Berkshire Hathaway: COVID-19 and the Great Disconnect

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

Warren Buffet, 1986 Letter to Shareholders1

This investment strategy had proven powerful for Berkshire Hathaway, Inc. It had transformed a bad textile company into a diversifed investment company, ranked as the 12th largest company in the world in 2019, right behind Apple.2 It had made Warren Bufet a billionaire and countless of his shareholders millionaires. At the end of 2019, Berkshire’s shareholders included Fidelity Investments and the central bank of Norway. The company’s stock was considered the number one retirement stock in America.3

Amid the 2020 coronavirus pandemic, U.S. fnancial markets crashed at record speed (–35% between February 12 and March 20, 2020), including the biggest single-day drop ever of –12.9% on March 16, 2020, eclipsing the record of October 28, 1929.4

Expected to be greedy when others are fearful, Bufet was a net seller of stocks and remained on the sideline during that period. His inaction, combined with an unusually cautionary tone at the annual shareholders’ meeting, triggered heavy criticisms. Some of his loyalists sold their stocks. As he was approaching his 90th birthday, many started to wonder whether Warren Bufet had changed his time-tested strategy. Was he disconnected from reality? Was he fearful himself?

On February 24, 2020, Warren Bufet, interviewed by CNBC’s anchor Becky Quick, made clear that, as the outbreak caused fears of a global economic slowdown, his long-term outlook remained unchanged.5 With US$128 billion6 in cash then, he had plenty of options.

Known as the “Oracle of Omaha,” Warren Edward Bufet was born on August 30, 1930, in Omaha, Nebraska, one of three children.12 His father was a stockbroker who became a member of the U.S. House of Representatives in 1942, and his mother was a homemaker. Gifted for mathematics, Warren Bufet started investing at age 11, enrolled at the University of Pennsylvania at age 16 to study business, and assumed control of Berkshire Hathaway in 1965. He was also known as one of the richest people in the world with an estimated net worth of US$68 billion as of May 2020, who had donated close to $28 billion between 2006 and 2017, according to USAToday .13 As Berkshire’s Chairman and CEO since 1970, Bufet remained the majority shareholder of the company.

A very witty and folksy personage, Bufet was also known for his enduring personal habits; i.e., living in the same house since 1957 and earning the same salary of US$100,000 (very modest compared to other CEOs) since 2006. The following quotes, collected by M. Frankel, a Certifed Financial Planner,14 described some of his values, especially in regards to his disciplined and strategic approach to investing:

On Money, Price, and Opportunities

· “Rule No. 1 is, never lose money. Rule No. 2 is, never forget Rule No. 1.” (Warren Bufet’s golden rule).

· “Price is what you pay. Value is what you get.”

· “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

· “Widespread fear is your friend as an investor because it serves up bargain purchases.”

· “The best thing that happens to us is when a great company gets into temporary trouble...We want to buy them when they’re on the operating table.”

On Valuation and Long-Term Ownership, as Opposed to Frequent Trading

· “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

· “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

· “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”

· “An investor should act as though he had a lifetime decision card with just twenty punches on it.”

· “Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least fve years. Those who seek short-term profts should look elsewhere.”

On Temperament and Patience

· “The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”

· “The stock market is a no-called-strike game. You don’t have to swing at everything—you can wait for your pitch.”

On Market Crashes and Prudence

· “The years ahead will occasionally deliver major market declines—even panics—that will afect virtually all stocks. No one can tell you when these traumas will occur.”

· “The best chance to deploy capital is when things are going down.”

· “Predicting rain doesn’t count; building the ark does.”

On Strategic and Sustainable Competitive Advantage

· “The key to investing is not assessing how much an industry is going to afect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.”

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This last quote, in particular, clearly indicated that Bufet was as much of a strategist as he was an investor. His strategy was to focus his research on a handful of industries and sectors, buying businesses that were well-managed and competitively dominant, enjoying the returns over time.15 It was this long-term view, holding stocks for an average of 7.5 years but sometimes for decades (e.g., Coca Cola, American Express) as compared to less than one year for retail (individual) investors, that played the biggest role in Bufett’s and Berkshire’s long-term success.

Amid the typical bustle of activities and billions that changed hands within seconds among stock market participants on any given day, Bufet was known to act calmly. His buy-and-hold strategy enabled Berkshire to defer any capital tax payment until the company sold any shares.16 In addition, the fact that Berkshire did not pay dividends eliminated any tax liability on dividends earned by shareholders.

His ability to think diferently about these important long-term implications had produced outstanding and unparalleled results since 1965.

From the time he assumed control of Berkshire Hathaway, mathematical calculations indicated that “US$1,000 invested with Warren Bufett since 1965 would be worth more than $27 million today,” whereas the same amount invested with the S&P 500 would be approximately $200,000.17

Along the way, Warren Bufet and Berkshire Hathaway made several large acquisitions, especially during the 2008 global fnancial crisis (see Exhibit 2).

