Berkshire A critique

 A CRITIQUE OF BERKSHIRE

Note this was written before C Munger passing.

Well that's it, finally. Since coming out of the hospital I have not been able to run, swim, go to the gym, just walk. A lot of walking and a lot of listening. Part of that listening has been the total audio recordings of Berkshire AGM commentary 1994-2023. That is a lot of Warren and Charlie.

The first time I can recall reading Berkshire AGM notes was back in the 1980’s. Back then Buffet was known, but not that well, Munger was not really known at all, especially outside of investing. From the start, it was clear that the investment strategy was clear and the disclosure was unlike anything I had seen before. Maybe not replicable but it is certainly understandable, which differentiated it from many other commentaries.

The accolades for these investing tyros are many, and deservedly so. What I thought I would do was construct a critique, as much as that is possible. Firstly, some points stood out to me after some 150 hours of basically listening to questions and answers.

There is a consistency that holds over many years and many different market environments. The same message, over and over, that I can simply sum as knowledge and patience. Stock knowledge, often built over many decades and the patience to wait for the great opportunity.

There are so many questions repeated year after year, succession, the issue de jour and despite Buffet continually saying he is not big in macro and that does not determine his investment approach, regardless there are questions on the federal deficit, currency, interest rates etc etc. of course the real gems are when he talks about stocks and industries.

The other thing that is apparent is that very few decisions are made ad hoc, off the cuff or without a rational ruler being run over them. A staggering discipline. The implication is that every criticism is countered by a rational reason for that decision.

The criticisms, well here are mine.

1.      Dialling down risk

If we believe that the investors that should take on risk are those that have the greatest knowledge and patience then surely BRK can take on risk, perhaps more than many others. There has, however, probably starting this century a winding down in the risk that BRK is prepared to take. Huge investments in railways and energy generation, to me, speak to longevity of returns rather than high returns. There are also wholly owned businesses that have ballooned in number and size over this century. Again, these for the most part are businesses with solid returns rather than huge growth opportunities. Buffet has spoken about being too large and that limits his ability to invest for higher returns and that has truth to it. What I make of this move is a “futureproofing” of BRK. I believe BRK is being set up to, as much as possible, run itself. The businesses it owns generate enormous amounts of predictable cash. Post Buffet there will be little or much fewer strategic decisions, there will be operational decisions, such as capex, products, and incremental add-ons but no large change in strategy even in investments. Excess cash will ultimately be returned through dividends or more likely share buybacks. One of Buffet's most famous sayings buy a company anyone can run and BRK looks to be prepared for decades of predictable cash growth in the post-Buffet era.

What are the ramifications of this? Well, more predictability, lower risk and probably lower returns. Those constantly comparing BRK to the SP500 miss that BRK is reducing its risk profile considerably. There is nothing magic about an indices risk profile, Buffet can choose his risk profile, the index is just one of many---that is for another post.

Is BRK for everyone under this scenario? No, but the stock is for a select group of investors.

2.      Invests to bet against the fade

I find this very interesting and a common trait in Buffet's investing style. Since he is quite open with his investments in more or less real-time, we can map his go-to favourite style. I would describe this as, along with extraordinary knowledge and patience, betting against the fade. What this means is that Buffet will invest in stocks that he perceives as quality and that are cheap. The stocks are cheap because the market is pricing in a fade. That is, the market does not believe the current earnings are sustainable and will fall. Buffet often takes this on. Buffet bets the earnings are much more sustainable than the market thinks. If he is right he gets a multiple rating, which can be big, if the earnings prove resilient he can also get an earnings surprise (eg AAPL). If he gets it wrong he looks stupid, surely everyone knew that the earnings were cyclical or structurally challenged etc (eg Dexter shoes). Buffet's hit rate and upside/downside skew in following this strategy is for the record, that is outstanding. What is interesting to me, is that it is the polar opposite of what most investors do. Most investors would buy an undeveloped business and one that is proving itself up and believe in a much larger and fully formed company, at the end. The difference to me is the risk involved and the degree of skill required. Maybe the reason why most share investors fail. Those who criticise Buffet for not embracing new growth areas such as tech, don't appear to appreciate the strategy involved, although Buffet could be criticised for not doing more in larger, established tech companies, but many have not opened the door to his style like AAPL did. There is a criticism to be had but I am more forgiving than many here, given his successful style execution.

3.      The team

There is little doubt in my mind that when the partnership ends it will have significant consequences. An investing partnership that has been successfully run for multiple decades is simply irreplaceable. When the Munger/Buffet partnership inevitably ends there will be repercussions that impact decisions, hard to see it not happening. Any of us who have worked with investment teams knows that changes have many impacts some of which are initially hard to anticipate. Obviously when both Munger and Buffet are no longer with us their skills and the confidence that they engender in the investment community will be gone forever. The repercussions could be long-dated but it is hard for me to see them as positive. BRK could evolve into a highly profitable conglomerate, caught up in the detailed issues of running many businesses without the capital allocation skills of its founders. I suspect large share buybacks but a loss of the magic and the premium.

Conclusion

Given that not much is done in BRK without serious premeditated thought we can only assume that the above are conscious decisions.

As an aside listening to shareholder questions over a few decades, the obsession with current issues is overwhelming, of course almost all of these disappear by the next AGM. The best many of these folk can do is stick with Buffet. The confidence they have in him is awe-inspiring when it's gone. It’s gone.