[Disclosure: Nicholas and several of his clients own shares of Berkshire Hathaway].
Due to the $130B of cash on Berkshire Hathaway’s books, the annual meeting was a mixed bag this year. Many shareholders were hoping to see that Buffett had put some $100B excess cash to work. Or at least some of it. After all, Buffett’s been building up that money-pile for years now, while watching the market run higher.
Yet through the recent drop, Buffett wasn’t even a meaningful net buyer of stock. Even if markets recovered before he could sign a mega-deal, you’d think he’d have added shares of something, whether banks, energy companies, or more of Berkshire's own shares, all of which experienced significant declines. But he let these opportunities pass, untouched. The explanation Buffett gave for this lack of activity was disconcerting. First, he stated that Berkshire might need all of the $130 billion in cash. Second, he suggested that Berkshire's own shares might not be particularly cheap if you consider some of the potential scenarios that could arise from the coronavirus and our response to it.
It's not clear what Buffett thinks will happen, but it is clear that he thinks some really dire scenarios are possible, which skew his estimates of fair value toward lower valuations.
To illustrate what this might look like, suppose he thinks there’s a 30% chance things go fine, and the economy returns to normal over the next year. And a 60% chance we struggle around for a couple years, then get back on our feet. In either of these cases, it’s probably reasonable to put some of that $130 billion to work. But then you get that bottom 10%, and you see some really hairy scenarios. These are outcomes where profits dry up across the economy, and we work through a period of illiquidity, painful debt repayment, and negative growth similar to what my great-grandparents saw in the Great Depression (which I’m told, wasn’t so great).
Is Buffett saying that this doomsday scenario is going to happen? No. It's just one of the possibilities. But if it does happen, he thinks Berkshire would need that $130 billion. On a positive note (sort of), I suspect the money might not be entirely for propping up Berkshire's existing businesses, and that at least some of it is earmarked for opportunistic acquisitions. This would be consistent with Berkshire's business model of the last 55 years. After all, it’s possible that if things go really badly for the economy, he might be able to buy businesses currently valued at $200 billion for somewhere in the range of $50-$80 billion. While other businesses are shrinking their operations Buffett, in that scenario, could potentially grow Berkshire’s total intrinsic value by 50-100%. In essence, Buffett is trading short term growth for stability, with an option to make accretive acquisitions down the road. This is, as I said earlier, a mixed bag. I think many of my fellow shareholders have dreamt of the day when Buffett fires that $100B elephant gun and brings home some prize game. It's sobering to hear that, a) for now, there might not be as much available for acquisitions as we had thought, and b) that Berkshire, with over a quarter of its market cap in cash, might actually be overpriced. Even non-shareholders in the investing community were probably hoping that he'd have done something to offer reassurance and signal his continuing optimism for the future. Yet, there's something to be said for having Warren Buffett make that decision for you, whatever he decides. You might not love his conclusion, but he's got a good track record when it comes to assessing risks, as well as opportunities. I would rather have a manager take too little risk than too much of it, and I think that's the side that Buffett means to error on.
Beyond that, there were some rays of hope to be found in the meeting. It sounds like Berkshire’s businesses are still in good shape and will likely emerge from this downturn relatively unimpaired. They’re probably not making tons of money, but it sounds at least like they aren’t losing too much.
This backdrop makes Berkshire an interesting investment (though it remains to be seen whether it is a “good” one). Berkshire’s underlying businesses are notoriously high quality. Combined with that fortress balance sheet, you have a company with really high durability, and just a dose of anti-fragility (“Anti-fragile” refers to something that gets stronger through a crisis). Many of Buffett's best purchases have happened in times of chaos, because Berkshire was in a strong financial position to take advantage of opportunities.
To wrap up, it was a weird meeting. Bullish Buffett wasn’t bullish, at a time when stock prices suggest moderate optimism in the underlying economy. That’s an unsettling combination, but it doesn't necessarily mean the end of the world for stocks. Remember the broad range of probabilities, and the differing severities of potential outcomes. I would also point out that digital assets are increasingly important to our economy, and are a source of great optimism for investors today. And if Buffett has a blind spot, it is that he under-appreciates the importance of the digital economy.
The best path forward, in my opinion, is to create a big-picture plan and stick to it, while making small adjustments over time, as needed, to account for changes in your life. Ideally, you would have a skilled professional by your side to help you do this.
[Disclosure: Nicholas and several of his clients own shares of Berkshire Hathaway].