What do you give your friend who has everything for his 90th birthday? If you are Microsoft founder Bill Gates, the world’s second-richest person, you might bake him a cake and share the kitchen video. And what does the sixth wealthiest person on earth — widely regarded as one of the greatest investors of all time — do for his birthday? Berkshire Hathaway’s CEO Warren Buffett was not wasting time with cakes baked by billionaire amateur bakers last weekend. He put out the word that he had just bought 5% stake in each of Japan’s five biggest trading firms or Sogo Shoshas for a cool US$6 billion ($8.17 billion). By mid-week this past week, Berkshire’s stake in the Japanese trading giants had jumped a total of 16% giving him nearly US$1 billion profit on his investment.
Buffett’s rise as the world’s most watched investor is the stuff of legend. In 1942, the 11-year-old scion of an Omaha business family which ran one of the town’s main grocery stores made his first stock purchase — six shares of Cities Service, at US$38 a share — for himself and his sister and sold them for US$40. In his freshman year at Columbia University, 19-year-old Buffett had a portfolio of stocks worth US$10,000. He made his first million soon after he turned 30. In 1965, he took control of struggling textile manufacturer Berkshire Hathaway and turned it into the world’s most storied investment firm. US$1 invested in Berkshire stock when he took control of it would be worth US$27,300 today. A similar investment in benchmark S&P 500 index would have grown to US$198.
Berkshire’s CEO learned his craft from Columbia University economics professor Benjamin Graham, also known as “the father of value investing”. “Buffett has always been good at visualising what others are often afraid to see,” Bill Smead, a veteran value investor and CEO of Smead Capital in Phoenix told The Edge Singapore in a recent phone interview. In 1988, just months before the fall of the Berlin Wall, Berkshire bought over a US$1 billion of Coca-Cola stock, he recalls, at 18 times earnings. “He thought people all over the world who didn’t have access to Coke before would want it,” Smead says. “Great wealth is created when you buy a stock that is out of favour or see something that no one sees,” he says.
The nonagenarian investor’s story “is a study in the logic and discipline of understanding future value,” notes a recent report from McKinsey & Co. The man who has been dubbed “Sage of Omaha” for his folksy wisdom on investing, says Smead, “never chases fads or the hottest stocks and is one of the most disciplined ‘Buy-and-Hold’ value investors there is.”
Not surprisingly, you will not find high-flying stocks like electric vehicle maker Tesla, video conferencing firm Zoom Video Communications or even social media giant Facebook in Berkshire’s portfolio. Indeed, until a few years ago, Buffett had deliberately shunned technology stocks because he found it hard to value them. He reversed course in 2011 with the purchase of IBM — a stock he later dumped taking a US$2 billion hit — but followed that exit with the purchase of iPhone maker Apple, now the biggest stock in his portfolio. Buffett “banks on businesses that have steady cash flows and will generate high returns and low risk,” McKinsey noted in its report last month.
In the aftermath of Covid-19, Smead notes that “the only place Buffett has gone to is inflation beneficiaries like oil companies or gold or non-US companies.” Berkshire bought US$10 billion in Occidental Petroleum shares last year to help fund the firm’s acquisition of rival Anadarko, which turned into one of the most ill-timed acquisitions in the history of oil. The acquisition cost Occidental U$55 billion and was aimed at expanding its footprint in the US shale sector. Berkshire accumulated more shares as Occidental paid its dividends only in stock to preserve cash. Last month, Buffett sold his shares at a total loss of US$8.4 billion but still holds warrants.
If his timing on Occidental deal was terrible, Buffett tried to get it right in early July when oil prices were still in the doldrums as he swooped in to take control of the gas assets of Dominion Energy for US$ 4 billion, plus an assumption of US$6 billion in debts in what was seen as a distressed sale. Last month, he uncharacteristically dabbled in precious metal by purchasing 1.2% stake in Barrick Gold for US$565 million. Smead says Buffett is not buying gold but a mining company that is cheap and pays dividends. “If there is one thread connecting all of these transactions with his investment in Japan it is Buffett’s obsession with value,” says Smead.
By buying the top-five Soga shoshas, “Buffett didn’t just get long Japan, he expressed his value credentials at the same time,” notes Peter Boockvar, Chief Investment Officer of Bleakley Advisory Group in New York. Itochu Corp is trading at 9.5 times expected earnings and has a dividend yield of 3.2%. Marubeni Corp is trading at 8.8 times earnings with a dividend yield of 2.4%. Mitsubishi Corp at 9.3 times with a 5.3% yield, Mitsui & Co is trading at 13 times forward earnings with a yield of 4.2%. Sumitomo Corp is trading at nine times last 12 months earnings and has a dividend yield of 5.1%, Boockvar says. “This is true value investing and one of the benefits of Abenomics was the focus on shareholder value and corporate governance,” he adds.
