Losing Faith in Berkshire

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Tuesday February 28, 2017

Over the 40 years or so that we have been investing, our system has evolved. We learned from what worked — and even more so from the errors that were made. Unfortunately, there were more of those than we care to remember. But evoking some of those painful memories has been critical to advancing our methodology, which though different than the early days, has remained rooted in our contrarian and value bent.

So, we were taken aback when looking at the recent investments of Warren Buffett and his sidekick, Charlie Munger. Let us preface by stressing that we have tremendous admiration for these two gentlemen, both for their investing skill and the honourable ways that they appear to lead their lives.

Our impressions were deepened further a number of years ago when attending the Berkshire Hathaway annual general meeting in Omaha, Nebraska. Listening to those gentlemen rhapsodize was a wonderful experience for us, and one that ranks high on our list of recommendations to investors.

To attend this gathering, we had to buy into the company. By no means is this a Contra enterprise, so the purchase was made more as an investment in knowledge and in a fun trip. It paid off on both counts.

Buying technology corporations was anathema to Mr. Buffett at one point. That has changed over the years, as his foray into IBM demonstrates. The original bite into Apple was downright confounding, and his recent bolstering of the position only added to our confusion.

When the second acquisition was made, the stock traded near historical highs, at more than $100 (US), with the book value less than one-quarter of that. Risk has increased by our reckoning, as Apple had nil debt in 2012, while today it stands at about $88 billion.

Investors should also consider that while Apple has had a tremendous run, people’s love for technology can be extraordinarily fickle, and there is a need to keep fans engaged with continual product improvements. The technology graveyard is littered with enterprises that could not keep up.

Mr. Buffett is famous for his quotes on why not to invest in the airline sector. One of our favourites: “I have an 800 [toll-free] number now that I call if I get the urge to buy an airline stock.” Evidently that line was disconnected, as he added to his positions in four corporations in the industry.

One of them, Southwest Airlines, has one of our favourite ticker symbols, LUV. It does not get much cuter than that. But as a financial outlay, loving it is not something Berkshire would normally appear to do. This is another stock that is trading near historical highs at around $58, while having a relatively miserly book value of less than $14. Not so attractive by those metrics.

His other purchases in this field include American Airlines Group, Delta Airlines and United Continental Holdings. Again, all trade at huge multiples to the book value and near historical highs. All could have been purchased at about one-quarter of their current prices four years ago. That would have been a heck of a lot prettier.

One could argue that Mr. Buffett is buying these enterprises for future cash flows, which is one of his hallmarks. While right now those numbers are pretty sexy in all cases, should a major global problem arise that restricts travel, all of these ventures in flying could nosedive. The price-to-eanings ratios are also reasonable. In addition, since these four are North America’s largest airlines by far, having all of them under Berkshire’s influence should diminish competition and allow for more pricing power.

Are Mr. Buffett and Mr. Munger passing the baton with a new generation making more decisions at Berkshire? That seems like a pretty realistic conclusion.

Given that the stocks purchased all seem top-heavy in price, it seems quite possible that the worth of the companies might topple when the markets take their inevitable beating. If that happens, for people who like playing the shorting game, Berkshire could prove a good play.

And since the company does not pay a dividend, the risk is somewhat diminished. However, with the 180-degree shift in the investments being made, it would not surprise us to see a dividend implemented, especially in light of the huge cash hoard this corporation holds. If that happens, it could propel the stock price up further, ceteris paribus (all other things being equal).

We do not play with shorting, having been burned in the past both with paper trades and real money. Quite simply, that is not part of the way we do business. Ultimately, when investing, it is critical to have a disciplined methodology. Looking at Berkshire’s recent stock plays, it appears the modus operandi has shifted dramatically. This is giving us pause and making us strongly consider selling our position.