Since Warren Buffet started Berkshire Hathaway (NYSE:BRK.A), the company's performance has been the envy of many investment managers and certainly rewarded its long-term investors handsomely. For example, its total return has exceeded the S&P 500 in 39 of the last 48 years. However, even the Consumer Staples component of the S&P 500 Index has also beat the index in most years since 1989 and arguably involved less risk than Berkshire (seekingalpha.com/article/1092981-why-you...).
However, a closer look at the last ten-years highlights that Berkshire is decidedly on the wrong side of the S&P 500 index with increasing frequency.
Let's breakdown the ten-year period thru 12/31/12 into two five-year periods 2003 to 2007 and 2008 to 2012 to make the comparison.
S&P 500 Index Berkshire Hathaway
2003-2012 7.08% 6.3%
2003-2007 12.81% 14.25%
2008-2012 1.66% -1.09%
Five of the years in which Berkshire has underperformed versus the S&P 500 were in this period.
Now many will say that it is easy to criticize when a man is down, but the problem is not just bad luck. Berkshire is simply too big, too diverse and faces serious leadership questions to be ignored simply because of Buffet's reputation or past performance.
Buffet even acknowledges that Berkshire's size is a challenge to superior performance. However, the company's long history of not paying dividends compounds its size problem. In terms of value creation, Berkshire should declare a special dividend as a first step to regular quarterly dividends and let their investors diversify themselves. It might also be a good idea if Buffet stopped doing giant killer acquisitions and focused on how his successors will manage his creation effectively rather then let it become incomprehensible to anyone else.
Berkshire's historical strategy has been to use its considerable cash flows from its insurance business to buy strategic stakes in Coca Cola (NYSE:KO), American Express (NYSE:AXP), Wells Fargo (NYSE:WFC), M&T Bank (NYSE:MTB), IBM and Proctor & Gamble (NYSE:PG). Along the way it has taken 100% ownership of Burlington Northern, Lubrizol, Sees Candies and most recently a 50% ownership of HJ Heinz.
When most of the strategic stakes are in publicly traded stocks, it is easy for investors to see how these businesses are doing and decide if they want to buy them with Berkshire's cost basis and oversight. However, when the stakes become 100% ownership, it begs the question, how do you know if the total is greater than the sum of the parts? It is probably no coincidence that as Berkshire has made larger acquisitions in recent years, its performance has lost its luster.
A portfolio this big eventually becomes a conglomerate or just a proxy for the S&P 500. As a conglomerate, it soon will become another ITT or RJR Nabisco. Older readers will recall that Harold Geneen through a series of acquisitions built up ITT to become a large, diversified corporation that only he understood. His successor took years undoing what Geneen had wrought. The KKR led leveraged buyout of RJR Nabisco was also the undoing of a conglomerate that owned consumer brands like Nabisco and Marlboro cigarettes and added the container shipping business Sea Land to the mix.
Too diverse also means that the company lacks a standout value proposition. Its managers will be in conflict with each other and the leadership about how to invest the cash flow. Putting aside the skill sets needed to be successful in candy making, railroads or ketchup, how do you allocate capital to the next winning investment? How do you stop senior management from hording cash needed to develop the railway instead of letting Buffet or his successor use the cash to make a huge acquisition? Buffet frequently mentions how much cash Berkshire has for another major purchase. That is good news for the sellers, but bad news for Berkshire shareholders.
As either a conglomerate or a proxy for the S&P 500, its returns will disappoint. If the insider trading fiasco that surrounded the Lubrizol acquisition and led to the departure of one of the lead candidates to follow Buffet is any indication, Berkshire Hathaway after Buffet may be a very unhappy story. Buffet says that his stake will go to the Gates Foundation. As taskmasters of businesses and senior management, foundations with major stakes in large businesses are not recognized as value managers. Conclusion, the recent trend and likely future suggest that Berkshire is past its prime under Buffet and his current strategy and investors should exit.