The Number 1 Risk To Berkshire Hathaway

| About: Berkshire Hathaway (BRK.A)


Assuming just a 10% CAGR, Berkshire Hathaway will reach one trillion dollars in market cap in 14-15 years.

Berkshire's culture, corporate structure and capital allocation lower financial risk, but they increase legal, regulatory, political, and even "zeitgeist risk" as their size increases.

The biggest risk facing Berkshire Hathaway is that it may become a trillion dollar company.

If you had to pick one big thing that would kill a small business how would you answer?

Well, here's what some business folks said over at The Atlantic:

Burdensome government regulations and a hyperactive legal culture topped the list of scourges in this new survey.

Put that in your back pocket for a few minutes. I promise we'll return to it later on.

Government regulations and legal hassles won't exactly kill Berkshire Hathaway (NYSE:BRK.A), (NYSE:BRK.B), but there's something important buried in that quote.

Let's press on...

Financial Meltdown Risk

It's extremely unlikely that Berkshire faces any serious risk from a financial meltdown unless the entire system fails. Then, it's a systemic risk and not a risk directly baked into Berkshire itself.

In fact, when the tide goes out and folks are naked, that's when Warren Buffett is especially ready, willing and able to successfully strike. There are plenty of examples, such as Buffett injecting cash into Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS).

This is a very small risk to Berkshire. They eat this kind of risk for breakfast, lunch and dinner.

The Grim Reaper Risk

Another risk is mortality. Although Warren Buffett and Charlie Munger might be with us for a long time, eventually they will pass on.

In the larger scheme of things, I don't believe this is a risk. There's very likely a premium on Berkshire due to Buffett the Man and his ability to personally secure deals. And, his name is gold in many circles for many reasons, such as longevity, connections and uncanny financial results. The don't call him the Oracle for nothing.

But, as a risk, I don't see it being too large other than losing some type of "Buffett Premium" in the stock when he is gone. The key reason is that the Berkshire culture is very strong. That culture will carry the company for a very long time and will help the business resist complacency.

So, this could turn into a huge risk down the road, but right now and into the medium-term, I would say Berkshire's culture is the antidote to the Grim Reaper Risk.

Bench Strength

Speaking of the Grim Reaper Risk, another potential risk is a weak team, or lack of bench strength.

But Buffett's got Todd Combs and Ted Weschler set up for investing, and they've kicked his butt. Buffett's son Howard has been designated as his successor as Berkshire's non-executive chairman. Ajit Jain is a machine. And, well, I could just go on and on. The bench is long and strong. Plus, the Berkshire board is strong.

On the corporate structure side of things, Berkshire is highly decentralized, and power is well-distributed. Many "business owners" inside Berkshire continue to work despite having plenty of money. Once again, the culture isn't a risk. It's an asset.

Too Big To Fail

Now we're starting to get close to the biggest risk for Berkshire. When I start to poke at Berkshire, I start to hear an echo from inside. I am brought back to the 2007/2008 financial crisis and near meltdown of the system.

Per Bloomberg (Jan 23, 2014):

Regulators are starting to scrutinize Warren Buffett's Berkshire Hathaway Inc. to determine whether it is important enough to the financial system to require Federal Reserve supervision, according to two people with knowledge of the matter.

And, remember how I started things off. Regulations and legal vultures can do significant damage to businesses, large and small.

In most cases, legal issues are just "money problems" that dent the bottom line. But, when they grow, what happens is that the entire system starts to eat the flesh and break the bones of the strongest businesses.

But, not Berkshire! They save companies and have oodles of cash on hand. So, it isn't that Berkshire is too big to fail. Instead, consider the inversion: Berkshire is not small enough to keep winning.

Wait, So Is This About Growth?

The answer is yes and no. The risk is growth, but it's not what you've been hearing from Warren Buffett. In fact, it's the exact opposite of what he's been saying.

First, let's orient. In 1990, Berkshire had a net income of $447 million, and in 2013, it had a net income of just under $15 billion. That's a 23-year compound annual growth rate of over 16%.

If you think I'm going to say that Berkshire cannot keep up a 16% CAGR, then you're wrong. I think it's possible. But, is it probable? That's hard to say, but I believe that Berkshire could continue to enjoy a CAGR of 10% or higher for the next 10-15 years.

And that is the biggest risk.

But, hold on. To be perfectly clear, this risk doesn't have anything to do with paying a dividend or stock buybacks or capital allocation. Again, the key point is that it's within reason that Berkshire can continue to have a CAGR of 10% or more for many more years.

Its BETA is remarkably low at 0.25 and it is seen as being super safe. Consider that these 10 safe, boring companies all have higher BETAs.

