Warren Buffett is the greatest investor of all time. He has created a behemoth company that touches consumers and businesses every day. Candy, ice cream, carpeting, bricks, roofing, soft drinks, insurance, furniture, modular homes, railroad tank cars, jet leasing, ketchup, mortgages and other bank services are just a few of the products that companies he owns part or all of sell. He also owns an entire Class-1 railroad and a large utility company.
I have admired Warren Buffett for many years, I have read books on him, and listened to lectures he has given, watched his appearances on CNBC and have read all of his yearly letters he writes to his Berkshire Hathaway (BRK.B) investors. On Saturday, I read his latest letter and I came away with one thought, I would not own Berkshire and would probably sell it, if I owned it.
Berkshire has for most of its 48 year history soundly outperformed the S&P 500, in only 9 of those 48 years has the S&P had better returns than Berkshire. However, the S&P has outperformed Berkshire in three out of the four years and five out of the last 10. That tells me that Berkshire has grown so big that it is difficult for Buffett to generate superior returns. Buffett himself warned that for the first time ever, the S&P may outperform Berkshire over a 5-year period.
"To date, we've never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch. (The record is on page 103.) But the S&P has now had gains in each of the last four years, outpacing us over that period. If the market continues to advance in 2013, our streak of five-year wins will end."
The sheer size of Berkshire makes it difficult for anyone, including the greatest investor of all time, to generate large gains. Buying a fast growing start-up would add almost nothing to Berkshire's returns. Buffett needs to find, as he says, elephants, large companies that can make a difference for Berkshire investors. Unfortunately, there are not that many elephants available and even when they are, making a deal for them is not easy. Buffett mentioned in his letter this year that he failed to acquire any large companies in 2012, despite trying a couple times.
Like all conglomerates, Berkshire has the difficulty of getting all the pieces of the puzzle to perform well. When you own as many different businesses as Berkshire owns, it is highly unlikely they will all be performing well. Berkshire owns a number of housing-related companies, Acme Brick, Clayton Homes and some of U.S. Gypsum (USG) to name a just a few. When the housing market tumbled, so did the companies Berkshire owns. Berkshire owns a number of insurance-related companies, when a natural disaster hits, some or all of those companies he owns will take a hit.
It can be argued that all those various businesses also protect against major downturns, because as one business struggles, another is performing exceedingly well. While I would agree with that argument, in the end, what that means overall for the company is that the most likely scenario is average returns.
Warren Buffett is 82 years old; his partner Charlie Munger is 89 years old. I am a great believer that with age comes wisdom; I know I am a far smarter investor now than I was 10 or 20 years ago. But, I also know that as one ages many things, including the mind, do not work as well. I have seen recent interviews with Buffett and he seems as sharp as a tack, so I am not saying Warren Buffett is over the hill, what I am saying is that there is a risk that Buffett will not have the same energy and foresight moving forward as he has had in the past. For shareholders, that is a risk and a risk that needs to be considered moving forward.
Berkshire Hathaway does not pay a dividend and after reading the most recent letter from Mr. Buffett, I can tell you Berkshire never will as long as Buffett is running the company. Buffett gave a rather long example of why he does not pay a dividend, which I will try and simplify for you. Basically, Warren Buffett believes the money being paid out in dividends should be kept in the company so that management can take that money and grow the business and create more wealth for shareholders through capital gains. An investor in need of cash can sell a few shares and still be ahead because the stock price of the company has risen more than it would have if the money reinvested in the business had been given out as dividends. I am not sure I agree with that, but that is his reasoning. With Warren Buffett reinvesting the money more wealth probably can be created, but there are quite a few management teams where the investor is better off getting his/her cash in the form of dividends.
Mr. Buffett himself has stated he is sitting on more cash than he would like and the cash continues to roll in at a fast pace. Sharing some of that cash as a dividend would probably draw in some new investors and would allow some mutual funds and ETF's that only buy dividend paying companies to purchase some shares, which would help support the stock price.
When Warren Leaves Us
At some point in the future, Warren Buffett, the greatest investor we have seen, will pass away. When he does, I am sure there will be quite a bit of selling in Berkshire stock. The reason most people own Berkshire is they want Warren Buffett to manage their money, when he is gone, that reason for owning Berkshire will be gone. Todd Combs and Ted Weschler currently work as investment managers for Berkshire. Warren has given each several billion dollars to invest and as Warren reports, they have done well. Despite how well Mr. Combs and Mr. Weschler have done, they do not have the reputation Warren Buffett has and probably never will. Investors will not have the same faith in Mr. Combs or Mr. Weschler or whoever runs Berkshire.
The reality is, Warren Buffett is for the most part a hands-off owner, he selects excellent managers and he lets them manage the business. When Warren Buffett passes away, the businesses Berkshire owns will be little changed. The railroads, insurance companies, candy companies, etc., will all continue to perform well. But that will not matter, investors will see that the man who put it all together is gone and will sell.
All of investing is based on risk reward, as an investor are you willing to invest your capital into a business in the hope you will get more capital back in the future. With Berkshire Hathaway, I believe an investor can anticipate receiving returns approximately equal to what an S&P 500 fund would provide. In years where the overall market performs well, Berkshire may trail and in years where the market struggles, Berkshire will probably perform better.
The risk in owning Berkshire is that when Mr. Buffett passes away the stock has a significant fall, which may take years to recover from. That is not a slight risk, it is likely risk. In my opinion, owning a company that will track the S&P 500, but will likely fall with the passing of its leader is not a risk/reward ratio I want. That is a risk that exceeds the reward and why I would sell Berkshire.