Whereas Warren Bufet had kept a relatively low profle throughout his career, he took center stage during the 2008 fnancial crisis, defending capitalism and America. A month after the implosion of Lehman Brothers, he published an article in the New York Times on October 16, 2008, titled “Buy American, I am.”18

However, the stock market, measured by the S&P 500 index, continued its downward spiral, tumbling from 946 on October 16, 2008 to 666 in intraday trading on March 6, 2009.19 For those dates, respectively, the VIX index (Wall Street’s fear gauge), had changed from 67.61 to 49.33.20

Called the Great Recession, the crisis of 2008 was addressed through several government bailouts and stimulus packages which totaled close to $1.5 trillion while unemployment reached 10% in the U.S. in 2009.21 Considered a fnancial crisis that started with the 2006 subprime mortgage crisis, the 2008 crisis could have turned into a global depression if left unaddressed. Meanwhile, Bufet made an estimated US$10 billion during that crisis, fnancing diferent several billion-dollar deals and making strategic acquisitions (see Exhibit 2).

Economic crises were known to happen from time to time in a capitalist system. However, the crisis of 2020 was triggered by a public health crisis and a planned shutdown of the economy as a result of the pandemic, caused by the novel coronavirus or COVID-19.

As a consequence of the global pandemic that caused so many tragedies and casualties, the U.S. economy was shut down by governing authorities to stop the spread of the virus. Naturally, the stock market plunged in February– March 2020 with unprecedented magnitude and speed, as mentioned above. After years of low volatility, fear came back (see Exhibit 1) and unemployment numbers increased with the same unprecedented magnitude and speed that had caused the crash (see Exhibit 3).

However, the swift and powerful rescue packages passed by Congress and the Federal Reserve system, led by FED Chairman Jerome Powell, injected US$3 trillion of liquidity22 into the economy and fueled renewed optimism.

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Right after the late March coronavirus sell-of, billionaire investor Bill Ackman acquired between US$219 million and US$255 million worth of Berkshire Hathaway.23 This move increased his US$5.7 billion hedge fund’s stake in the Oracle’s company from 11% to 13%, since he believed, as a longtime shareholder and seasoned investor, that “Berkshire will emerge from this crisis as a more valuable enterprise. ”In addition to this purchase of 1.4 million BRK.B-class24 shares, Vanguard Global Advisers, LLC, purchased fve million BRK.B shares on March 31, 2020.25 This LLC was part of the Vanguard Group, Inc., an investment company and the largest institutional investor of B-class shares in the world with a stake worth US$25.8 billion approximately. It was also important to keep in mind that more than 70% of B-class shareholders were institutional investors, which are typically more conservative than individual shareholders.

At the end of April, Brian Meredith, a respected analyst at Union des Banques Suisses, cut his estimate about Berkshire’s A-shares 12-month price target down to US$358,000 from US$393,000, due the impact of the coronavirus, using some-of-the-parts (SOTP) analysis to value the complex conglomerate.26 Bill Ackman added that he was “surprised they [Berkshire] haven’t done anything yet that’s visible, but my guess is they’ve been buying stocks, a lot” before concluding that “big opportunity for Berkshire is Berkshire itself,”27 a major buyback of shares. Interpreted as votes of confdence, buybacks (companies buying their own shares back, thus boosting their own stock price) had been instrumental in the longest bull market since 2009, reaching US$1.8 trillion in 2018.

Also in April, Ray Dalio, founder, Chairman, and Co-Chief Investment Ofcer of Bridgewater, the world’s largest hedge fund with more than US$160 billion under management, reiterated that he considered “cash as a bad investment even after the coronavirus sell-of,” especially relative to other investments that were expected to retain or increase their value in the long run.28

On May 2, 2020, at the annual shareholders’ meeting, which took place online instead of in person and with fewer than 10 people instead of the usual tens of thousands of attendees due to the pandemic, Bufet stated that today’s America was in better shape than it’s been at any other time in its history. He added that investors who invested in stocks for the long run would be amply rewarded.29

Known to collect dividends but not to pay any to Berkshire shareholders, Bufet preferred buybacks and had stated that “buybacks are so simple, it’s a way of distributing cash to shareholders. We will repurchase shares when it’s to the advantage of the continuing shareholder to have us do so.”30 However, he defended his position against any major buyback of the company’s stocks during the meltdown of March 2020. In fact, Bufett stopped the fexible and Board-approved but relatively limited buyback program (US$1.7 billion) on March 10, 2020, something that shocked Morningstar sector strategist Greggory Warren.31

At the May 2 meeting, called the Woodstock of capitalism, Bufet went further by cautioning shareholders not to necessarily expect Berkshire Hathaway to beat the S&P 500 going forward, concluding “in my opinion, the best thing to do is own the S&P 500 index fund.” These comments infuriated Bill Smead, chief investment ofcer of value-focused Smead Capital Management in Seattle, and a longtime Berkshire shareholder, who stated, “Does he work for State Street or BlackRock? If I was his Board. I’d fre him. This virus has got him scared.”

