The short case for Berkshire Hathaway (part 2); Millennium Management's outperformance in the hedge-fund world; Why I just added CVS Health to my list of stocks to take a look at

1) Today, I'm continuing my discussion of the bear arguments for one of my longtime favorite stocks: Berkshire Hathaway (BRK-B)...

In Friday's e-mail, I shared two pillars of it: that two of Berkshire's largest businesses, railroad BNSF Railway and auto insurer Geico, are poorly managed – resulting in loss of market share and subpar earnings.

So in today's e-mail, I'll share other elements of the short case on Berkshire... and then tomorrow, I'll respond to them.

As I showed in two charts on Friday, Berkshire's stock has had a nice run – outpacing the S&P 500 Index over the past five years and year to date. Take a look:

As a result of this outperformance, the stock is trading at – not a discount to – my calculation of its intrinsic value.

Warren Buffett, the investing legend who built Berkshire from nothing into one of the most valuable companies in the world, turned 94 a month ago. Mentally, he appears to be as sharp as ever... But physically, he's becoming increasingly frail.

So, what if Buffett begins to lose it mentally and starts making bad investment decisions – but doesn't recognize it (or refuses to acknowledge it because he loves his work so much) and the board won't "take away the keys," perhaps rationalizing that a diminished Buffett is still better than anyone else?

This risk is higher since the passing of his longtime right-hand man Charlie Munger last November. Buffett could always count on Munger to warn him if he was making a mistake.

And will his successors be able to fill his big shoes?

When Buffett is no longer running Berkshire, his job will be split into two parts: Greg Abel as CEO and, reporting to him, two chief investment officers, Todd Combs and Ted Weschler. And Ajit Jain will continue to run most of Berkshire's enormous insurance operations (it's not a great sign that he just sold 55% of his Berkshire stock).

They don't have Buffett's experience, wisdom, and track record... so it's an open question how good their investing decisions will be. Combs' stock picks, in particular, have materially underperformed the market since he joined Berkshire in 2010.

Meanwhile, Buffett's relationships and reputation are unrivaled. That means he is sometimes offered deals and terms that aren't offered to any other investor – and might not be offered to his successors.

Being offered investment opportunities (especially on terms/prices not available to anyone else) also applies to buying companies outright. There's a high degree of prestige in selling a business to Buffett (above and beyond the advantages of selling to Berkshire). For example, the owners of manufacturing company Iscar could surely have gotten a higher price had they taken the business public or sold it to a leveraged-buyout ("LBO") firm.

Equally importantly, will Abel be able to effectively manage and motivate the 80-plus managers of Berkshire's operating subsidiaries?

These folks are wealthy and don't need to work, but nevertheless work extremely hard and almost never leave thanks to Buffett's "halo" and superb managerial skills.

Looking at stock picks, Buffett made one of the greatest investments of all time by backing up the truck on Apple (AAPL) – the profits from which have singlehandedly propelled Berkshire's stock to market-beating returns since then.

But aside from Apple, some of Buffett's other high-profile moves (or lack of them) going back 15 years haven't been so great:

• Buffett failed to take full advantage of the two great buying opportunities during this period – the global financial crisis and the pandemic crash.
• He made a significant investment in IBM (IBM) in 2011 and held it for six years before finally realizing it was a value trap and exiting.
• By his own admission, Buffett significantly overpaid for Precision Castparts ($32 billion plus assuming $5 billion of debt), which has performed poorly.
• His large investments in two oil companies, Chevron (CVX) and Occidental Petroleum (OXY), currently valued at about $30 billion combined, haven't paid off so far.
• In his latest annual letter to Berkshire shareholders, Buffett acknowledged a "costly mistake" in failing to "anticipate or even consider the adverse developments in regulatory returns" in the electric-utility sector.

The last point is worth further discussion...

Electric-utility companies have high-voltage power lines that, in the western U.S. and Hawaii, have triggered devastating wildfires – for which the utilities are being sued.

In particular, Berkshire subsidiary PacifiCorp was sued earlier this year for $30 billion – nearly 4 times the maximum loss the company had projected – for claims related to the 2020 wildfires in Oregon.

Could this be the tip of the iceberg?

