The short case for Berkshire Hathaway

For more than a quarter-century, Berkshire Hathaway (BRK-B) has been one of my favorite stocks...

At various points over the years, I've called it "America's No. 1 Legacy Stock" or "America's No. 1 Retirement Stock"... I have attended the past 27 Berkshire annual meetings... It was the only stock I owned continuously for the 18 years I ran a hedge fund... I was a contributor to the definitive book on the late Charlie Munger, Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger... and, other than my parents and wife, no one has had more of an impact on my life than Warren Buffett.

So you can imagine my gut feeling when I saw a pitch on Value Investors Club ("VIC") – my favorite stock idea website – arguing that Berkshire's stock is a good short.

It's like someone telling me that my newborn baby is ugly.

However, I'm going to put my emotions aside and carefully consider the argument because of what I learned long ago from my hero and mentor Charlie Munger. He regularly preached about the importance of challenging your best-loved ideas – and be willing to amend them if necessary.

As he once said:

[You need to] have strong opinions, loosely held. We all are learning, modifying, or destroying ideas all the time... You must force yourself to consider arguments on the other side.

Munger elaborated on this in one of his most famous speeches at the 2007 USC Law School commencement when he said:

I'm not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people do who are supporting it. I think only when I reach that stage am I qualified to speak.

So with this in mind, today I'll share the short pitch on VIC by someone who goes by the handle arm504. Because only members can read posts within the first 45 days (if you're a member, you can see the whole post right here), I'll summarize the arguments below...

Arm504 first pays tribute to Buffett and Munger:

Let me make it clear that without Buffett, I wouldn't be where I am today. I am one of those that had the experience of reading Buffett's shareholder letters in college and it made complete sense to me. I was hooked, and I made my career by essentially following Buffett's investing principles. Essentially, I owe my career to Buffett/Munger and I am forever grateful.

Moving on, arm504 then lays out the summary:

That said, there are some important management problems at Berkshire that threaten the health of the overall business over time. At current prices, investors are assuming a fairly bright future for the operating businesses. I contend that Geico is in trouble, and that Burlington Northern ["BNSF"] is perhaps the worst managed railroad in North America (though Norfolk Southern (NSC) is in the conversation).

Essentially, arm504 argues that some of Berkshire's big subsidiaries are lower quality than the market thinks... and that the market will inevitably realize this.

On the message boards, in response to pushback, arm504 elaborated:

I don't know exactly what the market thinks Geico is worth. My contention is that it is worth considerably less than investors think. Same goes for BNSF. I say that after doing dozens of interviews with competitors and by watching Berkshire operate in smaller industries like RVs, manufactured housing, etc. My thesis will be wrong if these [subsidiaries] end up stronger than I anticipate relative to their competition.

I stand by the thesis that BRK is not as well managed as the market believes generally. We'll see that over time, and without the cult of Buffett... it just may impact the valuation of BRK.

Overall, arm504 argues that Berkshire isn't as well managed as the market generally believes – which over time could affect's Berkshire's valuation.

Turning to the critique of Geico, arm504 argues:

Let's go back to 2019 (I chose this year to get pre-COVID numbers and also some time – our thesis will take time to play out so any year is not representative... we need larger time increments). Geico doesn't report PIF [policies in force] data, but revenues (net premiums earned or NPE) in the first half of 2019 were $17,491. Compare that to Progressive (PGR) (where I'm using auto only), where NPE was $14,458. In the first half of 2019, Progressive auto premiums were 83% of Geico's auto business.

In 2024 (through six months), Geico's NPE was $20,703 compared to $27,853 for Progressive. In five years, Progressive goes from 83% of Geico NPE to 135% of Geico NPE. Todd Combs became CEO of Geico in January 2020. To be clear, I'm not blaming Todd... he was dealt a really bad hand and may not have known that when he took the job (or didn't have a choice but to take the job). At the beginning, Todd was an interim CEO. Interesting that they have not been able to find a high-quality insurance CEO that is willing to take the job. We have some ideas why that might be the case. If you want to go down a rabbit hole, spend some time reading what Geico employees think of the place these days. Yikes.

