By Hamlin Lovell, NordicInvestor
I attended the 2019 Berkshire Hathaway AGM, held in Omaha, Nebraska, on May 3, 2019, the day after I was at another event that Warren Buffett also participated in. The first Variant Perspectives: Women in Value Investing conference, organized by a group including Barbara Ann Bernard of Wincrest Capital, was opened up by Buffett. He believes there is no difference between how men and women invest, and is keen to encourage younger women to take more interest in investing. Buffett has met with groups of university students as part of an initiative called Smart Women Securities. Children as young as nine years old – both boys and girls – stood up and asked questions at the AGM, on camera and in front of an audience of 40,000 people. A handful of luminaries from the Nordic investment industry were also spotted at the event.
Berkshire Hathaway’s share price has generated spectacular performance over its history, but has underperformed the S&P500 index over the past decade. Cash, taxes, technology and Kraft Heinz are four reasons.
In the rising markets of recent years, Berkshire’s cash pile has acted as a drag on performance. Some of the cash is being used to buy back shares, and this should be accretive to shareholders if the buy backs take place at a discount to Berkshire’s estimate of its “intrinsic value”. Some of the cash is also earmarked for opportunistic investments, such as a possible $10 billion preferred stock bond, charging an 8% coupon with warrants on top, to help Occidental vie with Chevron for the possible purchase of Anadarko. Buffett is confident that he will eventually be able to deploy the cash at “very attractive rates of return”.
Still, even if Berkshire had been fully invested, and even if Berkshire’s underlying portfolio matched the S&P 500 index, Buffett pointed out that its net asset value would underperform due to a mix of corporate taxes and local state taxes, some of which might have been avoided with a different corporate structure. Buffett admitted that Berkshire has not been structured in the most tax efficient manner, but said that the USA has been good to the company and that it could not have done what it did anywhere else.
Large cap technology stocks have been disproportionately driving the performance of US equities, and Berkshire has been somewhat underweight of them versus the index; its main sector bets are US banks, airlines and consumer staples. Though Berkshire has been one of the largest shareholders of Apple for some years, with around 250 million shares, it has had few other technology holdings (eg Red Hat and Oracle) and not been exposed to other members of the FAANGMAN complex – until recently. Buffett announced that Berkshire has started investing in online retailer and cloud computer firm Amazon. His valuation is based on discounting future cash flows, not on the current PE ratio, which has always looked very high for this company. Buffett acknowledged that he does not understand how technology business models will evolve, but has hired people who do. Buffet is friends with Bill Gates and has donated billions to the Gates foundation, but is not invested in Microsoft.
Berkshire has not been invested in Chinese technology stocks such as the BAT complex (Baidu, Alibaba and Tencent), which have been powering ahead the Chinese equity market, either. Berkshire does not appear to have any investments in public Chinese companies at present, but the firm was an early investor in PetroChina as long ago as 2002. Buffett did say that he expects to invest more in China over time. He and Charlie Munger also view an escalation of the US-China trade war as being bad for equities.
Kraft Heinz has been one of Berkshire’s worst performing recent investments, down about 50% over the past year, and Berkshire’s first quarter were incomplete due to a delayed release of Kraft Heinz’s first quarter earnings, caused by a delay in filing its 10K form with the SEC. The Monday after the Berkshire AGM, it emerged that Kraft Heinz had been forced to restate three years of returns, due to improper accounting and some employee misconduct. This comes hot on the heels of a $15 billon write down of goodwill related to acquisitions. Given that Kraft Heinz is heavily leveraged, it seems possibly inconsistent for Buffett to be criticizing the leverage used by the private equity industry, as he did at the AGM!
Some asset managers, including Jupiter Asset Management in the UK, have been short of Kraft Heinz. Berkshire is a long term, long only value investor, and does not short stocks.
Incidentally, reports that Buffet is short of bitcoin are almost certainly fake news. Buffet has criticized bitcoin as a “gambling device”, but has explicitly said he would not take a short position in bitcoin futures, which are listed on CME Group.
Buffett has resisted pressures for ESG reporting, basically saying that it would be a lot of work to gather and aggregate the data from Berkshire’s 60 subsidiaries. It would also be a lot of work for ESG ratings agencies to gather the information from each individual subsidiary, which may be a reason why Berkshire reportedly received no rating from one ESG ratings agency at one stage. Yet another agency has given it a positive score, in part because a Berkshire US utility has stopped building new coal and gas plants and is increasing its share of renewables. Thus, there are differences of opinion between the ESG ratings agencies.
ESG reporting is generally held to be an area where European companies are, on average, ahead of those in the US. It remains to be seen how long some US companies, including Berkshire, can avoid ESG reporting. One theory is that those companies with more institutional investors, including pension funds with ESG policies, may be under pressure to start ESG reporting sooner than companies with a big retail shareholder base.
Berkshire owns credit ratings agency Moodys, which recently acquired ESG ratings firm Vigeo-Eiris. If Buffett has confidence in the management of Moodys, he might also pay closer attention to their acquisitions. There have been no announcements, but we could speculate on an interesting possibility: could the top management of Moodys encourage Berkshire to work with Vigeo-Eiris on developing ESG reporting?
Separately, Buffett’s hand might be forced by politics. He supports the US Democratic Party, and seven Democratic Senators, led by Elizabeth Warren, have introduced a bill called the Climate Risk Disclosure Act, which would force US companies to make disclosures around climate change risk, such as direct or indirect greenhouse gas emissions; fossil fuel assets owned or managed; valuation under current and Paris Climate accord scenarios; and risk management for climate change. Of course, the European Union Directive on Non-Financial Reporting has, since 2017, required some disclosures of social and environmental risks, and could be relevant for any subsidiaries that are based in the EU. Buffett said he is on the lookout for further UK acquisitions, and at least until and unless any Brexit deal is finalized, these could be covered by EU rules on corporate disclosures. UK companies might also be covered by such rules post-Brexit, because the UK financial rules may need to demonstrate “equivalence” with EU rules in many areas.