Berkshire is diversified enough and holds a tremendous amount of cash for safety and capital allocation (and market exploitation).

So again, the risk is growth. But not lack of growth. Instead, it's that Berkshire's powerful capital allocation and compounding will continue to work, maybe too well.

It's Not the Ant, It's the Colony.

They say that if an ant was the size of a human, it would collapse and die from the weight and strain. The reason is related to the Square-Cube Law. Many things gets weaker as they grow larger.

While I believe that this law applies to many large companies, it doesn't appear to apply to Berkshire. Buffett and Munger have created a structure with Berkshire that mimics their values and approach. The culture is wonderful, and strong.

When we step back from Buffett and Munger and see Berkshire as the ant, the ant is strong. The "giant ant" escapes the Square-Cube law. This is a testament to Buffett and Munger, but also to Berkshire itself. It's built to last, and grow.

But, now let's step back again from Berkshire entirely. When we see Berkshire as part of an entire ecosystem of companies, governments and consumers, things get weird. Berkshire starts to stick out, because it looks and smells strange. It starts to attract unhealthy attention. In short, it's been deliberately built to be an foreign object in the colony, and, that makes it stick out.

The One-Trillion Dollar Company

Many regular folks know of Warren Buffett, but far fewer are familiar with the Berkshire Hathaway parent company. As Berkshire grows, it will become more and more known.

It may become a lightning rod in a severe economic storm. More on that in a moment. First, take a look. I created a simple and blunt chart for you:

Trillion Dollar Company

Right now, Berkshire has a market cap of about $310 billion dollars. Assuming a simple 10% CAGR, it will take Berkshire just 14 years to hit $1 trillion in market cap. This is not unreasonable, or a fantasy. Remember, that 10% CAGR is well below the 16% that it's done over the last 23 years.

But wait, maybe Warren plans to slow things down on purpose. Is that possible? Nope.

Robert Lenzner over at Forbes writes:

This morning in fact, at the Omaha Convention Center, Buffett promised to make further acquisitions to build out the asset base of Berkshire Hathaway Energy, up to a $50 billion transaction, which he'd be glad to borrow money at today's ridiculously low rates of interest.


Buffett and Munger are getting help on acquisition ideas from Berkshire's relatively new money managers, Ted Wechsler and Todd Combs, as well as Buffett's financial assistant and protege Tracy Britt Cool."

So, the culture is in place to grow, grow, grow, with Buffett's leveraging the talent on the bench for help. So, after he's gone they'll still be pushing to grow... toward one trillion dollars.

The Number One Risk

Okay, so here's the One Trillion Dollar Risk in the form of questions so you can think for yourself, and judge.

At one trillion dollars will there be calls for new laws and regulations for such a monstrous company? Will there be whispers of anti-trust and monopoly power? Will the "little guy" on the street bang the drum to dismantle or destroy a company that controls unfathomable wealth? Will, envy, greed and jealousy become the zeitgeist in the next 10-15 years where Berkshire becomes the example of excessive growth with cash hoarding?

This is not fear-mongering. Zeitgeist Risk is built into the One Trillion Dollar Risk. Just think about how Occupy Wall Street changed watercooler conversations. People were angry at businesses, especially really big businesses.

To summarize, at one trillion dollars, Berkshire might be happy and healthy. It might be totally on fire with a bright future. But, will the bright light of success drive others to destroy it? Will human emotions outside this business fuel its collapse?

But First, What About $500 Billion?

I'm contemplating what happens when a company is too good. Too smart. Too elegant. It's thinking long-term and deeper about what happens when a company has a real shot at making it to one trillion dollars. That's smells like an exponential risk increase to me:

  • Legal constraints
  • New regulations
  • Political attacks
  • Investor backlash
  • Corporate wealth taxes

And again, the reason Berkshire would be getting hit would be due to it being so successful that it became too much of an outlier. Two or three times as large as companies like Exxon Mobil (NYSE:XOM), Wal-Mart (NYSE:WMT) and other juggernauts.

Or wait, maybe there's a ceiling on size? Companies such as Microsoft (NASDAQ:MSFT), Cisco Systems (NASDAQ:CSCO), Intel (NASDAQ:INTC), General Electric (NYSE:GE) and Exxon Mobil have all had a tough time getting over $500B and holding it.

What Next?

Let's first see if Berkshire can get above half a trillion dollars and hold it. If they do hold on, and they keep growing, then I say that the One Trillion Dollar Risk that I've outlined above is Berkshire's biggest threat. That risk will grow tremendously with every dollar captured once they have hit and then hold a $500 billion market cap and they are king of the hill.

Disclosure: I am long BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.