Continuing my analysis of Berkshire Hathaway with reader feedback; CEO Greg Abel's first annual letter and share-buyback announcement
1) Today I'd like to continue my analysis of Berkshire Hathaway (BRK-B), which began on Tuesday with a breakdown of Berkshire's recent earnings report.
Then yesterday, I shared Porter Stansberry's open letter to Berkshire's board of directors, along with my take on the matter.
The letter generated quite a few responses from my readers...
First, Sam W. writes:
I always enjoy reading your analyses, but regarding your recent e-mail comparing Berkshire Hathaway to the S&P 500 Index, I believe the standard side-by-side performance comparisons are missing the forest for the trees.
When analysts compare the two, they almost always fail to account for Berkshire's huge embedded optionality. I am truly surprised that this wasn't the main focus in your e-mail.
Comparing an index fund to Berkshire isn't an apples-to-apples comparison of equity portfolios. It's comparing a fully deployed, passive vehicle to a dynamic capital-allocation machine with a massive, un-expiring call option on market distress.
Then Sam gives three reasons why standard analysis misses the mark:
The cash pile is a call option, not a drag: Traditional analysis treats Berkshire's massive cash reserve as a drag on returns in a bull market. But realistically, that cash is a premium-free call option on the next macroeconomic dislocation. When the S&P 500 drops 70%, passive investors just take the hit. When the market drops 70%, Berkshire gets to play "buyer of last resort," deploying tens of billions [of dollars] into sweetheart deals (preferred equities, warrants, distressed buyouts) that simply aren't available to retail investors or index funds.
Structural flexibility: The S&P 500 is structurally forced to buy high (market-cap weighting automatically allocates more to companies as their valuations stretch). Berkshire has the optionality to do the exact opposite – hoarding cash when valuations are absurd and aggressively buying when capital is scarce.
The power of float: Unlike an index fund, Berkshire has operating businesses (specifically the insurance arm) that continuously generate cost-free (or even negatively priced) float, constantly replenishing that dry powder regardless of what the broader stock market is doing.
Sam concludes:
In short, comparing their trailing returns in a raging bull market – even if the time horizon is 17 years – completely ignores the value of this structural optionality. Berkshire isn't just a portfolio of stocks and businesses. It's a financial fortress designed to aggressively exploit the very panics that crush the S&P 500.
I think you make good points, Sam. However, they're not backed up by Berkshire's stock performance during the last two market crashes...
As you can see in the chart below, Berkshire's stock tracked the market during the global financial crisis from 2008 through 2010:
And it underperformed the market in 2020 during the COVID-19 pandemic:
Berkshire's stock did outperform in 2022, however, when meme and tech stocks took a beating:
Mike E. shares an eye-opening quote from Warren Buffett:
At the 2019 Berkshire Hathaway annual meeting, I asked a question through a submission to Buffett's longtime friend Carol Loomis, and Buffett's response changed the way I looked at Berkshire's stock. In his response, he said:
"And the one thing you should very definitely understand about Berkshire is that we run the business in a way that we think is consistent with serving shareholders who have virtually all of their net worth in Berkshire. I happen to be in that position myself, but I would do it that way under any circumstances. We have a lot of people who trust us, who really have disproportionate amounts of Berkshire compared to their net worth, if you were to follow standard investment procedures. And we want to make money for everybody, but we want to make very, very sure that we don't permanently lose money for anybody that buys our stock somewhere around intrinsic business value to begin with."
This response made me realize that the decisions Buffett was making, including being very conservative with the company's cash, was not optimal if you owned the stock as part of a well-diversified portfolio and your goal was maximizing your wealth over the long term.
This takeaway echoes my view that Berkshire is a "stay rich" stock that will mostly track the S&P 500, not a "get rich" stock – unless you're clever in only buying when it's trading at a discount to its intrinsic value.
Mike concludes:
Accordingly, I soon sold the stock – though I did own it again temporarily during the pandemic thinking Buffett would put a lot of the cash to use. And I won't be buying it back unless CEO Greg Abel takes it in a different direction. I think Berkshire has a great set of assets, but the capital allocation, and perhaps the organization of the company as Porter Stansberry is recommending, needs to change.