Criticisms kept coming, pointing out that during the bull market that started in 2009, Berkshire Hathaway’s stock had underperformed the overall market by more than 100%, still not paying any dividend that would have softened the blow for the past 11 years and accumulating more than US$130 billion in cash.32 According to Howard R. Gold, a MarketWatch columnist, this was the “end of the Warren Bufet era.”

Bufet was not new to criticisms. During the 1990s tech boom, he had been chastised by analysts and in the press for missing out on the boom in technology stocks and focusing on unglamorous purchases instead, e.g., carpeting, paint, and roofng materials companies.33 When the tech stock bubble burst, Bufet had only this message for investors in March 2001: “I told you so.” In response to more recent criticisms, Warren Bufett said in 2019 that, despite Berkshire Hathaway’s lackluster performance, he and Charlie Munger “continue, nevertheless, to hope for an elephant-sized acquisition.”34 However, Bufett considered prices too high to justify such a big purchase then.

Meanwhile, the optimism born from the April stock market rebound continued until early May when Jeremy Siegel, a professor at University of Pennsylvania’s Wharton School, asserted that the March coronavirus meltdown in stock prices was defnitely going to be the low and that “the massive monetary policy response from the Federal Reserve, along with additional progress on treatments and vaccines for COVID-19, could really boost stocks next year.”35 Opposed to that view, Jefrey Gundlach, also known as the Bond King, was betting against the stock market, arguing that “a retest of the low is very plausible. People don’t understand the magnitude of [...] the social unease at least that’s going to happen when [...] 26 million-plus people have lost their job.”36

In that context, the established valuation analysis using stock price and company earnings had become pointless since no one knew what earnings would be for the foreseeable future and “estimates have much further to go, at least for the second quarter,” according to Liz-Ann Sonders, Chief Investment Ofcer at Charles Schwab.37 This challenge and the fact that “we shut of air travel in this country,” as Warren Bufet explained, led his company to sell all of the U.S. airlines shares that they had accumulated since 2016,38 including the ones acquired during the February 2020 sell-of (US$45 million worth of Delta shares).39

Amid these challenges and diferent perceptions of reality and what the future might hold, one fact remained: Bufet still had not made his succession plan public. Due to COVID-19, his longtime partner and Berkshire Hathaway Vice Chairman, Charlie Munger, who was 96 years old, had not been able to make the trip to Omaha for the live-streamed shareholders’ meeting. His replacement on stage with Warren Bufet (at a safe distance) was another Vice Chairman, Greg Abel (57), a veteran of Berkshire Hathaway, responsible for non-insurance business, and seen as a potential successor to Bufet. As important as this was for the future of Berkshire Hathaway stock once he retires, this was speculation. Bufet said that he had chosen a successor and that this person already worked for the company.40 However, he was also known to “always leave the door slightly open for changing his mind.” This uncertainty added to the apparent disconnect between the expectations of Berkshire’s shareholders, Bufett’s behaviors, and the company’s subpar stock performance since 2009. On May 15, 2020, BRK.A was trading at US$253,500.41

With Bill Gates leaving Berkshire Hathaway’s Board of Directors and Ken Chenault, the former CEO of American Express, replacing him, the company had to decide what to do next: change the time-tested strategy, or stay the course?

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( Exhibit 2. Berkshire Hathaway’s 10 Largest Acquisitions Source: Compiled by the author from Ben Winck , “Warren Bufett Is Waiting to Deploy a $137 Billion Cash Pile for a Future Mega-Deal. Here Are Berkshire Hathaway’s 10 Biggest Acquisitions So Far,” Markets Insider , May 14, 2020. Accessed May 16, 2020. https://markets.businessinsider.com/news/stocks/warren-bufett-biggest-berkshire-hathaway - company-deals-takeovers-acquisitio ns-purchases-2020-5-1029204009. ) ( Exhibit 1. Berkshire Hathaway Stock Price vs. SP 500 and VIX Indexes *Weekly frequency, except for 3/23 the lowest fgures for BRK.A and S&P 500 during that period. Source: Compiled by the author from Bloomberg on May 16, 2020. https://www.bloomberg.com/quote/BRK/A:US; https://www.bloomberg.com/quote/SPX:IND; and https://www.bloomberg.com/quote/VIX:IND. )

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( Exhibit 3. Monthly Number of Unemployed Persons in the U.S. from April 2019 to April 2020 (In Millions, Adjusted) *Monthly frequency Source: Erin Dufn , “Monthly Number of Unemployed Persons in the U.S. from April 2019 to April 2020 (in millions, adjusted),” Statista , May 12, 2020. Accessed May 15, 2020. https://www.statista.com/statistics/193280/seasonally-adjusted - monthly-number-of-unemployed-persons-in-the- usa /. )

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( Appendix A. BRK.A vs. S&P 500 (^GSPC), January 1–May 15, 2020 Source: https://fnance.yahoo.com/ BRK.A vs. SP500 [ticker: ^GSPC] for the period January 1 - May 15, 2020, accessed on 10/15/2020. )

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