#113 - The Art of Doing Nothing

Berkshire Hathaway’s 2021 Annual Letter

Feb 27, 2022

Hi 👋 - Berkshire Hathaway published its annual letter yesterday. In other words, Christmas in February. Relative to the cautionary tone of Berkshire’s 2020 annual letter, colored by its $11 billion write-down of its investment in Precision Castparts, a go-go market, and the beginnings of the SPAC craze, the 2021 letter strikes a more balanced tone. With his fortune already made, I get the sense that Buffett is thinking more about his legacy. Let’s dig in.

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Capital Allocation: A High-Class Problem

Patience is one of Warren Buffett’s hallmark traits as an investor. Once again, this virtue was on display in 2021.

Berkshire is blessed with the high-class problem of generating more cash than it can profitably put to work. That’s a problem most people can only dream of. The company ended 2021 with $144 billion of cash on its balance sheet. Berkshire has committed to holding at least $30 billion of cash, leaving it plenty of dry powder.

From a capital allocation perspective, the company has three options for putting its war chest to work. The first is growing the earnings power of Berkshire’s portfolio of controlled businesses through organic investments and M&A. In 2021, it invested over $13 billion in its operating companies like Berkshire Hathaway Energy, a utility, BNSF, a railroad, and GEICO, an insurer with quirky ads. However, heady valuations deterred any large acquisitions. Even the pace of Berkshire’s smaller tuck-in deals slowed. The company deployed $460 million in M&A in 2021, compared to $2.5 billion in 2020 and $1.7 billion in 2019. (Buffett calls the shots on multi-billion dollar M&A, but tuck-ins are done by the operating businesses). Buffett would love to do a big deal (or ten), but not at the expense of price discipline. As always, he’s waiting for the fat pitch.

Source: Koyfin and Berkshire Hathaway 2021 Annual Report.

Berkshire’s second option is taking partial-ownership in companies through public equity investments like Apple and American Express. Similar to M&A, high valuations kept Berkshire on the sidelines in 2021. Buffett isn’t seeing many attractive equity opportunities:

From time to time, such [stock market investment] possibilities are both numerous and blatantly attractive. Today, though, we find little that excites us. That’s largely because of a truism: Long-term interest rates that are low push the prices of all productive investments upward, whether these are stocks, apartments, farms, oil wells, whatever. Other factors influence valuations as well, but interest rates will always be important.

Share repurchases are Berkshire’s third option. With high rich valuations making large deals unattractive but Berkshire’s earnings power steadily chugging along, Berkshire has been active here. Since 2019, the company has repurchased over $57 billion - about the size of Panama’s GDP - retiring 9% of outstanding shares. Similar to the other capital allocation options, this is done with an eye on value:

I want to underscore that for Berkshire repurchases to make sense, our shares must offer appropriate value. We don’t want to overpay for the shares of other companies, and it would be value-destroying if we were to overpay when we are buying Berkshire. As of February 23, 2022, since year-end we repurchased additional shares at a cost of $1.2 billion. Our appetite remains large but will always remain price-dependent.

If Buffett thinks that the intrinsic value of a B share is $350 and he’s able to repurchase it for $285, that’s a deal. If B shares are $250, even better. However, buying back stock above $350 is lighting money on fire. Buffett has a lot of cash, but he’s no pyromaniac. Indeed, repurchases slowed in the fourth quarter as Berkshire’s stock price increased. The company deployed $21.7 billion on repurchases in 2021, but only $1.5 billion in the fourth quarter.

No FOMO

Patience shows up again in Berkshire’s investment criteria. There are very few ways to get rich quickly and even fewer that are legal. Buffett understands this well. Time is a key component of compounding, and compounding is what Berkshire is all about.

Long time horizons complement patience. Berkshire is looking to check three boxes with an investment: durable competitive advantages (a moat), trustworthy and competent management, and a fair (or better) valuation:

Whatever our form of ownership, our goal is to have meaningful investments in businesses with both durable economic advantages and a first-class CEO. Please note particularly that we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves. That point is crucial: Charlie and I are not stock-pickers; we are business-pickers.

It’s not often that an opportunity ticks all three, which explains Berkshire’s growing cash hoard. Given the paucity of attractive opportunities, when he finds one, Buffett’s preferred holding period is forever. Not many investors can make this claim. The letter makes clear that Buffett thinks about ownership in terms of decades or even centuries:

And here I’ll venture a rare prediction: BNSF will be a key asset for Berkshire and our country a century from now

Patience also allows restraint. Centuries ago, French philosopher Blaise Pascal wrote that:

All of humanity's problems stem from man's inability to sit quietly in a room alone.

I get the sense this wouldn’t be an issue for Buffet (though he’d prefer the room to have a fridge stocked with Cherry Coke). Buffett is happy to sit on his hands, waiting for opportunities to present themselves. When the price is right, he acts aggressively.

This temperament is valuable when combined with Buffett’s experience. He started investing in equities at age eleven by purchasing three shares of Cities Services preferred stock and has been at it ever since. Markets are cyclical, and Buffett has survived numerous crises, crashes, and bear markets. In comparison, Robinhood hasn’t even been around for eleven years and has only operated in bull markets. (Another Buffett aphorism: it’s only when the tide goes out that you see who’s swimming naked.) Buffett knows bull markets don’t last forever. His hallmark patience coupled with Berkshire’s fortress balance sheet allow him to act opportunistically when it starts to pour:

Charlie and I have endured similar cash-heavy positions from time to time in the past. These periods are never pleasant; they are also never permanent.

While the exact timing of panics and market dislocations are impossible to predict, on a long enough time scale, financial crises happen as predictably as the sun rises in the east. Berkshire is not constrained by cash or narrow time horizons. The fewer the constraints, the bigger the opportunity set. For Berkshire, patience is a luxury.