Buffett/Capital Allocation: Berkshire Cash Earns Big Interest as Bargain Hunt Continues

The US Securities and Exchange Commission wants to require US-listed companies to explain their stock buyback philosophies more clearly to their shareholders. Warren Buffett has already done it, at the annual meeting of shareholders of multibillionaire Berkshire Hathaway in Omaha.

He and his partner Charlie Munger answered questions about Berkshire as usual capital allocation choices. For the first time in more than a quarter of a century, however, US base interest rates have shot above 5%. Despite the usual questions about what to do with Berkshire’s cash balance — now up to $131 billion — the opportunity cost of using that cash has finally been significant.

Buffett specifically said he thought Berkshire’s stock was cheap. This could confuse the average investor given that its market capitalization of over $700 billion exceeds its book value or book value of equity by approximately 40%. However, in the first quarter, Berkshire repurchased $4.4 billion of stock.

Sure, he said, he’d like to buy a $50 billion to $100 billion business. But public company processes are often time consuming and overly competitive on price. He favors opportunistic bailout funding or investments in the $5 billion to $20 billion range, as with Occidental Petroleum in 2019.

His much-vaunted “float” from Berkshire’s insurance segment now stands at $165 billion. This cash from premiums paid is essentially free to invest and is stable relative to bank deposits, an appropriate comparison this year. Meanwhile, Berkshire remains so well capitalized that it should absorb any property and damage claims from its clients.

Note that Berkshire’s stake in Apple, about 6% owned by the company, is worth $155 billion. The iPhone maker recently announced a $90 billion buyback, which contrasts with Buffett’s almost religious zeal to hold onto profits and cash flow to invest later.

Instead, its investors continue to receive no dividends and only a modest buyback. They have to accept that Berkshire passively earns a risk-free 5% on its cash.

Simplified, this reflects how much a low multiple is needed to pass the exam for a deal. Take the reciprocal of that 5 percent and 20 times the earnings is the approximate breakeven purchase price to beat those cash returns. Above that multiple and the deal isn’t worth it. Berkshire’s big game hunting may continue for some time.