The Days of Big Berkshire Gains Seem Like They're Over

The Days of Big Berkshire Gains Seem Like They're Over
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On Thursday the greatest investor in history, Warren Buffett, disclosed that Berkshire Hathaway (BRK.B) has disposed of about one-third of its IBM (IBM) holdings. (Note: From time to time I have been short IBM, for fundamental reasons, in the recent past.)

Though I currently have no position in Berkshire Hathaway, it remains my view that Berkshire is a mature company, and results over the last five to seven years seem to support my analysis.

Though I remain skeptical of Berkshire's overall relative and absolute growth prospects (it is now a "GDP grower") and in the diminished value of a number of its portfolio positions (notably a 2015 acquisition of General Motors (GM) shares as chronicled here andhere), the decision to sell a portion of Berkshire's IBM shares should be commended as it reflects Warren's flexibility and lack of intransigence.

Unlike our many talking heads, The Oracle, in a discussion on CNBC, said when asked about his IBM investment ... " I was wrong." (Just like I was wrong to short Berkshire several years ago!)

Admitting his mistakes -- as he has done frequently in the past (consider his constant discussion of his very expensive investment in Dexter Shoes) -- is one of Warren's many commendable business and personal traits.

As mentioned, in the past -- and as reflected in some of my questions at my appearance at the 2013 Berkshire Hathaway annual meeting, when Warren endorsed me as the "credentialed bear" of Berkshire and as noted here -- I have been critical of a number of Berkshire's core investment holdings, most notably so in " Not Your Father's Berkshire " last year.

I remain a critic.

Here is a portion of a broader discussion, written more than a year ago, of a critical assessment of Berkshire's investment portfolio and the headwinds facing a number of those specific core investments:

Breached Moats

Berkshire's investment portfolio consists of a number of old-economy companies with "breached moats" and less-defensible franchises. These include:

Coca-Cola (KO). Old economy.
IBM (IBM). Old economy.
American Express (AXP). Losing its franchise value in a more-commoditized market for financial products.
Wells Fargo (WFC). A plodding and undifferentiated super-regional bank.
Deere (DE). A casualty of exported commodity deflation.
Wal-Mart (WMT). Very old economy.

Expensive Acquisitions of Mature Businesses

As 85-year-old Buffett's unparalleled career closes in on its final decade, we can see that many of Berkshire's acquisitions over the past five to eight years represent The Oracle's legacy.

The recent acquisition of Precision Castparts and other firms solidify a more bullet-proof Berkshire portfolio that's increasingly insulated from catastrophic events in its numerous business lines. But there's a price to the reduced vulnerability that Berkshire has gained from diversification and massive size -- much slower growth.

As I've previously written, Buffett "used to 'chase gazelles' in his acquisitions, buying companies that were available on the cheap due to controversies (i.e., Geico, Coca-Cola and American Express). But now, he chases elephants -- slow-growing and mature companies that sell for expensive prices."

Rejecting Innovation and Favoring Cash Flow

Buffett only invested in technology in recent years via Berkshire's purchase of a large stake in IBM (a deal that hasn't worked out very well so far).

As the Oracle wrote in this weekend's letter to shareholders: "I now spend 10 hours a week playing bridge online. And as I write this letter, 'search' is invaluable to me. (I'm not ready for Tinder, however.)"

The 85-year-old very late to the party -- and after Berkshire's poor IBM experience, he's not likely to embrace the future opportunities in technology as aggressively as perhaps he should.

Are Auto Dealerships Another Big Misstep?

"This is the beginning of a journey that will have no end. Cecil and Larry (Van Tuyl) have given us the ideal platform with which to build an auto-dealership business that will be thriving and growing 50 and 100 years from now. The fun has just started." -- Warren Buffett, on buying Van Tuyl Group of auto dealerships, as quoted in Automotive News (March 10, 2015)

I'd like to highlight Berkshire's recent purchase of the Van Tuyl Group of auto dealerships because I think he might have been investing in another industry whose moat isn't as secure as he believes.

It's worth noting that in buying Burlington Northern a few years back, Buffett failed to envision the declining role of coal (a key railroad cargo) in the U.S. economy. It turns out that Burlington's competitive moat was far less secure than it appeared when Berkshire acquired the railroad giant. If Burlington was still public, how low would the shares be selling today?

Similarly, Berkshire's 2015 acquisition of the Van Tuyl Group might be in exactly the wrong sector to invest in for the future.

Auto dealerships are highly dependent on repairs and maintenance as revenue sources. But these seem vulnerable to what many see as inevitable, swift market-share gains for electric cars that have fewer parts and require far less maintenance than gas-powered models do. The growth of "car-sharing" services is another risk to the Van Tuyl acquisition.

To me, the Van Tuyl and Burlington purchases potentially represent a continuation of an unsuccessful "old-economy" strategy that's failed Berkshire since 2009.

As Warren Goes Gently into that Good Night

The challenges of Berkshire's size and Buffett's age in allocating capital to investments and acquisitions are illustrated by his delegation of capital authority to others. The Oracle is stepping back and will likely continue to do so over the balance of the decade. He's certainly earned that privilege.

I expect even more delegation ahead, which shouldn't be surprising for an 85-year-old man (even a relatively spry one). But while Todd Combs, Ted Weschler and 3G are all capable, they're not likely in the same league as Buffett. Why should investors "pay up" for an unfamiliar, less-accomplished group of capital allocators?

The Bottom Line

As I noted in my first missive last Thursday, Warren Buffett is arguably the greatest investor of all time.

But Berkshire Hathaway's shares might be increasingly vulnerable to more-ordinary results and returns in the future, as today's Berkshire Hathaway is no longer anything like your father's Berkshire Hathaway. Indeed, based on Buffett's own preferred metric of book-value increases, Berkshire has underperformed the S&P 500 in five of the last seven years.

As I've repeatedly written, my respect for The Oracle's many decades of unprecedented returns is different from my assessment of Berkshire's investments over recent years and my forecast for Berkshire's stock performance over the next several ones.

But from my perch, there's no longer a margin of safety in Berkshire's shares. I believe investors will begin to more seriously question the "Warren Buffett Premium" that Berkshire's results and returns over the past six years no longer justify to me.

Again, this is not your father's Berkshire Hathaway. Rather, it's a diversified, maturing company with investments in many old-economy companies that in hindsight either "over-earned" in the past or are being commoditized today. And many (like Wal-Mart and IBM) need to retool at a steep cost to deal with our changing economy and interconnected world.

However, Buffett has continued to favor cash cows and cash flow over innovation and technology. In fact, he's been ever more willing in recent years to pay rich prices for maturing companies. His legacy from this will be a Berkshire that's a diversified global corporation whose returns will likely resemble global gross-domestic-product growth. But the days of Berkshire's outsized gains in book value and share price seem like they're over.

Doug Kass is president of Seabreeze Partners Management Inc. This essay originally appeared at  

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