Change of guards
“What we are seeing is a change of guards at Berkshire and a more dynamic portfolio management process, particularly equities, which are now the domain of (Buffett’s two investment deputies) Todd Combs and Ted Weschler,” Cathy Seifert, director of research at CFRA in New York who covers Berkshire, tells The Edge Singapore.“Previously, Berkshire’s equity holdings were fairly static but since Todd and Ted arrived, things have started to change,” she says. “Japan is a move away from the dollar as well as a value play,” says Seifert. “Gold is also a portfolio hedge because right now with Apple stock where it is, Buffett is tilted too much towards technology,” she adds,
In previous recessionary cycles, Berkshire, flushed with cash, was able to buy a ton of distressed assets cheaply and then ride the recovery. The downturn was so sharp and short-lived in the aftermath of the recent pandemic that Berkshire CEO was not able to do any deals. Did Buffett miss the big rally because he was not quick to pounce when the market plunged 35% in March? Why did Berkshire do so well in 2008 but lagged this year?
“There are some valid comparisons between then and now but there are also huge contrasts,” says Seifert.“Back then, Berkshire was the fortress balance sheet and the go-to entity, or in essence a lender of last resort. This time around the US Fed, and the US Treasury acted much more promptly and decisively. Berkshire has a lot of dry powder or cash on hand to deploy and it has been a source of frustration within the company for years,” adds the CFRA analyst. Moreover, she notes Buffett now also faces increasing competition from private equity firms who have risen in prominence raising a lot of cash over the last decade.
It is also important to differentiate between cyclical and secular growth trends, argues Seifert. “Buffett’s move to rescue the banks in 2008 represented his view of a great cyclical opportunity, she says. “This time around in the aftermath of the pandemic, the real opportunity is secular.” Also, it involves technology, a sector where valuations are perennially high for the liking of a value investor. “The Covid crisis wasn’t a typical recession where Buffett has normally thrived,” Seifert says.
Buffett may have also restrained himself from taking a plunge in March because he was still bruising from a few large deals that have not worked out like the takeover of Kraft Heinz in a joint venture with Brazilian private equity group 3G, the CFRA analyst says. The Occidental petroleum deal, which was structured more like the deals he did during the credit crisis in 2008. However, the Occidental warrants he got as part of the deal are way out of the money now. The losses on Occidental, losses on his stakes in US airlines and losses on his sale of his bank stakes total over US$13 billion.
In May, Berkshire announced that it was selling all his stakes in US airlines that he had previously accumulated. Last month, Buffett said Berkshire had sold its entire stake in the largest US bank, JP Morgan. He has also been trimming his exposure to the beleaguered Wells Fargo, the number three US bank, but has added to his Bank of America stake. Buffett losses in banks, oil, airlines and other sectors must be weighed against his huge profits in Apple. Buffett built a 5.7% stake in Apple at the cost of US$35 billion between 2015 and 2017. It is now worth US$128.5 billion and will probably be remembered as the best investment anyone has ever made..
Post-Buffett Berkshire
So, where will Berkshire be in five years without Buffett and his 96-year-old investing partner Charlie Munger? Seifert says though Buffett does not telegraph it much, Berkshire already has a succession in place. Will activist investors push for a breakup of Berkshire to realise the real value of its conglomerate holding? “The way I look at it, the biggest unknown is how long will Berkshire’s conglomerate structure remain intact,” she says.
But who could force a conglomerate with a market capitalisation of over US$520 billion to change? “Clearly, Berkshire has a huge fan base but post-Buffet how many will continue to back a company whose stock has underperformed for so long?” asks Seifert. The way she sees it, with Buffett and Munger gone, unless Berkshire stock starts performing, long suffering shareholders are likely to spring into action. Berkshire shares have underperformed S&P 500 index over the past 10 years. S&P is up 226% while Berkshire is up 174% over the last decade.
“The only activist who might matter is probably Bill Gates,” says Smead. “He is a brilliant guy, a long-time friend of Buffett who has taught him a lot over the years but Gates doesn’t understand investing.” The Bill & Melinda Gates Foundation Trust owns 2.25% stake in Berkshire Hathaway.
“From the 1960s to 1981, capital in the US was organised around high inflation,” says Smead. “Over the past decade or two, everything has been organised around low inflation. What Buffett is doing now is making investment bets that benefit from inflation.”
He is also giving his lieutenants like Combs and Weschler more leeway in running investment strategy. Seifert says there will never be another Buffett in our lifetime or another conglomerate like Berkshire Hathaway for decades to come. Buffett and Munger built a legendary cash machine that is unlikely to be replicated anytime soon.
Assif Shameen is a technology and business writer based in North America
