We all know Warren Buffett is the greatest investor of all time. I learned a lot by reading his annual letters to the shareholders of Berkshire Hathaway (BRK.A) (BRK.B), which are a must-read for all passionate about investing. Buffett's holding company is a favorite core component of many individual as well as professional investors' portfolios. After all, the Oracle of Omaha is almost guaranteed to outperform the indexes year after year, and early investors who entrusted him with their money have become rich-- very rich.
Yet, as of 2012, if a friend asked me whether it would be sensible to invest a sizeable portion of his money in Buffett's legendary company expecting to make some money, I'd probably answer that there are more rewarding opportunities around. Here's why:
Berkshire pays no dividends.
One of Buffett's most famous quotes is "Our favorite holding period is forever", but if you buy shares in Berkshire there will come a day when you will be forced to contradict this principle. Buffett loves to invest in dividend paying companies, especially those that grow their dividends over time.
Dividend growth investing has become very popular recently, and for a very good reason, that is, your yield-on-cost grows over time and if you pick early a company such as Johnson and Johnson's (JNJ) or Exxon Mobil (XOM) - which have been increasing their dividends for at least 25 consecutive years - one day your dividend income will be so large that you might even consider retiring abroad. This is not the case with Berkshire, as it has never paid a dividend since it went public in 1965.
Buffett reasons that paying dividends out of Berkshire's earnings makes no sense because he has always been able to reinvest the profits and get a better return for his shareholders. That is indeed true, but as a Berkshire shareholder the only way you can take home money thanks to Buffett's investment acumen is to get rid of your shares at a higher price, thus contradicting the "holding forever" principle. Buffett loves to milk the cows he buys, but to his shareholders his firm is like a cow that always drinks her own milk to grow fatter-- but you will never get your cheese until you kill her.
Let's compare Buffett's beloved Coca Cola (KO) to Berkshire Hathaway. $10,000 invested in Berkshire ten years ago, on Jan 1, 2002, would be worth $16,100 today, whereas the same sum invested in Coke would be worth $14,700. With Berkshire, though, you would have received $ 0 in dividends since while your 217 shares of Coke bought in 2002 would have paid you $2,910 in dividends, and shall keep on paying even bigger dividends in the future. Not only your Coke investment plus dividends would have outperformed Berkshire, but if you reinvested Coke's dividends buying additional Coke shares, you would have outperformed even more.
Berkshire has become too large.
On different occasions recently, Buffett has warned his followers that his company has become so big that replicating past success will be almost impossible; "The bountiful years, we want to emphasize, will never return; the huge sums of capital we currently manage eliminate any chance of exceptional performance.", he wrote in his 2011 letter to shareholders. In order to move the needle of performance, larger and larger investments will be required and soon Buffett will be left out of options. Some of his critics claim Buffett may have lost his golden touch; Chris Goolgasian, a senior portfolio manager at State Street Global Advisors has written:
It strikes us that Buffett believes that only asset classes and investments that fit his specific investment beliefs can be sensible investments. While he won't own gold, he also never owned Apple (up around 1,500% since January of 2000) or Google (up 530% since August of 2004) or shorted subprime mortgages.
His recent deviation into tech stocks, with his investment in IBM (IBM), may be a sign that he is finding it more difficult to remain within his circle of competence and that the time has come to compel a change in his investment policies.
Buffett will turn 82 this year.
Warren, at almost 82, is still physically and mentally very healthy but the oracle himself acknowledges that he won't be at Berkshire's helm forever. Charlie Munger is almost 90 and while I wish them both well, it is more likely than not that by 2020 Berkshire's legendary founders will no longer be with us. Buffett's successor will have a hard time replicating, if only in part, the Oracle's investing magic.
The company is not cheap.
A cursory analysis of Berkshire's key ratios tells me that at this price the stock is not particularly cheap. The P/E ratio is 19, which is not a screaming buy and the Price to Book ratio is 1.2. While the P/B seems a bargain when compared to Berkshire's historical average 1.6 figure, we must remember that the share price in the past decades has always included a Buffett premium. But for the reasons discussed ahead, this premium is on the wane and will disappear as soon as Warren steps down.
If you want to become a better investor you definitely must read and learn from Buffett. His shareholder letters contain invaluable pearls of financial wisdom, and if you apply his tenets each time you make an investment decision you will have a greater chance of making more money than the average Joe.
If you are fascinated with the idea of holding a piece of one of the most successful companies in the history of capitalism, then go along and buy shares in Berkshire Hathaway. It is plausible you will not do worse than the indexes and can expect to sell them in a few years at a profit. But forget the 20% yearly returns on capital that early investors have enjoyed. Buffett's cumulative performance since January 1, 2007 has been quite unimpressive; he underperformed the Nasdaq by 15% and managed to outperform the DJIA only by a paltry 5% and the S&P 500 by 11%. Nothing to spit at, but it won't help you retire soon or buy the car of your dreams.
Disclosure: I am long KO.