Berkshire Hathaway update

17 Nov 2014 by Jim Fickett.

My stake in Berkshire Hathaway (BRK) is up 82% since I bought in 2011. Is it time to sell?

On the side of selling,

  • Some fraction of the increase in shareholder equity, and stock price, is simply due to the Fed inflating all asset prices (though it is very hard to guess, without access to the books of all the subsidiaries, what the precise fraction might be)
  • The ratio of price/book, which was very low – about 1.08 – in 2011, is now substantially higher, at 1.45 (current price to end-Q3 book value)
  • There will come a time when the Fed can no longer paper over corporate debt problems, the stock market will fall, and BRK with it

Nevertheless, I will hold. Although I think it is quite likely that at some point in the next few years the price will be lower, I also think that getting the timing right is difficult and, because BRK will continue to grow the real value of the underlying businesses, one can do just fine by staying in the game.

BRK has grown book value by an average of 19.7% per year since 1965, and one has never had to wait more than five years for a dip to be rectified and a new high set. Even for the five year periods including the 2008 crash, 5-year growth, annualized, has been at least 7%.

For the patient investor, book value is as good a measure as any for long-term health of an investment. But if you need your money, the stock price matters. Since 1980, the beginning of the price record on public sites, it is also true that the longest one has ever had to wait for an old peak to be exceeded is 5 years. And the current price-to-book ratio, while higher than recent values, is also not excessive in view of the historical record.

If one is planning to hold BRK for the long run, as I am, one must also keep the succession issue in view. Neither Warren Buffett nor Charlie Munger will live forever. When they are gone the allocation of capital will suffer. The Economist recently painted painted a picture of what post-Buffett governance might look like:

The most obvious flaw in the succession plan, apart from the firm’s inability to clone Mr Buffett, is the one name that has been announced. The chairman will be his eldest son, Howard, a board-member of more than 20 years’ standing, a farmer, photographer and, thanks to the $1 billion foundation given to him by his father, philanthropist. Even accepting that his duties will be centred on preserving the culture and ethics of the firm, not on decisions that benefit from business experience, it seems a curious appointment for a fierce critic of the hereditary principle such as Mr Buffett senior to have made.

The board Mr Buffett junior is likely to inherit will be largely made up of friends of his father and of Mr Munger. At present, it works better than one might expect, but as Mr Munger says, “[Warren] knows what they’re going to say, and everybody knows that what he says is going to govern.” Under new leadership, the dynamics of a board made up of owners could easily turn nasty if times get tough. The most influential director is likely to be Bill Gates, the philanthropist and co-founder of Microsoft; he has strong opinions and does not suffer fools gladly.

At the very least, the new chief executive will have to win the trust of the post-Buffett board, and it may be a long time before he can be confident that what he says will go. It would be surprising if this did not result in a slower, more bureaucratic decision-making process than that of Mr Buffett, who says he has thought through and approved a multi-billion-dollar investment while taking a bath.

Much of the magic of BRK comes from the fact that, while all the subsidiaries run their own businesses without interference from the top, their free cash flow is pooled and allocated by Buffett to wherever he thinks it will best grow. It seems very likely that at some point this will degenerate to the CEOs of the individual businesses fighting to keep control of their own excess cash, and the board rather ineffectually making a few changes.

Yet even in that unhappy scenario, the holder of BRK will own an index fund containing a large number of solid, well-run companies. And the intrinsic value of the conglomerate will continue to exceed book value by a considerable amount. So, although I do think growth will slow at some point, I also think the current price is reasonable even on that assumption.