This article first appeared in The Edge Malaysia Weekly on September 14, 2020 - September 20, 2020

WHAT do you give your friend, who has everything, for his 90th birthday? If you are Microsoft founder Bill Gates, the world’s second-richest person, you might bake him a cake and share the kitchen video. And what does the sixth-wealthiest person on earth — widely regarded as one of the greatest investors of all time — do for his birthday? Berkshire Hathaway’s CEO Warren Buffett did not waste any time with a cake baked by some billionaire amateur baker. He put out word that he had just bought a 5% stake in each of Japan’s five biggest general trading firms, or sogo shoshas, for a cool US$6 billion (RM25 billion). Within days, Berkshire’s stake in the Japanese giants was up a total of 16%, giving him US$1 billion profit on his investment.

Buffett’s rise as the world’s most watched investor is the stuff of legend. In 1942, the 11-year-old scion of an Omaha business family, which ran a grocery store, made his first stock purchase — six shares of Cities Service, at US$38 a share — for himself and his sister, eventually selling for US$40 a share. In his freshman year at Columbia University, 19-year-old Buffett had a portfolio of stocks worth US$10,000, or nearly US$110,000 in today’s dollars. He made his first million soon after he turned 30. In 1965, he took control of struggling textile manufacturer Berkshire Hathaway and turned it into the world’s most storied investment firm. US$1 invested in Berkshire stock when he took control of it would be worth US$27,300 today. A similar investment in benchmark Standard & Poor’s 500 index would have grown to US$198.

Berkshire’s CEO learnt his craft from Columbia University economics professor Benjamin Graham, also known as the “father of value investing”. “Buffett has always been good at visualising what others are often afraid to see,” Bill Smead, a veteran value investor and CEO of Smead Capital in Phoenix, told The Edge in a recent phone interview. In 1988, just months before the fall of the Berlin Wall, Berkshire bought more than US$1 billion of Coca-Cola stock, he recalls, at 18 times earnings. “He thought people all over the world who didn’t have access to Coke before would want it,” Smead says. “Great wealth is created when you buy a stock that is out of favour or see something that no one sees.”

The man who has been dubbed the “Oracle of Omaha” for his folksy wisdom on investing, says Smead, “never chases fads or hot stocks and is one of the most disciplined ‘buy-and-hold’ value investors there is”. You will not find high-flying stocks such as electric vehicle maker Tesla or video conferencing firm Zoom Video Communications in Berkshire’s portfolio. Indeed, until a few years ago, Buffett had deliberately shunned technology stocks because he found it hard to value them. He reversed course in 2011 with the purchase of IBM — a stock he later dumped, taking a US$2 billion hit — but followed that exit with the purchase of iPhone maker Apple, now the biggest stockholding in his portfolio.

Buffett “banks on businesses that have steady cash flows and will generate high returns and low risk”, McKinsey noted in its report last month. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” Buffett wrote in one of his annual letters to shareholders, the main medium of his homespun advice. Another gem from a shareholder’s letter: “Rule No 1: Never lose money. Rule No 2: Never forget rule No 1.” Buffett once remarked that anyone can pick good-value stocks but the most important quality for long-term investors, in his view, is temperament, not intellect.

In the aftermath of Covid-19, Smead notes that “the only place Buffett has gone to is inflation beneficiaries like oil companies or gold or non-US companies”. Berkshire bought US$10 billion in Occidental Petroleum shares last year to help it fund the acquisition of rival Anadarko Petroleum, which turned into one of the most ill-timed mergers in the history of oil.  The acquisition cost Occidental U$55 billion and was aimed at expanding its footprint in the fledgling US shale sector. Berkshire accumulated more shares as Occidental paid its dividends only in stock to preserve cash. Last month, Buffett sold his shares at a total loss of US$8.4 billion but still holds warrants.

In July, when oil prices were still in the doldrums, Buffett swooped in to take control of Dominion Energy’s gas assets for US$4 billion, plus an assumption of US$6 billion in debts, in what was seen as a distressed sale. Last month, he dabbled in precious metals by purchasing a 1.2% stake in Barrick Gold for US$565 million. Smead points out that Buffett is not buying gold but a mining company that is cheap and pays dividends. “If there is one thread connecting all of these transactions with his investment in Japan, it is Buffett’s obsession with value,” says Smead.

By buying the top five sogo shoshas, “Buffett didn’t just get long Japan, he expressed his value credentials at the same time”, notes Peter Boockvar, chief investment officer of Bleakley Advisory Group in New York. Itochu Corp is trading at 9.5 times expected earnings and has a dividend yield of 3.2%. Marubeni Corp is trading at 8.8 times earnings with a dividend yield of 2.4%, Mitsubishi Corp at 9.3 times with a 5.3% yield and Mitsui & Co is trading at 13 times forward earnings with a yield of 4.2%. Sumitomo Corp is trading at nine times the last 12 months’ earnings and has a dividend yield of 5.1%, Boockvar says. “This is true value investing, and one of the benefits of Abenomics was the focus on shareholder value and corporate governance,” he adds.

