Buffett’s Wilting Legacy

Issue #51, Volume #2

He Should Have Stuck With Stocks

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The only Buffett-watcher to predict his retirement this year… Buffett made capitalism more credible… Investing in Apple was a big winner for Berkshire… Berkshire Hathaway Energy has been a total failure… Buffett’s final message to U.S. investors… Retail investors refuse to stay away…

Well… nobody gets everything right when they’re trying to predict the future… but I believe I’m the only Buffett-watcher who accurately predicted his retirement this year. 

Warren Buffett announced that he’s going to retire at the end of the year, passing the Berkshire Hathaway (BRK) CEO role onto Greg Abel, the architect of Berkshire’s energy business unit, which used to be called MidAmerican Holdings and is now known as Berkshire Hathaway Energy (“BHE”). 

I’ve been calling for Buffett to retire for much of the last year. 

Why do I care? 

I’ve spent a huge amount of time over the course of my life studying Berkshire Hathaway and Warren Buffett. I’ve done so because, for my entire lifetime, investors had a virtually guaranteed way to beat the stock market: all they had to do was buy shares of Berkshire. 

As a result, for a huge number of investors around the world, Berkshire became a totem of capitalism. Before Berkshire, a lot of people thought of investing as gambling. And most people believed anyone who could beat the market only did so by cheating or stealing, like the 1987 movie Wall Street sought to portray. 

But Berkshire changed all of that. Its structure guaranteed investment success while Buffett’s personal reputation made investing respectable. The combination showed, beyond any doubt, that capitalism was more credible and more effective than socialism. 

Unfortunately, since 2000 and, even more so, since the Global Financial Crisis, Berkshire’s track record has become dramatically less consistent. Most investors simply don’t realize the enormous impact that Berkshire’s investment in Apple (AAPL) has had on Berkshire’s success. Berkshire made a “bet the company” investment into Apple, buying 1 billion (!) shares between 2016 and 2018, for around $36 billion – a stake equal to more than 10% of Berkshire’s total equity. 

It has now sold most of that stake, around 700 million shares, for after-tax gains of around $60 billion. It continues to hold 300 million shares, valued today at around $70 billion. Including around $6 billion in dividends, the total return on this investment over the last decade was close to $125 billion – or more than 20% of Berkshire’s total equity today. 

Buffett – of course – deserves enormous credit for making this outstanding investment. I’m certain that is the largest profit ever made from a bona-fide outside investor, via common stock. 

And if you look back across Buffett’s entire career, you’ll find other similar “bet the company” investments in common stocks. In the 1960s, he put 40% of the Buffett Partnerships assets into American Express (AXP). In the late 1980s, Berkshire invested $1 billion into Coca-Cola (KO), a stake equal to 20% of Berkshire’s equity. 

Buffett was, without a doubt, the best common stock investor who ever lived. 

The trouble today though is that Berkshire has become, more and more, a holding company, with 180+ operating subsidiaries. And, as a conglomerate CEO, Buffett is an abysmal failure. 

In Friday’s Daily Journal, I mentioned how poor Berkshire’s investment track record has been (except for Apple) since the Global Financial Crisis. What’s most interesting to me is how Buffett’s track record when it comes to large whole-company acquisitions has been uniformly bad: there isn’t a single instance of success. 

Since the financial crisis in 2008, Berkshire has made six major acquisitions: Precision Castparts ($32.7 billion), BNSF Railway ($26.5 billion), Pilot Flying J ($14 billion), H.J. Heinz ($12.1 billion), Dominion Energy ($9.7 billion), and Lubrizol ($9.2 billion). Total initial invested capital: over $100 billion. 

Subsequent capital investments into these businesses have been immense. Capital investments at BNSF alone have been over $50 billion. And Buffett has put another $35 billion into more windmills at BHE. As a result, over $200 billion of Berkshire’s equity (about 30%) resides in these three business units: BNSF, BHE, and Berkshire’s Manufacturing, Service, and Retailing (“MSR”) unit, which Precision Castparts makes up. 

These investments dwarf the size of Buffett’s common stock investments in the same period. Berkshire has become a conglomerate, not merely an insurance company with common stock investments as it once was. 

And, none – not a single one – of these investments has produced a market-beating return. Here’s their annualized returns versus the comparable S&P 500 return:

A big part of the problem has simply been management. Over the last decade, BNSF has notably underperformed its rival, Union Pacific (UNP). GEICO was, until Todd Combs took over for Buffett, dramatically losing market share to Progressive (PGR). Even worse, Buffett presided over huge write-offs at both Precision Castparts ($10 billion) and KraftHeinz ($15.4 billion). 

The biggest management mistake is yet to be accounted for, at least publicly, in Berkshire’s balance sheet.

That is Berkshire Hathaway Energy. BHE has been a disaster. Buffett has invested more than $100 billion in capital to build the nation’s largest electrical power company. In June 2022, the executive who built the business for Berkshire decided to sell his 1% stake back to the company. Buffett paid $870 million in cash, which therefore valued BHE at $87 billion. To that point, Berkshire had never taken any capital out of BHE – not a single dividend, not one penny. So after more than 20 years and $100 billion, Berkshire’s actual return from that investment was zero realized gains and unrealized losses of perhaps $20 billion. 

The guy who built that business – Greg Abel – is now going to run all of Berkshire Hathaway. That sounds like a terrible idea to me. 

