Hilliard’s Weekend Notebook


Thoughts, views and opinions as current events unfold: With topics taken from current market events and my latest book — When the Bubble Bursts: Surviving the Canadian Real Estate Crash (Dundurn: March 2015)  and my first book Investment Traps and How to Avoid Them (1999) — this short piece will give you unique and valuable insights filtered by my thirty-six years’ experience as an investment professional.


 

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Has Warren Buffett lost his Midas touch?

Has Warren Buffett lost his Midas touch?

 

With his recent foray into subprime lender Home Capital Group, after a reported due diligence period of just three days, some observers are wondering if the world’s best-performing investment manager is past his prime, in his 86th year. Given Buffett’s stellar long-term track record as an investor, this question will be of interest to investors.

 

So I delved into Buffett’s recent decision-making and found a couple of intriguing clues.

 

There’s a treasure trove of information about Berkshire in Buffett’s annual letters. They contain illuminating insights into the actions and thinking of Buffett and his long-time partner, Charlie Munger, who is 93. I can recommend going through them to gain an insight into how a great money manager thinks.

 

In my review of the last few years there were a couple of things that stand out. One is a small thing, but indicative, and the other is very big.

 

First, the small thing. In the performance section of the letters, long-standing practice had been to show the difference in the growth in the book value per share of Berkshire and the S&P 500 with dividends included. Up to 2009 Berkshire beat the S&P 500 in most years. Only seven years (of 44 since 1965) showed the S&P 500 winning the contest, until 2009. But in that year Berkshire started to lose the race.

 

Beginning in 2014 the Oracle of Omaha changed the format of showing results. Performance is still shown for both series, but now the difference has to be calculated.

Source: Berkshire Hathaway company reports

 

From 2009 to 2016 the S&P 500 (column on the far right) has won the battle six times while Berkshire (on the far left) came out on top only twice.

 

A manager who makes it more difficult to assess how he’s doing seems defensive, especially when he does it during a period of poor performance.

 

The big thing that I focused on is the largest acquisition made in the 52-year history of Berkshire. This purchase could have significant implications for Berkshire’s future returns.

 

In late 2010 Berkshire acquired Burlington Northern Santa Fe (BNSF) for $44 billion, its largest ever investment. In the 2016 letter Buffett lumps BNSF with utility and energy-related businesses under this heading:

 

Regulated, Capital-Intensive Businesses

 

These businesses make up about 1/3 of after-tax operating earnings of Berkshire.  BNSF, the biggest company in that group, had a challenging year in 2016, with earnings dropping by 14.2 per cent. Buffett invested another $9 billion in capital improvements, pointing out that:

 

“We relish making such investments as long as they promise reasonable returns — and …. we put a large amount of trust in future regulation.”

 

It seems that the railway’s poor recent returns are partly due to a decline in thermal coal shipments.  Coal is burned to heat water to make steam which goes into a turbine that generates electricity. From the American Association of Railroads in July 2016:

Source: American Association of Railroads

 

This looks like a secular trend away from coal. Maybe the BNSF investment makes sense, even with a decline in coal shipments. Or maybe Buffett’s investment managers and researchers didn’t foresee the surge in natural gas and the challenges that coal faces longer-term. But some people did. From Fortune magazine in August 2010:

 

Politics aside, natural gas is beating up on clean coal

Two of the largest U.S. coal companies, Peabody Energy and Arch Coal, mentioned in that 2010 article, filed for bankruptcy in 2016.

Of course hindsight is always easier than making the investment decision. And the BNSF purchase could still be a win, longer term. The necessity to make large purchases, with $100 billion of cash, gives a limited number of target companies that Berkshire can buy. So it’s way too early to bring in a verdict on that decision.

But the investment in Home Capital seems opportunistic, short-term and too small for Berkshire. And it’s a move that will raise more questions than it answers.

 

Hilliard MacBeth

 

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