What Options for Buffett Who Has $90 Billion To Invest?

Short answer:  Not Many.

Facts: Cash & cash equivalents at Berkshire Hathaway (BRK) reached $116 billion at the end of 2017, compared with $86.4 billion at the start of the year. Per Morningstar’s Gregg Warren estimates, Buffett finds himself with « around $90 billion in dry powder that could be committed to investments, acquisitions, share repurchases and dividends. »

Float at the insurance business represented $114.5 billion, way too much to cover potential losses/claims.

So what are the options for Buffett and Munger to deploy this cash? Let’s review them.

Capex?

Well that’s up to the management of BRK many subsidiaries. Last year, the company spent $11.5 billion and depreciated $7.6 billion, on revenue of $242.14 billion.

M&A?

Ruled out. As a reminder, large purchases (the « elephant gun ») of stand-alone companies require « durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. »

That hurdle couldn’t be passed by any potential investments reviewed in 2017, according to the letter, as « prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers », writes Buffett.

This is a clear warning that markets are probably too expensive, as demonstrated by Robert Shiller’s Cyclically-Adjusted Price Earnings ratio (this ratio currently stands at 33.41x a level last reached in 1929 and only surpassed in 2000).

Share buybacks?

No. The rule of thumb is that BRK will buy back its own shares when they trade below 1.2x book value. Share price closed at $304,020 on Feb 23. Book value is $211,750 but excluding the tax benefit, it is $194,800, which means that on that basis, the shares trade at 1.56x book value (or 1.43x if you take into account the published book value per share). So the answer is no buy back for now.

BRK’s market capitalization is $500.16 billion and its operating profit for 2017 was $14.46 billion, which means that taking cash out, the stock trades at 26.6x trailing earnings, which compares with 20.3x for the S&P 500 (on a trailing basis).

If you compare share price of A shares with reported EPS ($27,326) you find a trailing P/E of 11x, but this is distorted by tax, that’s why I looked at operating earnings rather than net income to derive the 26.6x trailing multiple. Price to book is a better option in valuing the business, since book value per share is « the » metric Buffett and Munger consider as one of the most important.

Dividends?

Not an option. Well Buffett and Munger have their track record speaking volumes for them. Their ability to allocate capital and deploy it in assets that have produced good returns is just a no brainer.

Dividends is a question that will certainly come to the fore when Buffett and/or Munger are no longer at the helm of BRK, which probably grows by the year (unfortunately). The fact they raised Greg Abel and Ajit Jain to Vice Chairman positions with BRK gives a good indication of the potential duo that could replace them.

« You and I are lucky to have Ajit and Greg working for us », writes Buffett. « Each has been with Berkshire for decades, and Berkshire’s blood flows through their veins. The character of each man matches their talents. And that says it all. »

Well if you can rely on Buffett’s judgment not to pay dividends and allocate capital properly, you can also rely on his judgment regarding the most qualified managers to run the business of BRK.

Conclusion

BRK will patiently sits on its cash and wait for the next downturn in financial markets to provide investment opportunities. Businesses will be run as usual. Large acquisitions will only appear if the price to be paid is reasonable.

Source: Berkshire Hathaway, 2017 Annual Report