The coronavirus crisis has not been kind to Warren Buffett.
Since hitting bottom on March 23, U.S. stock markets are now trading within spitting distance of record highs.
Meanwhile, Berkshire Hathaway (NYSE: BRK-B) has lagged in the recovery rally, gaining only about 14% from its March lows.
That compares with a stunning 44% return in the S&P 500.
Buffett has long predicted that future returns from Berkshire Hathaway and the S&P 500 would be “very close to the same.” Today, Berkshire investors are thinking, “If only.”
And Buffett had been flagging even before the pandemic.
At the end of 2019, Berkshire came off its worst performance against the S&P 500 in a decade. 2020 is shaping up to be just as bad.
Buffett may still bask in his reputation as the world’s greatest investor. But his performance has been lagging for years.
Over the past 10 years, Berkshire’s 8.4% annual return lagged the S&P 500’s gain of 14%.
That’s an astonishing difference of 5.6% per year for 10 years running.
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Buffett’s Coronavirus Crisis
Many observers – myself included – expected Buffett to exploit the coronavirus crisis to regain his investment mojo.
I thought Buffett would put a big chunk of Berkshire’s $128 billion in cash to work, adding to his core holdings in U.S. stocks at fire-sale prices.
Instead, Buffett decided, as his business partner Charlie Munger put it, “not to play.”
That’s a disappointment.
Not only did Buffett not add to his core stock holdings at bargain-bin prices… He failed to buy back much of Berkshire’s stock during the panic – despite the price falling below his publicly announced threshold of a 1.2 price-to-book ratio.
Instead of helping repair Buffett’s battered reputation, the coronavirus crisis exacerbated concerns over Buffett’s stewardship of Berkshire.
The question arises… Has the soon-to-be 90-year-old Buffett lost his touch?
Buffett’s Recent Flubs
Even before the onset of the pandemic, deals gone bad had already tarnished Buffett’s reputation.
First, Berkshire wrote down its holding in food producer Kraft Heinz (Nasdaq: KHC) by $3 billion last year. Buffett’s blind trust in the management skills of private equity firm 3G Capital – which Berkshire partnered with on the Heinz acquisition and Kraft merger – has yet to pay off. Kraft Heinz is down by two-thirds from its peak.
Second, Buffett’s $10 billion investment in oil producer Occidental Petroleum (NYSE: OXY) was disappointing as well. The stock is no longer paying a cash dividend. And Buffett’s stock warrants look worthless.
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Third, Buffett increased his shareholdings in America’s largest airlines at the start of 2020. But he then, with a rookie’s timing, sold all his airline stocks at the very peak of the coronavirus disruptions in April.
Finally, in early July, Berkshire paid just under $10 billion to Virginia’s Dominion Energy (NYSE: D) for a bunch of last-century natural gas pipelines.
Yes, Berkshire may have acquired the assets for less than market value.
But critics argue that deal served only to underscore how out of touch Buffett has become.
By investing in the “old” natural gas industry, Buffett overlooked the utility industry’s transition from coal to renewables.
Buffett and the Dot-Com Bust
Berkshire investors point out that Buffett has been here before.
Many investors had written Buffett off in the late 1990s for missing the great tech boom.
Buffett, of course, had the last laugh.
In 2000, even as dot-com shares tumbled, Berkshire stock rose by more than 25%.
Buffett bulls are expecting a repeat performance.
Why This Time Is Different
Global investor Sir John Templeton once observed, “The four most dangerous words in investing are ‘This time it’s different.'”
I agree.
Yet there are times when things really are different.
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Back in the financial crisis of 2008, Buffett rode to the rescue of many companies as a “lender of last resort.”
Today, government agencies and the Fed have muscled in on Buffett’s territory, showering companies with free loans and handouts. These policies have stripped Berkshire of its greatest edge: its massive cash float.
In previous crises, Berkshire cut sweetheart deals, like lending money at 10% to the likes of Goldman Sachs. Cash was once a very scarce resource.
Not this time.
As the COVID-19 pandemic unfolded, governments and central banks promised to do everything possible to support financial markets and to prevent credit markets from freezing up.
Buffett never got a chance to be greedy when others were fearful.
“We haven’t seen anything attractive,” he told his shareholders in May. The Federal Reserve “did the right thing, and they did it very promptly, and I salute them for it,” he told them, referring to the U.S. central bank’s decision to backstop the debt markets. “But a lot of companies that needed money… got to finance in huge ways.”
And even Warren Buffett can’t fight the Fed.
The Chink in Buffett’s Investment Armor
All of this highlights a much larger issue with Berkshire.
Buffett earned his stripes in the 1950s as a value investor.
By the 1970s, his partner Charlie Munger convinced him to pay up for high-quality companies with wide moats.
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The investment world continued to evolve. Yet Buffett and Munger didn’t.
Buffett and Munger readily acknowledge that they missed the likes of Amazon (Nasdaq: AMZN) and Microsoft (Nasdaq: MSFT).
They almost reveled in their ignorance of technology and in keeping tech companies in the box Buffett has on his desk that says “Too Hard.”
But here’s the painful reality… Under Munger’s tutelage, Buffett expanded his investing philosophy beyond Benjamin Graham. If Berkshire expects to generate value, Buffett has to adapt yet again.
And here’s the shift he has to make…
Buffett is held back by his fundamentally static view of the world. He bets on the parts of the economy that stay the same.
People will always buy insurance. They will eat Kraft cheese and drink Coca-Cola. Utilities will continue to use more natural gas.
Silicon Valley has the opposite view. It makes money from companies that change the world.
Consider this: Amazon, Microsoft, Apple (Nasdaq: AAPL), Alphabet (Nasdaq: GOOG), Facebook (Nasdaq: FB) and Netflix (Nasdaq: NFLX) have a far more substantial impact on your life than Geico, JPMorgan Chase (NYSE: JPM) or Coca-Cola (NYSE: KO).
That’s reflected in the stock market as well. Technology and communications now account for 38% of the S&P 500.
Yet Berkshire’s only technology holding of any size is Apple – though admittedly it’s the largest.
But many investors are losing patience with Buffett.
Even longtime Buffett fans like Pershing Square’s Bill Ackman have sold out of Berkshire.
And after having been a longtime Berkshire shareholder, I’ve done the same.
Good investing,
Nicholas
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