Does Buffett Deserve His Market Premium?

Next couple of years, I’d expect Berkshire Hathaway’s BRK.B 20% premium over asset value to melt away. What could make me wrong? Outperforming the S&P 500 Index would be a starter along with recovery in operating earnings for insurance properties and owned industrials like Precision Castparts, the Burlington Northern Railroad Santa Fe and Lubrizol.

Add in a recovery for banks like Wells Fargo WFC and Bank of America BAC . The Apple AAPL position truly is a homerun, now dwarfing all other positions at $112 billion. On Berkshire’s equity base, over $400 billion, Apple sits at 25% and is half the portfolio’s asset value.

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Everyone’s entitled to one or two portfolio luxuries, but Buffett has carried such a concept to extremes with great courage. I can rationalize outsized Apple, alone, a surrogate to technology’s sector weighting in the S&P 500 Index. Buffett’s pretty naked therein.

Portfolio concentration pretty much rivals a high intensity hedge fund operator like Bill Ackman at Pershing Square, but this is a $6.5 billion house. Even he carried a position in Berkshire. His pick of Lowe’s LOW , a winner, is actually a Buffett-kinda-value-play. Pershing’s 22% holding in Howard Hughes was one of a couple of real estate cyclical-recovery specs. Mine are Halliburton HAL and Freeport-McMoRan FCX . Betting on the end of deflation in our system next 12 months could be wishful thinking, but I’m all in, fingers crossed.

Berkshire’s huge overconcentration in the financial sector is difficult for me to rationalize today. It happened over decades and historically was a great play in a sector with a low price-earnings ratio. August of 2020, oversized financial holdings at $52 billion became overshadowed by Apple. The bruising from Wells Fargo and Bank of America, over $15 billion, was sizable.

Berkshire’s market capitalization tots up to roughly $500 billion. Frame of reference, Facebook’s at $675 billion, buoyant but considered problematic. Conceptually, anyone can buy Apple and a few bank stocks, say JPMorgan Chase JPM and Citigroup C , thereby eliminating the “Buffett premium.” Why not? His five-top holdings at $185 billion comprise the heart of portfolio assets.

I remember when personal holding companies invariably sold at steep discounts to asset value. The market busily marked down idiosyncrasies of the high-metabolic overachiever who controlled his company and was deemed capable of jumping off the “deep end” with foolish plays.

Has Buffett gone off the “deep end”? Maybe, yes, maybe, no, but for sure I don’t like his major holdings, excepting Apple. Don’t mark him down for having owned airlines, IBM, even Exxon Mobil XOM in past years. Everyone’s entitled to some bad picks. Warren did miss great five-year plays in internet and e-commerce paper – namely Facebook, Alphabet, Amazon AMZN , Alibaba BABA and Microsoft MSFT .

Obviously, such paper rested outside Buffett’s comfort zone of security analysis. Why pay a huge premium for a property that isn’t analyzable using traditional security analysis? Apple was his perfect pick. You could juggle with its metrics and if you liked the product offerings, Apple’s price-earnings ratio was comparable with the market, within the zone of 15 to 18 times forward 12-month numbers. After all the hype, Amazon remains unanalyzable. Forty-two analysts bless it, maybe one nay and two neutrals.

Approximately half of Berkshire’s net worth rests in publicly-traded stocks, but Buffett never discusses his picks, covering their fundamentals, the rationale for bank stocks today and expectations for growth at Apple. Investors coast along for the ride, elongated into years. The turnover ratio for the portfolio (the static ratio) is as low as it gets in the world of money managers. Static ratios for operators like Carl Icahn can run high, too, over 50%, but Buffett’s can be 80%, at least 60%, consistently.

When I focused on Berkshire’s wholly-owned operating companies I was surprised to find how vulnerable to Covid-19 stood Precision Castparts, Lubrizol, even the consumer sector and Burlington Northern. Insurance properties’ investment income account hangs in while losses in reinsurance stay sizable. Geico’s underwriting profitability is peaking as givebacks are due to policyholders who aren’t driving so much these days.

The write-down in goodwill, over $10 billion in Precision Castparts, surprised me. This is a very high-quality aerospace industrial. There’s still $71 billion in goodwill left on the balance sheet from past acquisitions, a big number. Buffett’s dream of prolific franchises in operating entities seems temporarily impaired. Analytically, I’d put a mid-teens multiplier on earnings of operating companies, inclusive of Burlington Northern and Lubrizol. Paying sizable control premiums on deals can end up costing you long-term.

Net, net, Berkshire is an operating conglomerate of industrials, retailing, energy, insurance underwriting and money management. Historically, conglomerate properties sell below market valuation. If relative asset value accretion from money management still proves elusive, Berkshire will remain an underperforming piece of paper, probably losing its 20% premium over net asset value.

Nothing is forever, but Warren has come close these past 60 years. Change in configuration of its market assets is meaningful. Over 25% of net worth now rests in the Apple position, about double the $50 billion in banks and American Express AXP . Sizable entities in manufacturing stand victimized by Covid-19’s hail storm. Not the time for railroads like Burlington Northern, Precision Castparts and oil related Lubrizol. Precision Castparts was a $37 billion acquisition in 2016.

I applaud Buffett for singling out American Express and Coca-Cola KO early on, when Wall Street was asleep on the potency of their franchises, five decades ago.

Berkshire, over five years, 2014 – 2019, underperformed both the S&P 500 Index and a peer group of insurance properties. The peer group is irrelevant because Berkshire is much more than Geico and its reinsurance holdings. Underperforming by 13% is a meaningful shortfall, but ignored so far by shareholders.

Some comparisons:

I’ve got 44% of assets in five stocks. Fairly aggressive, unhedged money management, but I don’t report results to anyone nor file 13Fs, quarterly. I’m sole honcho. Microsoft gave me a double past 12 months. Initial position under 5%.

Conceptually, I loathe bank stocks. They use tons of leverage which periodically gets them in deep trouble, like 2008 – 2009. Now, they’ve gotten cheap – little premium over book value, excepting JPMorgan Chase. Banks are selling near 10 to 12 times average mid-cycle earnings power. This seems a fair entry point, even with minimal interest rates still an earnings depressant. Why can’t we see negative interest rates in a depressed business-cycle setting going on and on? Look at Europe. I’m agnostic.

Sosnoff and / or his managed accounts own: Apple, Halliburton, Freeport-McMoRan, Facebook, Alphabet, Amazon, Alibaba and Microsoft.

msosnoff@gmail.com

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