Stop the Presses: Buffett May be Human
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Warren Buffett announced on Tuesday that he is suffering from stage 1 prostate cancer, according to his own words “the condition is not remotely life-threatening or even debilitating in any meaningful way”. Fortunately, Buffett seems to be in great health for his age, and he could easily continue managing Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) for any years into the future.
On the other hand, the news brought the issue of Buffett´s succession back into the spotlight and investors are wondering if Berkshire is prepared to keep functioning well after Buffett and Munger leave their positions. Buffett has been criticized before for not publicly announcing a successor, which would bring more clarity for Berkshire investors into the future of the company. Should investors refrain from investing in Berkshire Hathaway until the succession picture gets clearer? Can the company continue its remarkable trajectory after Buffett is gone?
To begin with, Buffett has acquired many extraordinary businesses over the decades, and he doesn’t have much influence on the day to day operations in this firms. Companies like GEICO or shares of Coca-Cola (NYSE: KO) where bought with the intention to be held “forever” like Buffett himself has stated. These are mature companies with outstanding competitive advantages, and they will probably continue doing well for Berkshire even after Buffett leaves his position.
Buffett is famous for choosing companies with solid management teams and letting them free to do their work without much intromission. He has praised GEICO´s management team and the company´s prudent risk management strategy many times in the past, so this wholly own subsidiary of Berkshire won´t probably change its underwriting policies after Buffett is gone. As for Coke, Berkshire owns around 9% of the company, so Buffett doesn´t even own a voting majority in the company, and he is probably not interested in such a thing.
But the Oracle of Omaha has done some things for Berkshire which can´t probably be replicated by any other manager or investment management team. His fabulous investment performance in the first years of Berkshire, as well as some more recent deals are only to be expected from a genius like Buffett and no one else.
We can compare in the following table from Berkshire´s latest annual report the evolution of the company´s book value versus the S&P 500 from a historical point of view. Berkshire has dramatically outperformed the index with a 20.2% compounded annual growth rate versus 9.4% for the S&P 500 from 1965 to 2011, that´s clearly something fabulous and unique.
Investors should notice however that the level of outperformance was much higher in the beginning than during the last years, and Buffett himself has explained that we shouldn´t expect such a big outperformance in the future. It is much more difficult to find extraordinary investment opportunities among big companies which are well known by everybody than when looking at smaller businesses.
Since Berkshire is so big now; it needs to invest in big corporations, which is not such a fertile ground as the smaller ones. Investors should not expect a dramatic outperformance from Berkshire, with or without Buffett, and from than point of view things wouldn´t change that much after Buffett is gone.
But it won´t be the same after Buffett, that´s for sure. In September of 2008 Berkshire invested $5 billion in Goldman Sachs (NYSE: GS) preferred stock yielding a 10% dividend, in a deal which included warrants for Goldman common stock at $115 through October 2013. This deal was structured in a very short period of time and in the middle of one of the worst financial crisis in history. I don´t believe Buffett´s successor - or successors – will be able to do that kind of things again for Berkshire.
More recently, in August 2011, Berkshire made a similar deal with Bank of America (NYSE: BAC) by investing another $5 billion in a combination of preferred stock and warrants. Again, the deal was structured quite quickly in a moment in which the bank needed the capital and recovering investor´s trust. The second consideration, public relations, may have been as important as the money for Bank of America and Buffett is quite unique in that respect.
If you are looking for a solid company with high possibilities of moderately over performing the markets in the long term, Berkshire may be a good choice. Those who want extraordinary outperformance for long periods of time, however, should look in other places. I don´t think Berkshire is capable of that anymore due to its size, and once Buffett is gone the chances of such an extraordinary success will be even lower.
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