Subscribe7 Reasons Not to Buy Warren Buffett’s Berkshire Hathaway
I am a big fan of Warren Buffett. However, I believe it is more advantageous to follow Buffett’s stock picks than own Berkshire Hathaway (BRK.A) for the following reasons:
1. Portfolio Concentrated in US Dollars
Berkshire has a portfolio of 41 stocks. The total portfolio value is $48,025,404,085 as of May 15, 2009, according to CNBC. The top 6 holdings: The Coca-Cola Company (KO), Wells Fargo & Company (WFC), Burlington Northern Santa Fe Corp. (BNI), Procter & Gamble Co. (PG), American Express Company (AXP) and Kraft Foods Inc. (KFT) account for almost 70% of it.
Paul Krugman, the recipient of the 2008 Nobel Price in Economics, in his new, greatly updated edition of The Return of Depression Economics, defines that failures on the demand side of the economy – insufficient private spending to make use of the available productive capacity – have become the clear and present limitation on prosperity for a large part of the world. The quintessential economic sentence is supported to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain.
With US government’s huge stimulate package, the deflated US dollar is unavoidable. With few exceptions, such as POSCO, Sanofi-Aventis (SNY), Swiss Re and Tesco plc, majority of Berkshire’s portfolio and operations are based in US and tired to US Dollar. That’s why I rather own iShares MSCI Emerging Markets Index (EEM) or Vanguard Emerging Markets Stock ETF (VWO).
2. Troubled Derivative Bets
Berkshire is big into the derivatives market, which made more complexity to the already black-box-like conglomerate’s balance sheet. The company as of March 31 had $13.85 billion of paper losses on derivatives, according to Reuters. Contracts tied to junk bond defaults mature between 2009 and 2013, and Buffett admitted they may lose money. S&P said the U.S. junk bond default rate rose to 5.42 percent from 3.96 percent at year-end.
1st quarter 2009 operating earnings, which exclude investment and derivatives gains and losses, came in at $1.705 billion. In other words, Berkshire’s paper loss in derivatives would wipe out 2 years operating earnings.
3. Buy What You Know
Berkshire is an insurance-focused conglomerate and owns more than 60 subsidiaries including insurance, clothing, furniture, candy, restaurants, natural gas and corporate jet firms. As you can see from the chart I compiled, from its 1st quarter 2009 report, 34% of revenue was from insurance.
I never understand insurance companies’ financial statements. The only thing I know about insurance is about projections, assumptions, probabilities and promises for future delivery, typically at a far-off date. Most of the products are highly intangible. Every year when I read Warren Buffett’s annual letters, I always skipped the insurance portion, otherwise I would have had to reach for some aspirin.
4. Low Margins
Buffett said many of Berkshire’s nearly 80 businesses were hurt by the recession and lower consumer spending, including housing-related units that make bricks, insulation and paint. Even if the rescue of the financial system starts to bring credit markets back to life, we might still face a global slump that’s gathering momentum. The only bright spots coming in are its utilities and insurance companies, which include Geico and General Reinsurance.
The 2nd biggest operation, McLane, is marked by high sales volume and very low profit margins and has been subject to increased price competition in recent years. The gross margin rate was 6.95% in 2009. Approximately one-third of McLane’s annual revenues are from Wal-Mart. A curtailment of purchasing by Wal-Mart (WMT) could have a material adverse impact on the earnings of McLane.
Out of Berkshire’s total $260 billion assets, only $48 billion is in equity. In other words, majority continue earnings are still need to come from operational business.
5. Downgrade By Moody’s
Two credit rating agencies took away Berkshire’s "triple-A" ratings in 2009, including Moody’s Investors Service. The global credit crisis might be temporary, but the company could face significant pressure if it persists. According to CFA ( source: cfapubs.org), between 1980 and 2000, banking sector accounted for 4% of the Japan Nikkei in 1980, peaked at 22%, and then came back to about 4% again. If the same happens to US, then we could still have a long way to go.
6. No Dividend
Berkshire didn’t pay any dividend.
7. “Warren Buffett Premium”
The average Price/Book for Property & Casualty Insurance company is 1.05, while Berkshire’s is 1.35. If anything happens Buffett, the stock might drop 30% instantly. Even something happens to Charlie Munger…
On Jan 2, 2008, Berkshire (BRK.A)’s price was 139,300. By the year-end on Dec 31, 2008, it was 96,600: it dropped over 30%. Though it still performed better than S&P, it was certainly not the loss of 9.6% reported by the Main Street media, which looked at book value only. We need to compare apples to apples.
