Warren Buffett spent a good deal of time at Berkshire Hathaway’s (NYSE:BRK.A, NYSE:BRK.B) annual meeting in early May defending the company. Acknowledging that Berkshire Hathaway stock has underperformed the S&P 500 over the past decade, the Oracle of Omaha suggested that past performance doesn’t mean that it won’t do well in the future.
It’s a bit of a leap of faith to trust Buffett and his sidekick, Charlie Munger, but if you’ve owned BRK.B stock for a long time, that’s what you’ve done.
There’s no doubt Buffett’s made mistakes over the 53-plus years he’s run the company, but at the end of the day, he’s created several billionaires over the years including himself, so you’re not going to hear those people complaining about his lack of performance.
Not in a million years.
To suggest that Buffett should do this or that to tweak Berkshire so that it can deliver better performance has become a sport all of its own. We all have ideas we think will be just the tonic for Berkshire Hathaway stock.
Here are seven I think would help BRK.B end its losing streak. They are in no particular order of urgency or likelihood.
Investors have been clamoring for Berkshire Hathaway stock to pay a dividend for as long as I can remember. Unfortunately, Warren Buffett prefers to be paid dividends rather than the other way around.
It’s hard to argue with his logic.
In 2018, Berkshire raked in $3.8 billion in dividends from its equity holdings, almost 80% from its five-largest holdings. At a 5% interest rate, BRK.B could borrow $76 billion for future acquisitions using its dividends for annual interest payments.
So, there’s plenty of evidence that the company’s equity portfolio is doing a good job generating passive income for the company.
As for a regular dividend, Buffett would prefer not to get locked into some quarterly arrangement. He prefers to use the money for growth.
However, as my InvestorPlace colleague Aaron Levitt recently wrote, a special dividend would reward long-time shareholders and use up some of its $114 billion in cash.
In Europe, they figure out how much dividend to pay at the end of the fiscal year. Berkshire Hathaway stock could do the same based on some formula that takes into account the amount it’s repurchased over the past year and the length of ownership.
Increase Share Repurchases
I’ve never been a fan of share repurchases because it’s my experience that most companies overpay for their stock.
Recently, a report came out from Ned Davis Research that shows the S&P 500 would have been 500 points lower at the end of the first quarter of 2019, if not for share repurchases. Over the last eight years, the bull market has largely been sustained by buybacks, as share repurchases over that period equaled $3.5 trillion.
In the past year, Buffett’s lowered his price of admission for making share repurchases. In Q1 2019, it repurchased $1.7 billion of Berkshire Hathaway stock. He’s on record stating that he’d spend $100 billion buying back its stock in the future if he thought Berkshire could get a reasonable price.
I hope he does, but only when the market tanks and no one else has any money to buy back their stock.
And here’s another thing.
If buybacks have had such a significant effect on stock prices, the fact BRK.B has done very little of its own share repurchases over the past eight years suggests its performance isn’t nearly as bad as everyone thinks.
Sell McLane Company
This isn’t an new thought on my part.
I first suggested Buffett sell McLane Company, Berkshire’s food and beverage wholesale distributor, in 2013.
“For the first nine months of 2013, the food and beverage wholesale distributor generated 26% of BRK.B’s overall revenue, but just 2.1% of the company’s earnings before taxes,” I wrote in November 2013. “While I understand the wholesale distribution business is high-volume, low-margin, it generates a worse yield (1.1% earnings before taxes margin) than Walmart’s (NYSE:WMT) dividend yield of 2.4%.”
How is it doing today?
In 2018, McLane Company accounted for 20% of Berkshire’s overall revenue while its pre-tax earnings were just 6.1% of the company’s pre-tax operating profit and they were only that high because BRK.B had $22.7 billion in net unrealized losses from its equity holdings.
Berkshire originally acquired McLane Company from Walmart in 2003 for $1.5 billion. I’m sure it could find a buyer for the firm.
Do a Spinoff
One of the problems Berkshire Hathaway stock faces today is that potential acquisitions know that the company is trying to bag the elephant. As a result, the price asked moves higher, knowing that Buffett wants to make a big acquisition and has the money to do so.
Once upon a time, companies came to Berkshire wanting to be acquired regardless of the price. Now, it appears that acquisition prices have gotten so out of hand; potential acquisitions are asking the world.
In the past two years, BRK.B made a total of $6.0 billion in acquisitions. In 2016, that number was five times higher due to the Precision Castparts acquisition.
Acquisitions are few and far between.
To speed this process up, I suggested in 2018, that Berkshire spinoff some of its excess cash and McLane Company.
“It might be wiser for Buffett to spin off $30 billion of the excess cash plus McLane Company, its wholesale distribution business,” I wrote in August 2017. “The separately traded company would be run by his chosen (but yet unnamed) successor, which would allow it to begin succession planning while buying some smaller businesses that might not fit the Berkshire Hathaway M&A criteria.”
Today, I think it still makes sense, but I’d sell McLane Company after completing the spinoff. Think of it as a kind of special dividend.
Buy Some Smaller Companies
In some ways, Berkshire Hathaway stock is like a large mutual fund. In other ways, it’s similar to private equity in that it makes a big acquisition in a particular industry and then uses that company as a platform for growth — both organically and through bolt-on transactions.
Right now, BRK.B has seven platforms for growth: insurance, railroads, energy, manufacturing, service and retail, and financial services. The $6 billion in acquisitions over the last two years were of the bolt-on variety.
This suggestion works better if Berkshire follows through on my previous proposal to spinoff some cash into a smaller business that can go after little fish.
Until that happens, I’m not sure $6 billion is ever going to be enough for investors.
Buy the S&P 500
At the annual shareholders meeting in Omaha in early May, an investor pointed out to Buffett that if he’d taken Berkshire Hathaway stock’s cash and T-bills over the past 15 years — keeping Buffett’s often-quoted $20-billion cushion — and invested in an index like the S&P 500, the company would have $43 billion in additional cash and a book value that’s 12% higher.
Buffett’s long argued that regular investors ought to buy a low-cost S&P 500 index fund along with a short-term bond fund.
So, while he likes to have cash in order to make his now famous “preferred share” deals — the most recent being a $10 billion investment in Occidental Petroleum (NYSE:OXY) — I’m sure he could put $60 billion in the Vanguard S&P 500 ETF (NYSEARCA:VOO) and still have plenty of financial flexibility for making these kinds of deals or pulling the trigger on a big acquisition.
After all, if you can’t beat them, join them.
Acquire Brookfield Asset Management
This last one is my personal favorite.
Although Buffett has said that he’s already chosen his successor, I’d like him to consider Bruce Flatt and Brookfield Asset Management (NYSE:BAM) as a possible alternative.
Up until the past couple of years, Flatt flew under the radar of most investors. However, Brookfield’s announcement that it had purchased 62% of Oaktree Capital Management (NYSE:OAK) in March for $4.8 billion, surely opened a lot of eyes.
Flatt is only 54, the perfect age for someone taking over the Berkshire operation. Furthermore, he understands the Berkshire model; Brookfield runs several asset management platforms including infrastructure, real estate, private equity, and now with Oaktree, it’s got a distressed debt and credit business.
Brookfield’s current market value is $46 billion. Let’s assume Berkshire would have to pay a 50% premium. That puts the deal at almost $70 billion, well within the company’s means.
More importantly, it gives Berkshire Hathaway stock one heck of a leader for the next 10-15 years.
It won’t happen because Buffett doesn’t chase deals. But if he did, this would be ideal.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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