Why Warren Buffett’s Investors Are Expressing Doubts (Hint: He’s Holding Back $110 Billion in Cash)

Warren Buffett, long acknowledged as one of greatest investors of all time, has sat atop the perch of his investment fund Berkshire Hathaway for more than 60 years.

An investor who purchased 50 shares of Berkshire in 1965 would now have an investment worth $20 million. Is it any wonder then, why investors the world over, express their reverence for Buffett by calling him the “Oracle of Omaha?”

Despite Berkshire’s sterling record however, many of its shareholders have become disenchanted lately and are calling for a change in investment strategy.

From 1968 to 2018, Berkshire stock has returned 2,472,627%, versus 15,000% for the S&P 500. Despite this enviable long-term performance, Berkshire’s stock over the past decade, rose by 259% while the S&P 500 returned a total of 314%.

Given this persistent underperformance, many shareholders have begun to question the viability of Buffett’s investment strategy.

Because Buffett hasn’t found any companies to purchase that meet his strict investment criteria, Berkshire Hathaway has amassed a staggering stockpile of cash — $110 billion. Some investors want Buffett to stop hoarding cash and put those idle and unproductive funds to work.

In terms of price/earnings ratios, combined book value of the diverse companies in its portfolio and their intrinsic earnings power, Berkshire stock itself is selling at reasonable levels, relative to the S&P 500.

Indeed, some might call it a “bargain.” Ironically, as Dave Rolfe, chief investment officer at Wedgewood Partners in St. Louis noted, “Think of how the stock would have performed if Berkshire had steadily bought stock over the past 10 years rather than let all the cash build.”

Buffett’s investing philosophy

Warren Buffett is a disciple of value investing, the principle of which he has embraced over his illustrious career and from which he has never wavered. One of the bedrock tenets of value investing is that astute investors will assiduously attempt to purchase only shares of those companies that are selling below their “intrinsic value.”

It is important to note that the market price of a company’s shares and intrinsic value can differ substantially. Buffett has always said that when he buys stock he is buying an interest in a business and not a piece of paper to be traded on a stock exchange.

Intrinsic value can be ascertained, in part, by analyzing a number of financial measures among which include the following: a company’s book value; its earnings power; its historical earnings per share pattern; its debt to equity ratio; its ability to consistently generate free cash flow; and its price/earnings ratio, as well as the nature of its business.

A company whose stock is selling below its book value per share is one indication the stock is a bargain because it is selling for less than the businesses liquidation value or assets on hand. As Buffet is fond of saying, “Price is what you pay, value is what you get.”

Proponents of value investing realize that the intrinsic value of a business often bears no relationship to the market price of its shares at any given time. Intelligent investors, will never follow the herd and, when warranted, will buck conventional wisdom and eschew stocks whose market price can never be justified by the company’s future earnings capacity.

In short, value investing can be summarized as a quest to find companies that are undervalued. Those individuals with the necessary temperament, will always invest with a “margin of safety,” to guard against market risk and to help insure that you never vastly pay more than a stock is worth.

Given these bedrock principles of value investing, to which Buffett has been wedded since his early days with Berkshire, it is no mystery why his investment fund has not made any significant purchases for its portfolio and indeed has underperformed the market as a whole for the past decade.

Big misses

Some of Buffett’s critics have claimed that his unwavering belief in these value investing principles, which may have been appropriate for the heavy industrialized and fixed-asset companies of last century, is no longer germane in the 21st century tech world where many of the fastest-growing companies in this sector have limited hard assets but an unbroken string of earnings.

Buffet has acknowledged that he missed out on Amazon and other members of the high-flying tech sector. Nevertheless, Buffett has some pertinent responses to his critics.

First, it should be noted that the bull market of the past decade flourished in an environment of historically unprecedented zero interest rates and easy money that propelled all the major indexes. It is also important to note that the surging market of the past decade that followed an unbroken upwards trajectory was fueled in large part by only a few of the tech giants in the FAANG group of stocks: Facebook, Apple, Alphabet, Netflix and Google.

The current prices of many of these stocks and others, bear no relationship to their intrinsic worth as ongoing businesses. As Buffet noted in 2017, “Prices for decent, but far from spectacular, businesses hit an all-time high” in 2017. As Buffett further observed, “Indeed, price seemed almost irrelevant to an army of optimistic purchasers.”