Last Friday, May 15, 2009, the Wall Street Journal reported that the Treasury department will make $22 billion federal bailout funds available to a number of life insurers. This will certainly help insurance industry as a whole. In addition, as Donald Guloien, new President and Chief Executive Officer of Manulife Financial Corporation (MFC) stated in his memo to Manulife employees on May 4, 2009, “We would expect that global financial regulators may require higher levels of capital, and this will favor the stronger and more conservative companies.” People are looking for reliable, strong and trustworthy companies, and there will be a “flight to quality” that will favor Berkshire as well. However, you can always buy ETFs such as Financial Select Sector SPDR (XLF), if you like the financial sector.
By not owning Berkshire, you are not benefiting from deals and terms that are only available to it, such as Harley Davidson’s (HOG) 15% and Tiffany’s (TIF) 10% debt offerings, GE and Goldman Sachs Group Inc.’s 10% preferred stock, etc. To make that up, you might check into iShares S&P U.S. Preferred Stock Index (PFF) that might give you something in comfort. Disclose: I have long position on EEM and owner of PointFinancialAdvisor.com. This was original published in http://seekingalpha.com/article/137996-7-reasons-not-to-buy-berkshire-hathaway
Hao Jin
Point Financial Advisor
Disclose: I have long position on EEM.
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Comment by Brett on 26 May 2009:
Let’s just file this article under “stupid” shall we? There are plenty of reasons to stay away from Berkshire Hathaway (if you are potentially a new shareholder), but you gave very few of them.
One thing you mention that I’d be worried about is how Berkshire’s business is so dependent upon Buffett and Buffett is pushing 80 years old. Should he die then the situation at Berkshire is completely unknown. He tells people his replacement will be a worthy replacement but there is just no replacing Buffett. Nobody in the history of world has the track record he has attained. George Soros, Philip Fisher, Ben Graham – these people were great but none of them personally amassed 40 billion dollars (or more) using their skills. Plus I believe a large reason Berkshire is able to retain such talented people running their subsidiaries is directly tied to Buffett’s personality. People like to work with him, and that is one of the perks of running See’s Candy or Geico. Once Buffett is gone might some of these “talents” he raves about in his annual report decide to jump ship? It’s possible, and that would effect results at Berkshire, but basically it’s a huge unknown.
But back to your article being stupid. “No dividend.” Are you serious? Buffett has repeatedly stated why Berkshire doesn’t pay out dividends, and it’s simply because he can add more value to the company retaining earnings than by paying out earnings to the shareholders. That is what he does – he is a capital allocator and he is the best there ever has been in the history of the world. By retaining the earnings and putting them back in the business he turns every dollar he retains into more than 1 dollar in market capitalization in Berkshire’s stock. I think that fact is evident by the stock price – at $90000/share (at the peak it was 147k/share) I think it is fairly obvious that Buffett is doing exactly what he says he’s doing (adding more value than the stock holder would had he just paid out the money).
“Buy what you know” – Again, you can’t be serious. While this is a great philosophy (and one that Buffett speaks of regularly), anyone who reads Buffett’s shareholder report regularly can get a good idea of how the insurance business works and what to look for when deciding whether an insurance business is run well or not. In every single report he goes into detail explaining the caveats of the business and in particular the gritty details of the super-cat business that is now Berkshire’s bread and butter. Berkshire’s great competitive advantage in insurance (and particularly the super-cat business) is their balance sheet which allows them to write a contract that could set them up for a loss of 6 billion (or more) on a single event. They do not write policy for volume, but instead write solely to attain an underwriting profit. They will only sign insurance contracts if they think the price is right, and that represents a huge contrast from insurance companies whose sole purpose is to expand market share at no regard for cost or proper underwriting. There main guy on the matter, Ajit Jain, has a consistent history of writing policies that adhere to strict underwriting principles and so far Berkshire has come out ahead (over the years) in this business despite atrocities like Katrina and the 2004 Asian tsunami, etc. Should he leave Berkshire, then again who knows how profitable this business will be in the future, but for now it is pretty obvious that Berkshire is the leader in insurance with Geico, B-H Reinsurance, and General Re (which is now turning up handsome profits after losing so much money when he first bought it).
In regard to derivatives, the information you put in this article is old information. Buffett has since completely restructured those derivatives bets. Now stocks only need to rebound 15% over the next decade for Berkshire to come out from underwater on the bets (according to the NY Post). That is a highly likely scenario.