When asked about this at Berkshire's annual meeting in May, Abel said the claims were "unfounded" and that "all the litigation will be challenged"... but it's worth keeping an eye on.

So, to summarize the bear case: Many of Berkshire's businesses are performing poorly, Buffett appears to have lost his touch, his successors are largely unknown and unproven, an important insider just dumped more than half his stake, and the stock is fully valued.

Yes, Berkshire has been one of my favorite stocks for more than a quarter-century. But as I explained on Friday:

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.

Tomorrow, I'll cover my response to these bear points... Stay tuned!

2) Two new articles in the Wall Street Journal caught my eye...

The first from yesterday is about hedge-fund giant Millennium Management and its successful investment approach: The Giant Hedge Fund That Hates Risk and Still Wins. Excerpt:

The investment pros at one of the world's largest hedge funds, Millennium Management, have a strict rule: Don't lose money.

Millennium parcels out the roughly $69 billion it manages for clients across more than 2,600 traders, analysts and other investment staffers working on hundreds of teams. Each team operates independently, betting on things like bonds converging or which companies get added to stock-market indexes or the outlook for commodity prices. But all of them face unusually tight limits on risk-taking, according to people familiar with the firm's inner workings.

For example, portfolio managers who are allocated $1 billion can lose only $50 million before that buying power will likely be cut in half. If they lose an additional $25 million, they will likely be fired.

And as the article goes on to say:

Protecting itself against even modest losses has made Millennium one of the most stable performers in the hedge-fund industry and made Israel "Izzy" Englander, the firm's chief executive, a billionaire. Millennium has generated $56 billion in gains for investors after fees since the firm's inception in 1989, according to LCH Investments. Among hedge funds, that trails only Citadel.

Millennium has had a single down year, 2008. Over the past five years, it hasn't lost more than 1% in any given month.

How has Millennium generated such consistent returns?

As the WSJ article continues, by being hugely diversified and "market neutral" – meaning every long investment is matched with a short one:

Many of the most successful traders historically were defined by their risk appetites and track records that featured home-run returns alongside strikeouts. Nowadays, among investors such as pension plans and charitable foundations, go-for-broke hedge funds are out of fashion while those that reliably generate decent gains are in demand.

It is that type of returns that multimanager firms such as Englander's are designed to deliver. A group of 53 multimanager hedge funds produced annualized gains of 9.9% over the past five years ended in June, outperforming the overall hedge-fund industry, according to Goldman Sachs's prime-brokerage unit. They did it with less than half as much volatility as other hedge funds and nearly no correlation to the broader stock market.

This style of investing is pretty much the opposite of mine. But I try to learn about all of the different ways people are making money in the markets, for two reasons: a) to see if there are any tools I can incorporate into my toolkit... and b) to determine if other investors might be causing dislocations in stocks or sectors I follow that I can take advantage of.

For instance, in late 2022, I noticed that all of the hot-money momentum traders were dumping tech stocks because other investors were doing so, creating bad charts. This gave fundamentals-based investors like me the opportunity to scoop up beaten-down stocks like Meta Platforms (META) and Netflix (NFLX), as I've discussed in recent e-mails.

3) And in this second WSJ article today, I was interested to see that my old friend Larry Robbins of Glenview Capital Management has established a large position in CVS Health (CVS) and is engaging with the company's leadership: Glenview Capital Plans Push for Changes at CVS. Excerpt:

A major hedge-fund investor will meet top executives of CVS Health on Monday to propose ways the struggling healthcare company can improve its operations, the potential start of an activist stance by the fund, according to people close to the matter.

The slated meeting, between CVS and hedge fund Glenview Capital Management, comes amid signs investors are turning restless with a company that remains among the best-recognized in the healthcare industry but has seen its shares tumble 24% this year to date.

Larry Robbins, founder of healthcare-focused Glenview, has established a large position in CVS, the people said. The giant healthcare company amounts to about $700 million of his $2.5 billion hedge fund, according to a person familiar with the matter. Glenview owns about 1% of CVS's shares outstanding.

Glenview's position is a sign of Robbins's belief in the company's potential and his confidence he can get executives to pursue a new path, the person said.

Larry is one of the smartest investors I know, so I've added CVS to my list of stocks to take a look at...

Best regards,

Whitney

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