Buffett has amassed a large cash position, because he simply could find no suitable candidates to purchase that were selling below their intrinsic value. The past decade has favored “momentum” or growth stocks, such as members of the FAANG group, that seem to rise continually, regardless of underlying business conditions.

Nonetheless, Buffett purchased a 5% stake in Apple, and he intends to purchase more — if the stock becomes cheaper — thus remaining loyal to his value-investing approach.

Returning cash to shareholders

There are two ways that Buffett can assuage growing investor dissatisfaction with Berkshire’s underwhelming performance. One is to purchase the company’s own stock. The other is to start paying shareholders a dividend.

Buffett’s justification for piling up huge amounts of cash, is that he wanted enough financial firepower to purchase good companies whose stock may have dropped significantly due to a market decline.

However, Berkshire’s swelling cash balances are now simply too great not to return some of that money to shareholders.

The difficulty however is the paltry number of buybacks that has been made to date. Berkshire bought back $1.7 billion in stock in the first quarter of 2019. This represents less than 0.25% of the company’s $520 billion market capitalization. Over the same period, Berkshire’s cash pile increased to $114.2 billion from $111.9 billion.

Buffett seems to have relented and promised recently to commit Berkshire to purchasing $100 billion of its shares. Stock repurchases are favored by Berkshire shareholders, because it would increase earnings per share and the price of the stock would likely increase as outstanding share balance would be reduced.

One fund manager, Bill Smead of Smead Capital Management, who owns Berkshire stock, says ideally, he would like Berkshire to spend at least $5 billion per quarter of share buybacks. Smead argues that amount would not dent Berkshire’s cash position, given the earnings power of its constituent businesses.

Recommended Articles

FIRE Your Old Financial Life and Retire Early. Here’s How…

A Chicago flight attendant has hit the news for turning her financial life around. At 39, Bianca DiValerio was nearly broke after a divorce and the sale of several failing

Interview: Rates Will Stay Low, Uber ‘to the Moon’

Don't expect the Federal Reserve to even tap on the brakes anytime soon, says Bob Iaccino, editor of the Stock Think Tank. On Thursday, Fed Chairman Jerome threw cold water

3 Crucial Ways to Keep Your Brain Strong Well into Retirement

For people whose whole life has revolved around using their mind, retirement can be a bind. All of those degrees and awards, the presentation notes, the papers, the grand vision

self employed taxes

Help! I’m Self-Employed and My Taxes Are a Mess!

In the not-so-distant past, the word “gig” was used only to describe the work environment for musicians and comedians who would travel from city to city for performances for one

Your Chances of Seeing a Doctor When You Get Sick Are Falling Fast

New studies have emerged that point to a severe shortage of doctors and other vital health workers is on the horizon for the United States. The first report, conducted by the Association

Iaccino: I Took Profits On Bitcoin, but It Has Nowhere to Go But Up

Bitcoin's pull back from recent highs has not dissuaded Stock Think Tank editor Bob Iaccino from owning the cryptocurrency — but he has taken profits. Bitcoin climbed from below $20,000

Facebook Discloses Secret Rules On What Posts Get Blocked — and Why

Ever had a post on Facebook blocked — by Facebook? For the first time, the company is explaining why. The social media giant has now disclosed the once-secret rules on

Iaccino: Buy the Rumors, Sell the Facts On Biden Transition

Bob Iaccino, editor of the Stock Think Tank, says investors should prepare to "buy the rumor and sell the fact" when it comes to plans of the incoming administration of

financial checklist

12 Crucial Money Steps to Take Now for a Better Year Ahead

The beginning of a new year is an ideal time to reset your finances and work towards a more profitable and productive year. Here is a financial checklist with 12

A Simple Strategy to Live Longer by Quitting Work Yet Still ‘Working’

Some see early retirement as the kiss of death, but one study has shown this to be a myth. Retiring early can actually lengthen your life. A 2017 study published in the

deal on new car

Get a Great Deal On a New Car or Truck Using This Tactic

My lease was up on my 2018 vehicle. I was excited to go car shopping. However, what I realized as I ventured out was that the auto industry also has

Renting vs. Buying: What’s Best for Your Retirement?

A white picket fence surrounding a house with 2.4 children, a dog, a cat, a station wagon. This is the American dream. But owning your own home might not be