implications on BRK's valuation if the liquid/float assets equal to 100% of insurance float are really "non-working" capital permanently attached to the insurance business, no?

    If this is a case of "watch what Buffett actually does" rather than "listen to what Buffett says", then the perennial undervaluation of BRK may not be true. If one removes these non-working assets from the two-column valuation method, wouldn't the usual calculations of intrinsic value suffer as a result?

    It could be that Mr. Market doesn't undervalue BRK after all and instead, correctly values it - more or less.

    wabuffo100

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    1. Yes, this is the point I made a few years ago when I first realized this. People said float is equity, or float is better than equity, and people argued to add float to valuation. Made me wonder. Then did a table like this and realized, hey, wait a minute... So I realized float can't be valued as or like equity so it must be discounted (even assuming zero or better cost of float).

      And now with interest rates at zero, this float is getting pretty close to worthless from a valuation standpoint...

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  8. Simalar to banking and brokerage regulations that limits how firms can invest client money (for ex, brokerages have to invest client money in US government backed securities if not cash), I wonder if there is an insurance regulation effectively forcing BRK to keep its float in cash?

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    1. Yes, there are, but it has been suggested in the past that this is not why cash/FI = float. Given Buffett's comments (ready to deploy 'cash'), and this pattern of cash/bonds = float, and his insistence that this is coincidental and not deliberate, it doesn't add up...

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    2. Honestly, I don´t know the answer. It is an interesting observation. But if the float is worthless or little value why would Buffett be looking at to increase it all the time? Adding more to worthless stuff doesn't seem to rational. Yes if you don´t do anything with the float then it is worthless. That is why it is frustrating he did so little during the sell off or at least buy something he knows like brk. Could have put 20bn into HD and LOW which seems like a safer bet to me than adding to old line real estate brokers who may be obsolete in 10 yrs.

      Was something so bizarre about the virtual annual meeting. Almost like he was trying to sound and look morose. Maybe they could buy some more lights next time and invest in a zoom account.

      I do feel like all this soothsaying on Buffett´s comments is kinda deliberate consciously or sub consciously. He talks in code and gives Yoda like responses to most questions. Even super deep and difficult topics he will come back with some 5 word quip. Its like the mystery method on a grand scale. If he told you exactly what he thought in great detail it would seem less interesting. But now everyone has just a taste and has to let their mind wander with fantastical ideas of what is going on in his brain. My guess, not much, just inertia and lack of people coming to him with deals not much else.

      I really think the should just focus on the s&p 500 and systematically decide which companies they like and add to them during major sell offs. It´s that simple. Find the best 25 best companies in the index they are comfortable with and buy them. They are getting so cute it´s starting to backfire. If Buffett didn´t like PCP enough to buy any shares why would he buy the whole company?

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    3. Well, even if float doesn't have a lot of value now, it is valuable when interest rates are not zero. For example, when it was 6%, that was basically 'free' money (of course, nothing is ever really free).

      As for S&P 500, that's very interesting and makes a lot of sense. But I think for Buffett, it's just a hassle not worth it. He wants to bag an elephant, and he really wants a private deal (or 100% of listed company), and if he has a portfolio, he has to spend time liquidating, and that's a hassle too (even though he has some smart guys that can do that for him).

      Frankly, this friction between us shareholders and Buffett is probably simply the fact that we want him to make us rich, whereas he just wants to stay rich. Ever since the Gen Re aquisition, he has been sort of acting like he is trying to turn BRK into an endowment that is idiot-proof. That's why he would buy things like BNI, which would never have been a candidate in the old model (too capital intensive). In the endowment era of BRK, capital intensive is fine as long as capital can be reinvested at reasonable rates. In fact, he probably really likes that as it's less work for him, and less of a problem for the next generation; the more the businesses can use up and invest cash and the less comes to Omaha, the capital allocation becomes less of an issue (relatively; it will always be an big issue).

      Or something like that...

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    4. Oops, I should have said, capital intensive might actually be preferable now as long as return on that investment is reasonable. He wants to make BRK succession-proof...

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  9. Very good points and well analyzed. I feel like that thesis Buffett´s is just looking for capital intensive businesses to stay rich or however you want to phrase it is more mind reading. Again he says so little and its very cryptic so people read a lot into very few words. He made his largest stock buy ever in Apple which at the time many considered very risky; technology, competition etc. So to me it´s just lack of activity for whatever reason. He is always talking about buying things that go w the American growth machine. There are a bunch he seems to have passed up and don´t really know why. I would rather own a piece of something good to great vs all of something mediocre that some rich guy finally decides to sell.

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  10. Are you still holding Wells Fargo? I have a big slice and have been DRIP-ing the dividends but I. wonder if I'm being too patient and should sell? Thanks. Jeffrey Smith

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    1. Hi, I have been more of a JPM person, but WFC is certainly interesting at this point. I don't own any at the moment, though...

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