Berkshire Hathaway: A Stroke of Luck or the Result of Unparalleled Genius?

Good day. I’m ready for the nonsensical hype of artificial intelligence to end. . . and be replaced by meaningless the power of fusion hype! A theoretical question: If it became clear tomorrow that cheap, clean, and abundant fusion power would be available on a commercial scale within a decade, and that no single company or nation would have a monopoly on that technology, what would happen to the total value of the world? stock markets? I could go down, right? Email me your guess: robert.armstrong@ft.com.

Berkshire Hathaway: lucky or good?

Berkshire Hathaway launched its second quarter report over the weekend, and there weren’t a lot of news in that. The cash pile continues to grow and is near all-time highs, at $147 billion, and Warren Buffett’s conglomerate/hedge fund is selling far more shares than it is buying. What caught my eye, however, was this chart on the FT story, showing Berkshire is underperforming the S&P this year:

This fact tickled my confirmation bias, because my assumption has long been that Berkshire cannot outperform the broader market for any significant period of time. With a market capitalization of $768 billion and exposure to a wide variety of economic sectors, is the market, in general terms. The genius of Warren Buffett and Charlie Munger is very great and is proven by their historical record. But they have reached a scale where they are up against the law of large numbers, and the best they can hope for in the long run is a tie.

That being said, the last time registered As for the company, about a year and a half ago, Berkshire was vastly outperforming the S&P, helped by its heavy energy weighting. This made me worry that my hypothesis might be wrong. So it was good for my ego to see things change direction.

Not so fast. Looking into a longer time frame, Berkshire has maintained its streak of outperformance since early last year:

As a result of this bullish burst, Berkshire now leads the S&P for 10 years as well: 201 percent versus 200 percent, or about seven-hundredths of a percentage point of outperformance per year, a tiny difference, according to S&P. IC capital. So my thesis still seems to hold up in the long run. But the last 10 years have been strange enough, and Berkshire’s recent outperformance has been significant enough, that it’s worth asking whether the past year and a half has been lucky or good for Berkshire.

The first thing to obviously think about is Apple. According to Berkshire’s second-quarter report, as of June 30, the company’s stake in Apple was worth $178 billion. That was half the value of Berkshire’s stock portfolio and 17 percent of its total assets. Apple shares have since fallen, but even so, Berkshire’s stake in Apple is equal to about a fifth of its current market capitalization (Apple’s weight in the S&P, by contrast, is 7 percent). . However you measure it, this is as single-stock-focused a position as any large-cap stock manager I’ve ever heard of (excluding crazy people).

So is Apple responsible for Berkshire’s run of strong performance? Some of it, but not a huge amount. While Apple has been great in 2023, since early last year when Berkshire began to shine, the stock has returned just over 3 percent, 7 points better than the S&P. Apple’s exact contribution to Berkshire’s performance is impossible to calculate, of course, because Berkshire’s value does not directly correspond to its net asset value; that value includes a fluctuating franchise premium. But Apple’s direct contribution to Berkshire’s market capitalization since early 2021 was in the billions of dollars. The total increase in Berkshire’s market capitalization in that period was close to $100 billion.

Berkshire’s other big overweights are in energy, utilities, rail and insurance. Looking at the performance of those industries, it becomes clear that while the good run in the insurance industry has helped, energy, which accounts for about 16 percent of Berkshire’s after-tax profits when excluding the actions, remains the key story. The huge run of stocks for energy companies at the start of 2022 has not been reversed.

So, speaking very broadly, Berkshire’s strong performance can be summed up as a little help from Apple, a little help from insurance and a lot of help from energy. Of course, individual Berkshire companies aren’t performing exactly like their sectors, and their individual performance may be part of what’s making a difference to the S&P 500. But sector performance in areas where Berkshire is overweight gives us a good clue.

Another factor that may have supported Berkshire’s stock price is the Federal Reserve. His huge pile of cash has gone from yielding roughly zero to yielding 4 or 5 percent. In other words, the opportunity cost of holding all that cash, in the hope of making an acquisition, has gone down.

The question is whether those overweight positions in thriving industries (and Apple, which is an industry unto itself at the moment) represent superior asset selection strategy finally coming to fruition, or a matter of being in the right place in the market. right time. . Is what we’re seeing in Berkshire the basis for long-term outperformance versus the S&P 500? If not, it’s almost certainly better for most investors to own an S&P 500 index, because the S&P 500 doesn’t have a brilliant and highly revered CEO who is 92 years old.

One way to make the case for long-term outperformance is that Buffett has focused on buying assets in industries that have high barriers to entry, compound earnings, but no glamour. After a decade or two in which the market has rewarded the most attractive sectors like technology, Buffett’s stakes in energy, railways, insurance, utilities and the like are poised to top out for decades to come. I like this theory because I’m a value guy. But the absolutely huge position in Apple greatly dilutes the argument.

A more difficult question is whether a cash-holding company like Berkshire is permanently more valuable, relative to non-cash-holding companies, in a higher-rate environment. I’m not sure how to answer this. I find it hard to imagine that excess cash, whatever the returns, won’t be a drag on stock performance over the long term. A public company is supposed to earn a margin above the risk-free rate; a higher risk-free rate should not by itself make a company more valuable. And it seems to me that the size of Berkshire has pushed it to a point where it can’t deploy its cash flow efficiently. On the other hand, if the higher rate environment brings with it greater asset price volatility and lower stock valuations, Buffett may get more attractive opportunities to put that cash to work quickly and earn high returns.

Overall, I think my hypothesis that Berkshire cannot sustainably outperform again is at odds with the new evidence. But I’m not sure, and I’d love to hear from readers.

a good read

The natural gas industry in the United States is absolutely wild.