And as arm504 continues, "Berkshire has been getting absolutely crushed by Progressive":

Our thesis is that Geico fashioned themselves as the low-cost, no-frills auto insurer and thus made it very difficult internally to pivot to a different world. What is that world? It is driven by technology. Progressive has a massive lead in understanding risk and thus pricing. A couple of years ago, Geico suddenly realized that they didn't have pricing right and decided to give a huge chunk of business to Progressive (I'm simplifying here... attempting to get the 2nd grade book report tag).

At the last annual meeting, Ajit Jain made the claim that Berkshire could catch up with Progressive in a couple of years. I contend that it is highly unlikely that they'll ever catch Progressive. Some of it is cultural. When you build your identity on lowest cost, you are unwilling to invest in technology that does not have an obvious, immediate payoff. Geico's technology is a joke, and it would take billions to fix it even if it is possible (i.e., can they hire the right people?). Would Todd Combs be willing to walk into Warren's office and explain that the Geico expense ratio needs to rise by at least 5 points (probably considerably more) for several years in an ATTEMPT to catch Progressive? I doubt it.

Turning to Burlington Northern, arm504 writes:

Their closest comp is Union Pacific [(UNP)] so we'll compare the two. In the first half of 2019, BNSF posted revenues of $11,655 with EBIT of $3,973. Five years later, revenues are lower at BNSF ($11,361) and EBIT is lower ($3,543). Not so for UNP – they posted first half 2019 revenues of $10,980 with EBIT of $4,220. This year so far, UNP revenues are $12,038 with EBIT of $4,772.

As you can see in the chart below of revenues and operating income, arm504 is indeed correct that BNSF has significantly underperformed UNP. Take a look at the changes since 2019:

Arm504 summarizes the short thesis:

Our contention is that the low-cost culture of Berkshire worked great for a long time. It remains a viable strategy for a wide variety of companies, but not for some of Berkshire's big subsidiaries. They have underinvested in their operating infrastructure and are paying the price in the marketplace. As a result, they are unable to attract the best management and have put themselves on a slippery slope. So long as Warren is CEO, it is hard to imagine this changing.

We have done some interviews and spent time studying some of their smaller subsidiaries and found similar problems. They don't move the needle by themselves, but it is indicative of the current culture throughout the company.

Finally, arm504 concludes with comments on where the argument could be wrong, as well as comments on Berkshire's valuation:

I acknowledge that we could be wrong here. It is possible that Progressive and the railroad competitors are over-investing and thus setting themselves up for lower returns in the future. I think that is highly unlikely, though time will tell. The story among various BRK subsidiaries lines up too much and operating performance has degraded over time throughout the company. That said, we'll keep an eye on datapoints that would suggest our thesis is wrong (we'll see it in auto insurance first... we understand that situation best).

Regarding valuation – I'm not going to go into much detail about valuation in this write-up. Berkshire is very clearly on the high end of its historical valuation range. I suspect we'll see that Buffett isn't buying too much BRK stock this quarter. Our thesis really isn't driven by current valuation and something changing soon. Rather, it's driven by what we perceive is a slowly deteriorating business relative to market perception. This will play out over years.

Overall, arm504's thesis isn't driven by valuation but rather the idea of "a slowly deteriorating business relative to market perception"... which would play out over years.

Turning to Berkshire's stock, arm504 is correct that it has had a good run – surpassing the S&P 500 Index over the past five years:

And in 2024 alone, Berkshire has also outperformed the S&P 500 so far:

So after seeing this, is my conviction in Berkshire wavering?

I'll continue the conversation on Monday... so stay tuned!

Best regards,

Whitney

P.S. I haven't forgotten about Adobe (ADBE) – I'll share part two of my analysis (you can see part one right here) after I finish discussing Berkshire.

P.P.S. I welcome your feedback – send me an e-mail by clicking here.