“What we are seeing is a change of guard at Berkshire and a more dynamic portfolio management process, particularly equities, which are now the domain of [Buffett’s two investment deputies] Todd Combs and Ted Weschler,” Cathy Seifert, director of research at CFRA in New York who covers Berkshire, tells The Edge. “Previously, Berkshire’s equity holdings were fairly static but, since Todd and Ted arrived, things have changed. Japan is a move away from the dollar as well as a value play. Gold is also a portfolio hedge because, right now, with Apple stock where it is, Buffett is tilted too much towards technology.”

In previous recessionary cycles, Berkshire, flush with cash, was able to buy a ton of distressed assets cheaply and then ride the recovery. The downturn was so sharp and short-lived in the aftermath of the recent pandemic that the Berkshire CEO was not able to do any deals. Did Buffett miss the big rally because he was not quick to pounce when the market plunged 35% in March? Why did Berkshire do so well in 2008 but lag this year? “There are some valid comparisons between then and now, but there are also huge contrasts,” says Seifert. “Back then, Berkshire was the go-to entity with a fortress balance sheet; in essence, a lender of last resort. This time around, the [US] Fed, and the [US] Treasury acted much more promptly and decisively. Berkshire has a lot of dry powder or cash on hand to deploy, and it has been a source of frustration within the company for years.” Moreover, she notes, Buffett now also faces increasing competition from private equity firms, which have risen in prominence, raising a lot of cash over the last decade.

It is also important to differentiate between cyclical and secular growth trends, argues Seifert. “Buffett’s move to rescue the banks in 2008 represented his view of a great cyclical opportunity,” she says. “In the aftermath of the pandemic, the real opportunity is secular.” Also, it involves technology, a sector in which valuations are perennially high for the liking of a value investor. “The Covid crisis wasn’t a typical recession where Buffett has normally thrived,” Seifert notes.

Buffett may have also restrained himself from taking a plunge in March because he was still bruising from a few large deals that have not worked out, such as the takeover of Kraft Heinz in a joint venture with Brazilian private equity group 3G, Seifert says. The same is true of the Occidental deal, which was structured more like the ones he did during the credit crisis in 2008. However, the Occidental warrants he got as part of the deal are way out of the money now. The losses on Occidental, on his stakes in US airlines and on his sale of his bank stakes total more than US$13 billion.

In May, Buffett announced that Berkshire was selling all its stakes in US airlines that it had previously accumulated. Last month, Buffett said Berkshire had sold its entire stake in the largest US bank, JP Morgan. He has also been trimming his exposure to the beleaguered Wells Fargo, the No 3 US bank, but has added to his Bank of America stake. Buffett’s losses in banks, oil, airlines and other sectors must be weighed against his huge profits in Apple. He built a 5.8% stake in Apple at the cost of US$35 billion between 2015 and 2017. It is now worth US$118 billion, probably the single-best investment bet ­anyone has ever made.

So, where will Berkshire be in five years without Buffett and his 96-year-old investing partner Charlie Munger? Seifert says though Buffett does not telegraph it much, Berkshire already has a succession plan in place. Will activist investors push for a break-up of Berkshire to realise the real value of its conglomerate holding? “The way I look at it, the biggest unknown is how long Berkshire’s conglomerate structure will remain intact,” she says.

But who could force a conglomerate with a market capitalisation of more than US$520 billion to remake itself? “Berkshire has a huge fan base but, post-Buffet, how many will continue to back a company whose stock has underperformed for so long?” asks Seifert. The way she sees it, with Buffett and Munger gone, unless Berkshire stock starts performing, long-suffering shareholders are likely to spring into action. Berkshire shares have underperformed the S&P 500 over the past 10 years. The index is up 226% whereas Berkshire is up 174% over the last decade.

“The only activist who might matter is probably Bill Gates,” says Smead. “He is a brilliant guy, a long-time friend of Buffett, who has taught him a lot over the years, but Gates doesn’t understand investing.” The Bill & Melinda Gates Foundation Trust owns a 2.25% stake in Berkshire. “From the 1960s to 1981, capital in the US was organised around high inflation,” says Smead. “Over the past decade or so, everything has been organised around low inflation. What Buffett is doing now is making investment bets that benefit from inflation.” That should put Berkshire in good stead over the next decade, he argues.

Buffett is also giving key lieutenants,  Combs and Weschler, more leeway in running overall investment strategy. Still, the nonagenarian investor is not ready to hang up his boots anytime soon. If Berkshire shares continue to lag, expect it to buy more of its own stock — the ultimate value investment.  Buffett’s legacy will be his intense focus on the competitive advantage of companies he invests in, or what he calls their economic moat, as well as their long-term cash flow generation, management quality and return on capital. The incredible cash machine that Buffett and Munger began building 55 years ago is unlikely to be replicated anytime soon.

Assif Shameen is a technology and business writer based in North America

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