Rob F. also hopes that Abel can unlock value:
Hopefully Greg Abel can succeed at the two critical factors missing from Buffett: being ruthless at cutting expenses (Buffett loathed cutting headcount) while investing more preemptively in several divisions. Look at how Progressive (PGR) ate Geico's lunch for a decade while Buffett hoarded cash.
Like you, Buffett has had an enormous impact on my life. Reading John Train's The Money Masters changed the course of my life, and I will always be grateful to Buffett, Charlie Munger, and Train.
That said, Berkshire has misspent on numerous industrial businesses and makes little sense as an ongoing conglomerate, unless Abel can succeed in the seemingly contrary tasks of cutting costs and competing through capital commitments. It's not a contradiction – he needs to do both.
Thank you all for your insightful responses!
2) There were no surprises in Abel's first annual letter to Berkshire shareholders as the new CEO...
He began with a tribute to Buffett and noted – in the understatement of the year – that "Warren is obviously a very hard act to follow."
He also disclosed that Buffett is "in the office five days a week, and available to us as we underwrite insurance, operate our non-insurance businesses, and deploy capital including equity investments." That's good to hear!
He then discussed the company's decentralized model, integrity, financial strength, risk management, and operational excellence... underscoring that "Berkshire's culture and values remain unchanged and will continue into perpetuity."
Abel was vague about what he plans to do with Berkshire's $373 billion cash hoard, echoing what Buffett has long said:
We are committed to maintaining exceptional financial strength. Our balance sheet is a strategic asset to be deployed at the right time. It allows us to act decisively, invest when others are tentative or fearful, and stand firm when financial storms roll through.
We uphold Berkshire's financial resilience and independence by holding limited levels of debt. We will remain an asset, not a risk, to America and the global financial system. Our cash and U.S. Treasury holdings now exceed $370 billion. While some of this capital is required to support our insurance operations and protect Berkshire against extreme scenarios, it also constitutes our dry powder.
There will undoubtedly be incremental opportunities to deploy our owners' capital without compromising Berkshire's resilience. My role is to ensure our liquidity levels and capital deployment remain intentional and deliberate. We will always aim for ownership of productive businesses over U.S. Treasuries.
Abel concluded by inviting shareholders to attend the annual meeting in Omaha, Nebraska on Saturday, May 2:
This year's program will include a CEO's update on Berkshire, and two Q&A sessions – one with [Vice Chairman of Insurance Operations Ajit Jain] and me, and a second featuring Katie Farmer (BNSF), Adam Johnson (NetJets and president of consumer products, service, and retailing), and me, where Katie and Adam will discuss the challenges and opportunities they see in their respective businesses. In that way, we will be able to cover Berkshire's insurance and non-insurance operations. While each session has a natural focus based on who is on stage with me, shareholders may ask me any question at any time.
I plan to attend the meeting for the 27th time. It won't be the same without Buffett on stage, but it's always a fun weekend, and I look forward to getting to know Abel better.
3) I noted in Tuesday's e-mail that Berkshire hasn't repurchased any shares in the past six quarters, a topic that Abel addressed in his letter:
Share repurchases are another important capital allocation option. We will buy back Berkshire shares when they trade below our estimate of intrinsic value, conservatively determined, ensuring that repurchases enhance per-share value for continuing owners. We may also purchase large blocks of shares directly from major holders when the opportunity presents itself. These purchases allow shareholders to own an incrementally larger piece of Berkshire's businesses, without deploying any additional capital of their own.
This morning, Abel put his (and Berkshire's) money where his mouth is with this announcement, covered by CNBC:
Berkshire Hathaway said Thursday it has resumed repurchasing its own shares for the first time since 2024 and separately new CEO Greg Abel bought $15 million worth of stock himself, an amount equal to his after-tax annual salary.
Abel told CNBC he will continue using his full salary to purchase Berkshire shares every year.
The Omaha, Nebraska-based conglomerate disclosed in a regulatory filing that it began buying back its Class A and Class B shares on Wednesday...
"I absolutely talked to Warren," Abel told CNBC's "Squawk Box" on Thursday. "So how I approached it was, obviously looking at the value, having a view of intrinsic value [and then] consulted with Warren relative to the value and the timing."
This is a good sign – assuming the stock is undervalued, of course...
I'll update my estimate of Berkshire's intrinsic value tomorrow. So stay tuned!
Best regards,
Whitney
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P.P.S. I welcome your feedback – send me an e-mail by clicking here.