When the Financial Times interviewed Warren Buffett last year, he predicted that future returns from his company Berkshire Hathaway and from the U.S. stock market as a whole would be “very close to the same.”
Berkshire shareholders could be forgiven for thinking: if only.
The famed stockpicker had his worst performance versus the S&P 500 in a decade in 2019, and 2020 is shaping up to be nearly as bad. Instead of taking advantage of the coronavirus crisis that hit markets in March, Buffett was a casualty. Instead of highlighting Berkshire’s balance sheet strength, the crisis exacerbated longstanding concerns over the company’s direction. Some longtime Buffett watchers argue that it is time to fundamentally rethink Berkshire’s mix of businesses and investments.
The question comes more loudly now than at any time since Berkshire missed out on the dotcom boom: has Buffett lost his touch?
Berkshire’s “chronic underperformance” requires answers, according to Cathy Seifert, an analyst who covers the company at CFRA Research, particularly in light of some questionable investment decisions in recent years.
The company had written down its holding in food producer Kraft Heinz by US$3 billion last year, she pointed out, while Buffett’s US$10-billion investment in oil producer Occidental Petroleum was no longer paying a cash dividend and its stock warrants looked worthless now.
“Those two things, I believe, have really tarnished Berkshire’s reputation for dealmaking,” Seifert said of the two investments. The Occidental deal “was an unmitigated disaster.”
On top of this, Buffett increased his shareholdings in America’s largest airlines at the start of the year before selling them at the peak of the coronavirus disruptions in April, crystallizing a loss.
But it is not just the individual investment slip-ups. It has been more than four years since Berkshire clinched its last major acquisition — the takeover of aerospace components maker Precision Castparts — over which time its cash pile has climbed to a record US$137 billion. Buffett did not pounce when many investors, analysts and bankers expected him to after markets went into freefall in March, raising the question, what is the point of all that money?
“I am nervous that he may have missed this whole rally,” said James Shanahan, an analyst with Edward Jones. “If the rally started in late March and he was a net seller in April, it seems like . . . he missed it all. That’s frustrating. A lot of retail investors were ploughing money into the market and doing better than professional investors. I think you can include Buffett in that.”
I am nervous that he may have missed this whole rally
James Shanahan, analyst
Buffett did not respond to a request for comment. “We haven’t seen anything attractive,” he told his shareholders in May. The Federal Reserve “did the right thing and they did it very promptly and I salute them for it,” he told them, referring to the U.S. central bank’s decision to backstop the debt markets. “But a lot of companies that needed money . . . got to finance in huge ways.”
The blink-and-you’ll-miss-it stock market crash in March contrasts with the long climb back from the financial crisis after 2008. Berkshire did not clinch all of its great deals at the nadir, investors point out. Its takeover of the Burlington Northern railroad was agreed in late 2009. A US$5-billion investment in Bank of America did not come until two years later.
But Buffett did secure several lucrative deals in 2008, including multibillion-dollar investments in Goldman Sachs and General Electric, raising questions about whether he has become less nimble.
Pershing Square founder Bill Ackman, the hedge fund manager who has been a longtime admirer of Buffett, sold his holding in Berkshire shares in order to invest the money in other stocks himself. Smaller outfits such as his do not need to make such large bets to move the needle as Buffett must make at Berkshire.
Hard-hit companies that raised cash this time, including Airbnb and Expedia, turned to private equity firms such as Silver Lake.
Those companies — tech-focused travel groups — fall outside Buffett’s traditional areas of interest, highlighting a broader concern regarding Berkshire’s asset allocation and its ability to keep up with the U.S. stock market, let alone outperform.
The US$760 billion-in-assets conglomerate is skewed towards financial companies — it owns large insurance companies, such as Geico, outright and stakes in many of America’s largest banks — and industrials. It is heavily underweight technology, which led the stock market higher last year and has done so again in 2020.
Financials have declined from 15 per cent of the S&P 500 nearly four years ago to 10.5 per cent now, but insurance underwriting and investments represented just under a quarter of Berkshire’s operating profits last year and its stakes in financial stocks accounted for more than a third of its equity portfolio in March.
Bank shares have been hard hit by an expectation that loan losses will rise in the recession and that profits will be suppressed by the dramatic fall in interest rates, which in turn will weigh on the returns of Berkshire’s more-than-US$100-billion Treasuries portfolio.
Meanwhile, technology and communications, including internet companies, now account for 38 per cent of the S&P 500.
Some investors say Buffett must find a way to reconcile his value investing philosophy with what in the dotcom era was called the new economy — which is no longer new.
“If Berkshire is to have the prospects of generating the value it has in the past, it has to adapt by buying these companies that will generate significant value over the next 25 years,” said Christopher Rossbach, chief investment officer of J Stern & Co. J Stern manages money for the Stern family, which has held Berkshire shares for decades, as well as other investors.
“Both Warren and Charlie (Munger, Berkshire’s vice-chairman) have acknowledged that they have missed Amazon and that they should be looking at these companies but they have also said they don’t understand them,” Rossbach said. “They have kept them in the box that Warren has on his desk that says ‘Too hard’. What will it take for them to take these stocks out of the box?”
An investment in Apple in 2016, now the largest single holding in the stock portfolio, illustrated Buffett’s ability to find comfort in technology companies, and Berkshire last year took a small stake in Amazon. But steep valuations in the sector — at least by Berkshire standards — have prevented bigger bets, and outperforming the S&P 500 will entail buying more than just two of its three largest constituents.
Many shareholders who might not be forgiving of underperformance by any other investment manager continue to trust in Buffett to turn things round. His performance in 2000 is one reason: when dotcom shares tumbled, Berkshire stock rose by more than a quarter. If global stocks retest their March lows — and if there is a second coronavirus wave, say — Buffett’s caution could be cast in a very different light.
“Berkshire Hathaway remains designed to reward investors over time but not on time,” said Thomas Russo, a managing member of Gardner Russo & Gardner, which owns Berkshire stock.
“It is one of the reasons we say to people, ‘Don’t be in a hurry to spend that money’,” referring to Buffett’s US$137-billion cash pile. “If you rush it, he could make a mistake.”
© 2020 The Financial Times Ltd.