What’s worse, subsequent to Abel’s sale of his BHE stake to Berkshire, liabilities relating to the 2020 wildfires have mounted and are now expected to cost BHE something between $20 billion and $40 billion. When Berkshire bought out Walter Scott’s estate (75.2 million shares of BHE at $650 per share) the deal valued BHE at $49 billion, a decline of 43%. That valuation implies that Buffett has lost about 50% of the $100 billion he’s invested into BHE, a loss that, if recognized, would wipe out 8% of Berkshire’s equity. 

What’s so frustrating about these holdings is that over the last 25 years as Buffett invested more capital into regulated utilities, so many of the world’s greatest businesses have gone on sale – in the aftermath of 9/11, during the financial crisis (2009), during the European debt crisis (2011), during the oil bust (2015), and, most recently, during the COVID panic (2020). 

I continue to believe that Berkshire has a critical role to play in setting a great example of what can be achieved with investing and capitalism. Painting that picture requires having access to all of the world’s best businesses – virtually none of which ever come up for sale in their entirety, but which sell, in small parts, every day on the world’s stock exchanges. 

Berkshire Hathaway shouldn’t own a railroad. It should own shares in the world’s three best railroads. And the leader of Berkshire Hathaway should be able to constantly steer its portfolio toward the best investment opportunities as they emerge. Holding huge, low-quality businesses forever makes no sense. Especially when your CEO is the best investor who ever lived. 

If Berkshire wants to remain relevant going forward, it must divest its asset-heavy, low-returning businesses (BNSF, BHE, MSR). Doing so would dramatically revalue the remaining equity higher, while allowing these slow-growth businesses to become debt financed, increasing future returns for those companies. 

That’s what will happen – eventually. The sooner it happens, the better for shareholders. Buffett should be wise enough to recognize these mistakes and to encourage his successor to set them right. 

One more thing. 

I’ve often wondered why Buffett didn’t speak out more strongly against our government’s gross mismanagement of its budget. I’m not so cynical as to believe that Buffett wanted higher inflation because it benefits Berkshire Hathaway. But I wish that as an icon of capitalism, he had been willing to encourage better financial management from Washington. He could have done so in a very non-partisan way. And I think it would have helped warn more Americans what would inevitably happen to their savings and the real value of their wages. 

But at the meeting Saturday, he did offer a final warning to every American. I hope you will heed it. Buffett said: 

We are operating at a fiscal deficit now that is unsustainable. Over a very long period of time – we don’t know whether that means two years or 20 years, because there’s never been a country like the United States. But, you know, if something can’t go on forever it will end, to quote the famous economist Herbert Stein. We are doing something that is unsustainable and it has the aspect to it that it becomes uncontrollable. You just give up on it. Paul Volcker kept that from happening in the United States – we came close. We’ve come close multiple times. We’ve still had very substantial inflation in the United States, but it’s never been runaway – yet. That’s not something you want to try or experiment with, because it feeds on itself. So I wouldn’t want the job of trying to correct what’s going on in the revenue and the expenditures in the United States with roughly a 7% gap when probably a 3% gap is sustainable, when the further you get away from that the uncontrollable begins. I think that it’s a job I don’t want… but it’s a job that should be done. And Congress isn’t doing it… I’m going to quit while I’m ahead.”

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Three Things To Know Before We Go…

1. OPEC+ opens the floodgates. On Saturday, the OPEC+ oil cartel agreed to raise its production by 410,000 barrels per day in June, or nearly three times the increase previously scheduled for the month. Analysts believe the move, led by Saudi Arabia, is a punishment in the form of lower prices for cartel members Kazakhstan and Iraq who have defied the cartel and exceeded their quotas. Oil dropped as much as 5% in overnight trading, falling below $60 per barrel. If OPEC+ continues with its current strategy, a more aggressive pace of supply increases could reduce the price even more. 

2. Institutional and retail investors faceoff. The S&P 500 fell 11% from April 1 to April 8 as a result of global uncertainty created by President Donald Trump’s tariff policies, before recovering to end the month down just 0.76%. Unlike past periods of volatility, retail investors didn’t sell – instead, they bought the dip in early April, pouring a record $40 billion into U.S. equities, according to JPMorgan. Meanwhile, institutional investors headed to the sidelines, with hedge fund short positions in U.S.-listed ETFs hitting an all-time high. When retail is buying what the smart money is dumping, it raises a troubling question: what does the smart money know that retail doesn’t?

3. More evidence of rising inflation. This morning the Institute of Supply Management’s Services PMI showed that input costs rose sharply again in April. The survey’s prices paid index jumped to 65.1, a 4.2-percentage point increase from March’s reading of 60.9 and its highest level since early 2023. This follows a similar trend in manufacturing prices paid in several Federal Reserve regional surveys recently, and suggests consumer prices could be rising in the months ahead.

And One More Thing… Survey Results – Online Trading Platforms

In Friday’s Daily Journal, we asked readers which trading platforms they use the most. Charles Schwab is the clear favorite, with 44% of survey takers reporting using it the most, with Fidelity Investments second at 30%. E-Trade and Interactive Brokers tied for third at 9%.

Tell me what you think, good, bad, or indifferent: [email protected]

Good investing,

Porter Stansberry
Stevenson, Maryland

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