Warren Buffet, management consultant
The consequence of his incredible success finally caught up with Warren Buffet last year. At its 44th attempt, the S&P 500 finally grew faster than the book value of Berkshire Hathaway over a five year period. Mea culpa is expected in the annual letter to shareholders next month.
What that has prompted is some retreading of the reasons why Berkshire doesn’t pay a dividend. In essence, this empire of insurance, stocks and real businesses has been built on compounding retained earnings. The Sage of Omaha keeps the money because he can invest it better than you.
So if he can’t anymore, then maybe he should start to hand back the money as more than $1bn in cash flow piles up each month.
Voila, dear shareholders, a dividend. My life’s work is complete…
We don’t fancy the chances. The billionaire is many things, but ego-free is not one of them. Check out the deluge of Berkshire
tat memorabilia bearing his face at the annual meeting in Omaha if you don’t believe us, or see the most recent of his four tweets.
If you refer to yourself as the Oracle, even in jest, we’re pretty sure you are attached to your investment record.
Meanwhile, in terms of the self-imposed rules under which Warren Buffet and Charlie Munger run Berkshire, there is wiggle room around when they admit that they can no longer turn a dollar of investors’ money into more than a dollar.
The Rational Walk has one of the best explanations we’ve seen of the so-called retained earnings test published in each annual report, revised for clarity in 2009.
“The five-year test should be: (1) during the period did our book-value gain exceed the performance of the S&P; and (2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense.”
The first is still true, but while Berkshire has, almost certainly, failed the second, the Rational Walk argues that it is less relevant than it used to be.
“While using book value as a proxy may have worked adequately at a time when most of Berkshire’s value resided in publicly traded securities, it appears outdated now that Berkshire has accumulated a large collection of wholly owned operating companies. The market value of Berkshire’s stock holdings are marked to market at each financial reporting date but the market value of wholly owned subsidiaries are not similarly marked.”
For instance the value of Union Pacific, a peer of the Burlington Northern Santa Fe railroad which Berkshire purchased in 2010, has almost tripled.
But more important, Warren doesn’t promise to outrace a charging bull:
“As Mr. Buffett has repeatedly noted, Berkshire is built to shine in periods where stock markets are not going straight up.
Over the next several weeks, speculation is likely to increase regarding the possibility of a dividend payment due to the failure of the five year retained earnings test. While we admire Mr. Buffett for setting standards in advance and sticking to them, it would be perfectly understandable to defer any decision on dividends for the time being. Other than the significant tax consequences to shareholders, removing capital from Berkshire at this time could be counterproductive if it limits Mr. Buffett’s flexibility in the midst of a market decline. The retained earnings test might be better formulated to incorporate Berkshire’s performance relative to the S&P 500 over a full market cycle.”
Patience, that most Buffettian of values, is required.
Still, there is perhaps one more thing that Mr Warren Buffet can do. His approach has evolved over the decades — he was persuaded by Charlie Munger to rely less on absolute measures of value that held back his stock picking. He began to buy whole companies in the 1990s, and then very large companies in the last decade.
The most recent evolution was to team up last year with 3G Partners in the $28bn purchase of Heinz: the deal broke Berkshire’s longstanding rule of not replacing company management when they buy a company.
In other words, acquisition criteria 4, as detailed in each annual report:
“Management in place (we can’t supply it).”
Yet if the removal of several layers of management at Heinz is a success, and 3G remains willing, that parenthesis is no longer entirely true. So Mr Warren Buffet might then aim his famed elephant gun at good companies run less well than they might otherwise be, a considerably larger field of prey.
Certainly, the discussion of such possibilities and what it and the Heinz acquisition mean for the culture of Berkshire Hathaway would make for a far more interesting letter than yet another explanation of the power of compound interest.