The main potential problem with Berkshire in the future (in my opinion) is its sheer size. It already has a market cap of 140 billion and a book value of 109 billion – a company this size will find natural impediments to capital growth in the future. Buffett in his reports states that he is aiming to increase the intrinsic value of the company by 15% each year – but even that will prove to be hard in the coming decade because even if he did some how manage to grow Berkshire by such a percentage over the next decade book value of the company would likely have to increase from 109 billion to 440 billion in 10 years – it’s an astronomical number (in today’s dollars). It’s impossible to say whether it can happen or not (given a long bull market anything could happen), but the fact of the matter is that the larger the company gets the harder it becomes for these large percentage gains to continue.
Comment by Muhammad Moosa on 26 May 2009:
Bershires shares have gone up 1.6% annaully compunded over the last 10 years-paltry.
In South Africa you would have got 10% per annum in any bank and in the safest banking system on earth-our banks are and have been profitable over the last 100 years wih no sub-prime/etc.
For very very old people Buffett would have achieved good returns.
Not sure about Buffett being the best capital allocator in history,etc,etc.
Bill Gates is probably the greatest businessman/investor-Rockerfeller,etc
Mukesh Ambani has seen a 90% increase in his wealth recently and is probably as rich as Buffett at 52
Comment by Paul on 26 May 2009:
I disagree with the author and agree 100% with Brett’s comments. Does the person that wrote the article not know anything about Buffett’s style of investing, give me a break about the dividends, this has been explained by Buffett over and over.
I’ll agree that points 1 and 7 have a bit of merit, but not to a great extent. The other points are like Brett said “stupid”.
Comment by Randy Hill on 26 May 2009:
I am a big fan of Warren Buffett. However, I believe it is more advantageous to follow Buffett’s stock picks than own Berkshire Hathaway (BRK.A) for the following reasons:
“1. Portfolio Concentrated in US Dollars
Berkshire has a portfolio of 41 stocks. The total portfolio value is $48,025,404,085 as of May 15, 2009, according to CNBC. The top 6 holdings: TheCoca-Cola Company (KO)”
Ironic given that 75% of KO’s business is outside the U.S, as is 56% of P&G’s, over 30% of Kraft’s and AXP’s. And you draw the line at a very conveniant location enabling you to ignore holdings that have businesses almost entirely outside the U.S.
“2. Troubled Derivative Bets
Berkshire is big into the derivatives market, which made more complexity to the already black-box-like conglomerate’s balance sheet. .. Berkshire’s paper loss in derivatives would wipe out 2 years operating earnings.”
Do you understand what “paper loss” even means? You certainly don’t understand what derivatives are, one hint, stock options are derivatives. The vast majority of Berkshires derivatives are easily understandable, they are just long dated stock options. And the idea that BRK has much risk here is silly, they’ve already taken in $5B in premiums, and the “paper loss” is going to shrink substantially in the next report, because if you haven’t noticed, markets are up. And BRK has 10-20 years before it owes a dime on the equity options, so it’s pretty unlikely the stock market won’t be higher in that period. Esp. if as you say, you expect a deflated U.S dollar and inflation.
“3. Buy What You Know
..
I never understand insurance companies’ financial statements.” This is a key point, if you can’t read pretty simple financial statements you shouldn’t be buying any individual stock.
“Out of Berkshire’s total $260 billion assets, only $48 billion is in equity. In other words, majority continue earnings are still need to come from operational business.”
And your point is? That BRK has great operational businesses
“5. Downgrade By Moody’s”
Berkshire has little, and requires little, debt. So what’s your point? That BRK was downgraded from the highest possible rating, to the next highest possible rating and is still one of the highest rated companies in the world?
“6. No Dividend
Berkshire [b]invests it’s earnings for you, like someone should do for this author[/b].
“7. “Warren Buffett Premiumâ€
The average Price/Book for Property & Casualty Insurance company is 1.05, while Berkshire’s is 1.35. ”
I thought you didn’t want to compare apples to oranges? Isn’t a minority of BRK in insurance?
“If anything happens Buffett, the stock might drop 30% instantly. Even something happens to Charlie Munger…”
And your point? Berskhire is a tremendous value, and if it falls after Buffett’s death it will still be a tremendous value. GEICO, See’s, Coke, etc will continue to churn out profits and increase BRK’s net work, and it will rebound. And the new CEO may even institute stock buybacks and dividends if it doesn’t.
You cherry picked a bunch of misleading facts, and don’t understand berkshire or investing at all. you shouldn’t buy ETF’s, you should buy a Vanguard Target Retirement fund and stay away from making financial decisions, because you simply aren’t equipped to analyse them in the depth necessary for good decisions.