|Summary: The long-term performance of Berkshire Hathaway, the investment company controlled by billionaire Warren Buffett since 1965, has been nothing short of phenomenal. But the per-share book value of Berkshire has underperformed the market several times in recent years, leading some to question whether Buffett has lost his touch.|
|Key take-out: The per-share book value of Berkshire Hathaway shares rose 14.4% last year, against an S&P 500 index gain of more than 15%.|
|Key beneficiaries: General investors. Category: Growth.|
It’s once again that time of year, when millions of investors around the world sit down with a Coke and read Warren Buffett’s folksy musings on markets, corporate culture and the state of his beloved Berkshire Hathaway – popularly considered to be the ultimate buy-and-hold yardstick.
But in this year’s investor letter, amid the whimsy comments, there are faint warning bells: Berkshire’s per-share book value, Buffett’s preferred performance metric, rose by less than the S&P 500 (including dividends) in 2012. Of the nine years that’s happened since Buffett took control in 1965, five have been in the past decade – and three since 2008. If the trend continues in 2013, it will be the first time Berkshire’s book value has failed to keep up with the benchmark index over a five-year period.
If fact, on a five-year total return basis Buffett is already down, as this chart from the Financial Times shows. His sub-par returns appear to be part of a long-term trend.
For Eureka Report subscribers, many of whom regard Buffett as the world’s best investor, it may come as a surprise to read you’d be better off in an exchange-traded fund that tracks the S&P 500 than with the investment sage. But in recent years that has been the case.
It’s also one of the reasons Wall Street pundits such as Doug Kass, president of Seabreeze Partners, have been doubting Buffett since the crisis. Kass suggests “The Oracle of Omaha” has transformed himself into the “Mozart of Marketing”, using his notion of long-term as a convenient shroud to persistent underperformance. Trading mostly on the legend of its fading leader, Kass thinks Berkshire may now be more of a “cult” than a superior investment vehicle.
That Buffett has “lost his touch” has become a popular catch-cry in rising markets. That’s partly because his strategy is most likely to outperform as the S&P 500 tracks down or sideways – not only is it difficult for conservative stock pickers to beat an index yielding more than 15% in a year, but cheap financing and optimistic valuations also mean acquisitions become more expensive.
Indeed, it’s not uncommon to hear that Buffett overpaid for Heinz last month. The $US23.3 billion price-tag, split with 3G Capital Management, amounts to more than 19 times expected fiscal 2014 earnings, or a 20% premium to the sauce maker’s market value at the time. And unlike Buffett’s recent purchase of freight rail operator Burlington Santa Fe, Heinz wasn’t trading cheaply – the Berkshire/3G offer was 19% above what had been the company’s all-time high share price.
That’s not to say Heinz is a bad investment. It’s a great global brand that offers stable growth and industry-leading returns on capital. As part of Berkshire’s $US13 billion contribution, it also bought $US8 billion in preferred stock yielding 9% – a solid, if unremarkable return.
But many view the buyout as confirmation Buffett’s priorities have quietly shifted over the years. As Fortune magazine recently declared: “The idea of Buffett as [an] extreme value hunter has become more image than reality.”
Of course, there are some very lucrative deals among Berkshire’s largest purchases since 2008, as this list from The Motley Fool shows.
As financial markets were seizing up during the crisis, Buffett was on the phone negotiating personal bailouts for General Electric and Goldman Sachs in exchange for preferred shares yielding 10% and warrants that are now comfortably in the black. However, his most profitable deal during the period appears to have been a $US5 billion investment in Bank of America, which included 10-year warrants for 700 million shares at $US7.14. The stock has since bounced above $US11.
But Alice Schroeder, who penned The Snowball: Warren Buffett and the Business of Life, says these were special opportunities linked to Buffett’s reputation and relationships. In contrast, she says his latest major stock picks, including ConocoPhillips, IBM and Kraft Foods, have been lacklustre. “The impression is that Buffett no longer buys based on the brilliant insights of yore, but rather, chooses conservative mega-cap stocks when they appear to be moderately priced bets,” Schroeder, a former Wall Street insurance analyst, wrote on Bloomberg.
These bets will probably work out OK, but even Buffett admits his future returns are unlikely to match those of his celebrated past. As Berkshire bulges – its $250 billion market capitalisation puts it among America’s largest companies – its performance advantage is rapidly shrinking.
Buffett’s underperformance has sparked an interesting debate about whether he is in fact the best investor around. Nassim Taleb, author of The Black Swan, famously argued there isn’t enough evidence to show that it is skill, and not good luck, behind Buffett’s enviable returns of the past. Taleb says George Soros, whose strategy is built on short-term speculation, is a “vastly more robust” investor.
There are also others who have consistently achieved better results than Buffett – and not only in recent years. Secretive hedge fund manager Jim Simons was just named the greatest money manager alive in the new book The Physics of Wall Street, by James Owen Weatherall. The recently-retired Simons may not be a household name, but his $US5 billion Medallion fund is said to have returned an average of almost 40% per year since it was launched in 1988, compared with Berkshire’s lifetime average of roughly 20%.
Unfortunately, Medallion is closed to outsiders. And big-name managers offering exposure to other top performing hedge funds, through so-called funds of funds, often undershoot their own benchmarks once fees are deducted.
Berkshire on the other hand is open to all. Most local brokers will allow you to buy shares directly (class A shares currently trade above $US150,000, while class B are more affordable at around $US100), or through other products that track the company and/or its biggest investments.
But, with US markets firing on all cylinders, this correspondent is reminded of a gem from Buffett’s 1993 missive: “By periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals.”
When “most” includes Buffett himself, low-cost ETFs such as the ASX-listed iShares Core S&P 500 might be worth a look.