More Bad Decisions At Berkshire: Time To Sell? - Bezek's Daily Briefing

| About: Berkshire Hathaway (BRK.B)

Summary

Markets recover; Monday's big gains reverse Friday's slide.

The Berkshire we knew and loved is gone; they're not superior investors anymore.

But the firm isn't necessarily a sell; a break-up of the company would still reward shareholders richly.

Stocks were up big on Monday, reversing Friday's losses. The S&P 500 (NYSEARCA:SPY) jumped 20 points, the Dow (NYSEARCA:DIA) climbed almost 200 and the Nasdaq rose more than one percent. In all, it was a robust recovery for the bulls after last week's difficulties.

Any advantage the bears had picked up was neutralized. Oil (NYSEARCA:USO) and biotech (NYSEARCA:XBI) both led the advance, along with the curious incident we'll discuss in a second.

The market remains firmly in chop mode. More sideways action wouldn't be surprising.

Berkshire: Losing Appeal

It can be hard to watch a legend fade. A hall-of-fame quarterback at age 38 throwing interceptions all day; at some point you just wish they'd hang up their cleats rather than continuing to tarnish their reputation.

Similarly, Berkshire Hathaway (NYSE:BRK.B) (NYSE:BRK.A) is a grizzled veteran. It's one of investing's all-time champion companies, but in recent years it has had almost as many misses as hits. The company's utterly baffling decisions continue to mount, now occurring at an almost-quarterly pace.

Does Berkshire need to be retired from our portfolios, before it really starts to unravel? Unfortunately, the evidence is becoming harder to overlook.

The latest blow to puzzled shareholders came on Monday, with the announcement that Berkshire had bought into Apple (NASDAQ:AAPL). Let's count the reasons why this investment decision stinks.

First off, Apple is a tech company. Admittedly, much less of a tech company than they used to be since they haven't introduced relevant new products in years, but still tech nonetheless.

Berkshire has repeatedly stated that they don't like investing in tech; they prefer simpler businesses that are easier to forecast. Berkshire also has a spotty record with tech investments; need I say more than IBM (NYSE:IBM)?

Yes, there's the old saying that no one gets fired for buying IBM, and that's probably true of Apple now as well. However, few people get rich buying the world's largest company either; there's virtually no way to get an advantage against the market in the world's biggest company.

In defense of IBM, you can at least argue the company has some sort of (limited) moat with its specific product offerings.

Apple has nothing except its momentary advantage in smartphones. There's nothing durable to support the business beyond the next few years; when smartphones fade to sub-$100 commodity products - as all portable formerly hot tech gizmos do - then what?

Apple is not a 'buy and hold forever' sort of stock; it's not even a 'buy and hold for a few years' sort of thing; you have to watch it very clearly to see if they find some good use for their cash before the iPhone platform erodes too greatly.

The good news is that Apple is fairly "cheap" based on valuation metrics compared to the broader market; Berkshire isn't paying through the nose to buy a shrinking past-its-prime tech firm. Still, it's a value trap and a major unforced error that at best will slightly beat the market over the long run. This isn't sort of home run that made Berkshire famous.

This is the equivalent of buying Dell or Hewlett-Packard when they were trading at sub-10 P/E ratios for years at a time; sure, you aren't going to lose your shirt, but you probably aren't going to beat the market either.

Arguably, another piece of good news is that Buffett himself wasn't responsible for this error. The culpability falls to one of his lieutenant investors. Of course, that comes with the flipside; that more of our investment money in Berkshire is being handled by people who aren't nearly at the same level of talent as Buffett or Munger.

When you look at absurd Berkshire investments such as General Motors (NYSE:GM), you can be pretty sure it is one of the ordinary investors responsible for the silliness. Berkshire never used to invest heavily in indebted cyclical firms with limited moats that will get wiped out by the next mid-sized recession. Autos have a horrific long-term track record as an industry. It's directly antithetical to the investment principles that built Berkshire into what it is today.

You could try to excuse some of this by saying the market is expensive and causing us all to go stir crazy. I get that. But Berkshire didn't go crazy in 2000. They didn't start buying collapsing tech companies then. And yet now they're buying warmed over energy dreck like Kinder Morgan (NYSE:KMI). Similarly, what on earth is the justification for Suncor (NYSE:SU)?

Berkshire has lost its core principles, and regardless of whether Buffett or his underlings are at fault, we must deal with a sad reality. The company is no longer seemingly capable of coming up with ideas better than buying Apple - the world's most well-known company - or Kinder Morgan, which was among the most-widely covered stories of 2015. Just look at Seeking Alpha's homepage for the most popular articles and there's a good chance us Berkshire owners will get to own those stocks soon too! Hooray.

Be it size limitations or lack of vision, Berkshire is now essentially picking mega caps at random; any adherence to the principles that made it famous seems to be gone.

Why I'm Not Selling - At Least Not Yet

The case for Berkshire now is more that it's significantly undervalued; not that its investments are better than the market. We have to assume Berkshire's new investments, from now forward, will do no better than the S&P 500.

However, the company is arguably worth at bare minimum 1.3x book value due to the values of long-held assets on the balance sheet rising. So there's very little downside; Berkshire's holdings represent a broad chunk of the best parts of American industry, along with the new duds bought recently. Fortunately, a few lemons don't ruin the whole pie.

And once Berkshire moves into the post-Buffett era, it is likely to be broken up. The firm, as it currently is composed, should cause a great deal of monopoly and competitive concerns for the government, along with being "too big too fail" as a financial institution. The FTC just declared Office Depot (NYSE:ODP) to be a potential monopoly, after all.

Buffett gets a free pass from political scrutiny, likely due to his solid reputation and political connections. However, the firm after him will likely fall under regulatory scrutiny.

Investors won't be happy either. Berkshire's returns have been falling in recent years; the company trails the S&P 500 frequently as of late. With the poor stock selection in recent years, there's little reason to expect this trend to reverse.

Thus, we can expect both investors and regulatory agencies to have motivation to split up Berkshire into a bunch of different companies. It will be a spin-off bonanza. I'd be very happy with a scenario where I get shares of many of the best holdings, such as Coca-Cola (NYSE:KO) along with the fully-owned businesses such as the railroad.

I believe the privately-held businesses would trade at a big premium to book value once they traded as distinct entities. Put another way, if everything Berkshire owned was sold at market value and the fully-owned companies were IPOed, the resulting benefit to a B shareholder would be significantly above $142.

As a patient long-term investor, I'm willing to wait for this catalyst to occur as long as the investment decisions don't keep deteriorating. However, it's heartbreaking to watch one of the country's formerly best investment firms now buy obvious value traps like Kinder Morgan and Apple. It's a stunning fall from grace. And if Berkshire makes a move into biotech by buying another value trap like Gilead (NASDAQ:GILD), I may just lose my cool and sell anyway.

Disclosure: I am/we are long BRK.B, KO, IBM.

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.