Even in the best market conditions, Warren Buffett's investment decisions attract a lot of attention. In the choppy market we have now, with many global economies best described as fragile, Buffett's recent stock buybacks have become headline news. We'll look at Berkshire Hathaway Inc.'s (BRK.B, BRK.A) buyback and what it suggests about Buffett's outlook on the current market.
- Despite a choppy market, Warren Buffett's Berkshire Hathaway hasn't made the large bets that it did in the financial crisis.
- The growing hoard of cash has become a talking point in the market, as it suggests there aren't good deals out there.
- While Berkshire might need billion-dollar deals to move the needle, smaller investors can still find plenty of value in the market.
Investing in Yourself
Warren Buffett and Charlie Munger have both been critical of stock buybacks as something companies do when they run out of good ideas. In the current market, however, it seems that Berkshire has run out of opportunities that meet its criteria.
Berkshire's biggest investment over the first three quarters of 2020 has been in itself to the tune of $15.7 billion. Buffett has allowed that he would buy shares of Berkshire back if he thought the market was undervaluing the firm, but it has never been his stated preference. A buyback of this size spanning several quarters, however, doesn't appear to be solely driven by concerns over valuations.
Growth Can Be Challenging When You're Already Huge
We have been speculating for years about Berkshire becoming more of a cash-generation machine than a growth stock. The fact is that Berkshire's rapid growth is well behind it, but Buffett and Munger seem to find a way to keep adding significant cash-generating businesses to the family. The problem is that the conglomerate is already so large that acquisitions have to be huge to have any significant impact on the bottom line. Berkshire investments under $1 billion dollars are unlikely to move the needle much no matter how well they perform.
Buffett and Munger are sitting on a pile of over $140 billion in cash and cash equivalents with more flowing into it every day. There is no doubt that they would prefer to deploy this hoard into the market for a better return than T-Bills, but they also need to deploy it in a way that will be impactful for the company's bottom line. Buffett has made investments, including almost $2 billion in pharmaceutical companies and $6 billion into Japanese firms, but these are small in comparison to the buybacks.
The Great Financial Crisis vs. the Pandemic
The most obvious point to be made about Buffett's growing cash hoard and lack of deals is that this isn't the 2007-08 Financial Crisis, when Buffett deployed his cash to provide desperate companies liquidity on favorable terms. As the pandemic is a health crisis that has bled into the financial world, the Federal Reserve has been much less reluctant with its stimulus. This is likely because the Fed sees the markets as still functioning, so there is less risk with providing bridge liquidity until the pandemic resolves.
During the 2007-08 financial crisis, the Fed was not at all certain about the liabilities it would be taking on backstopping the economy, so that uncertainty led to reluctance until the last possible moment. This gave Berkshire Hathaway time to deploy its cash to its investors' benefit – something that has not been true for the pandemic.
What Buffett's Buybacks Suggest About the Market
Buffett is still investing, but the big deals he wants to take on – the elephant-sized deals – are clearly hard to come by in today's market. Instead, Buffett's relatively quiet period of buying stock is a further sign that Berkshire is moving away from dabbling in stocks and more and more to buying entire businesses.
This doesn't mean there aren't value buys in the market, however, as investors bargain shopping ahead of the recent vaccine surprises can attest. Berkshire's more modest moves do suggest that there is still an appetite for hunting bargains, but they are not as significant as the market discount Buffett and Munger perceive in Berkshire stock. Buffett is simply operating on a different scale – one on which, it bears repeating, investments under $1 billion are seen as dabbling. Not many other investors can drop several hundred million in a sector and still be seen as testing the waters.
The Shareholder Shakeout Theory
The acceleration in Berkshire’s stock buybacks in 2020 has also prompted speculation that Buffett and Munger may be purposely reducing the number of shares sitting with less devoted shareholders ahead of what will eventually be one of the most significant successions in financial history. Buffett is 90 and Munger is 96, and they have been grooming their potential successors for years now. Buffett and Munger may both be carried out of Berkshire on their shields, so to speak, but that day is inevitably drawing closer. The theory goes that Buffett is giving fairweather investors a chance to cash out their holdings in advance of a transition.
While this may be a practical result of the stock buybacks, it is hard to credit the idea that Buffett or Munger are doing the buybacks with this in mind. Buffett has always been very practical about Berkshire just being another stock to investors and would likely expect them to buy or sell according to the value they see in the underlying business. The idea of Buffett trying to move the stock into friendly hands or curate a more loyal shareholder base for a transition just doesn't fit his outlook and conduct to date.
The Bottom Line
The duo of Buffett and Munger have built a conglomerate with incredible size and cash-generation powers. The insurance operations alone would be one of the world's largest and most profitable firms, and those earnings can still be dwarfed by the investment gains in a good year. This massive size does come at the cost of the smaller, hidden value investments that helped make Buffett's name in the market.
These smaller investments delivered great returns for Berkshire over the years, and those returns were plowed back into the market for more returns until it made more sense to buy entire businesses and act as a lender of last resort during times of crisis. When the Federal Reserve is your main competition in the market, you're obviously a big deal.
Most importantly for investors, Buffett's idle cash hoard doesn't mean that there aren't value stocks in the market – it just means that none of them fit his desire to make big deals. That is actually good news in a way, as it leaves more potential bargain stocks in the market for the rest of us.