Chairman and CEO of Berkshire Hathaway Warren Buffett. Photo by Kevork Djansezian/Getty Images.
For me, there’s a glaring omission in Berkshire Hathaway’s quarterly report. Nowhere does Warren Buffett talk about his $220 billion portfolio of stocks. The 10-Q is a dense, 55-page slog, proliferating in tables and stats.
More than you can shake a stick, there’s detailed breakdowns of all parts of its business. But, aside from listing portfolio holdings, no commentary on concentration in banks and the outsized position in Apple.
Shareholders of Berkshire Hathaway pay a 25% premium over its $400 billion asset value. This is probably the most dangerous metric in my valuation analysis because it could erode next couple of years. I’m not forecasting recession around the corner so bank stocks can hang in, at least, market performers.
Neutral on Apple, but consider, Buffett missed the great five-year play in internet and e-commerce properties. Probably, stocks like Amazon, Alphabet and Facebook tick outside his zone of valuation. Over five years, Microsoft elevated from $40 to $140. Certainly, as analyzable as Apple.
Since the financial meltdown of 2008-2009, I’d rate Buffett a better investment banker than money manager. The purchase of industrial assets years ago like the Burlington Northern Santa Fe and Precision Castparts did sop up some excess liquidity. They do add scope to Berkshire’s operating-property portfolio, but there’s a recurrent cyclicality in their numbers. The nine-month gain in earnings came from equity portfolio’s appreciation on paper, not realized gains.
Actually, I was surprised by the flattish tone to earnings in all of Berkshire’s operating businesses inclusive of insurance underwriting, industrials, energy and utilities. I expected more from Geico, but its combined-loss ratio moved higher by 9.7%, year-to-date.
Burlington Northern’s coal revenues declined 6%. One of the compelling reasons for its purchase years ago was that coal exports could be a growth sector, but it’s not so. Whoever said acquiring companies was easy? There’s always a buyer’s premium to pay. Goodwill in Berkshire’s balance sheet is a big number, $81 billion on a base of $135 billion in fixed assets.
But, I’d x-out all of this goodwill on the balance sheet as a future liability. Sound businesses can sell at a big enough premium to wipe out carried goodwill. I see these properties as monuments to Buffett’s legacy as a buyer of GDP operating properties that can flow on forever, like “Ol’ Man River.”
Net Cash flow from operating businesses came in flat, year-to-date. There’s more cyclicality than pure growthiness herein.
Balance sheet metrics need some sorting out. There’s an unrealized gain of $107 billion on a $220 billion portfolio. I’m sure Warren is married for life to American Express, Coca-Cola et al. Same goes for bank stocks. I’ll never understand how he dares add to this commitment, about $100 billion of the $220 billion portfolio.
Cash equivalents and short-term Treasuries rose $14 billion year-over-year to $124 billion end of September. Some of this must be in the float generated by Geico and General Re, largely available to the parent. Deals, high-yield bonds, corporate loans with equity kickers, warrants, whatever. Latent earnings paid in cash carries a discounted value, but is considerable on $400 billion in present asset value. The contra is there’s a lot in T-bills with a minimal yield.
What about bank stocks in the financial sector and the S&P 500 Index? Not long ago financials carried 10% of the index, now 13%. I’ve 20% of my assets in Bank of America, Citigroup and Charles Schwab. Berkshire sits with 40% of portfolio assets in financials inclusive of Wells Fargo and American Express. Mid-sixties I was analyzing American Express along with Buffett. He’s held on for over 50 years while I tapped out prematurely.
My dream today (and probably Buffett’s) is that the price-earnings ratio for banks, now near 10 or 11 times earnings, could be rerated as high as a 13 p/e ratio. JPMorgan Chase, at a new high, is already at 13 times earnings. All this happens next couple years with aggressive annual share buybacks of at least 5% of market capitalization. I’m assuming no recession and an elevated net interest margin ratio, no more than 18 months ahead.
Although I’d give Warren more credit as an investment banker than portfolio manager, the huge bet on Apple’s nose is a winning ticket now worth $57 billion, over 25% of portfolio assets. Such “Street” courage and savvy is rarely remarked upon. Just a handful of hedge fund honchos make such big percentage calls with their own money.
What is the right premium over book value that investors should pay for Buffett’s wisdom as a stock picker, investment banker and acquirer of industrials and a railroad? Overall portfolio performance is not a barn burner past five years. You want Buffett to step in for you and buy when there’s panic in the streets like 2008-2009. In a benign bull market, plenty of cream puffs will outshine him.
Past couple of years, Berkshire as a stock has backed and filled, tracking a trading range between $190 and $220 a share. You could’ve fallen asleep as a shareholder. I’m willing to overlook substantial goodwill on the asset side of the balance sheet. Retrospectively, this year, more aggressive investment in equities was the right construct. The S&P 500 is ahead 24%.
I’m a frightened bull, 80% long with 20% in high-yield bonds. The market’s price-earnings ratio is pricey at 18. Historically, this is peak valuation, even when interest rates are low as today. To turn bullish on the Berkshire stock I’d need to model 10% annualized-earnings growth for its operating properties, notably insurance and industrials. Throw in sizable share buybacks of $50 billion and a buoyant stock market setting where financials are outstanding performers. Everyone learns to love banks.
And, then, Warren remains healthy and functional in our rough and tumble investment world. His achievement over 60 years never will be equaled again. Investors need to make a judgment call whether it’s the bottom of the eighth or ninth inning here.
Personally, I’m not thrilled by the industrials held or in the insurance sector where there’s plenty of capacity and flattish investment income. This won’t reverse itself so fast. Holding 40% of assets in bank stocks is too extreme for me. I prefer Facebook, Alibaba, Alphabet and Microsoft to Apple but that’s a quirk and debatable.
Time is the ultimate clarity here. Net, net, I’m neutral. The construct is too hard for me to accept the premium over book value.
Sosnoff and / or his managed accounts own: Alphabet, Facebook, Microsoft, Bank of America, Citigroup, Charles Schwab, Wells Fargo preferreds, JPMorgan Chase and Alibaba.
