- 1Greggory Warren on Berkshire Hathaway and the Annual Shareholders Meeting in Omaha
- 2How to value Berkshire Hathaway?
- 3Berkshire’s culture
- 4Berkshire Hathaway's cash position
- 5Acquisition targets for Berkshire Hathaway
- 7High quality parts of Berkshire Hathaway
- 8The investment in Apple and Amazon
- 9Who might follow Warren Buffett as CEO?
- 10How Greggory Warren generates his ideas for questions for Warren & Charlie
This video on Berkshire Hathaway was recorded in November 2019 but it isn’t outdated – as well as this transcript. It gives you a lot of insights about Berkshire Hathaway, the leading personalities including Warren Buffett and it also shows you the culture of the company, so enjoy!
Hello YouTube, welcome to the second part of our video with Greggory Warren of Morningstar. Today we talked about economic moats, Berkshire Hathaway, and my participation on the company’s annual panel. So, if you like it, subscribe and leave a comment, thank you.
[00:00:39] Tilman Versch: Hello Greggory, welcome back to the second part of our interview. This time we want to cover Berkshire and learn more about your coverage of the company and your insights. Let me start with the question: How did you get the honor to ask questions for Warren and Charlie during the annual meeting?
[00:01:01] Greggory Warren: That’s kind of a funny story, because I think it was 2012 when they first rolled out the analyst to be on the panel and when they came out, they grabbed three sell-side analysts and they didn’t pick us up because at that point we weren’t reporting but annual numbers, EPS numbers. So, we didn’t hop on the radar but we had a relationship and we knew the folks and the Berkshire offices so we did reach out at that point like “Hey, what happened? Did we fall out of favor or something?” And the response was “Oh, we forgot. We’ll put you in the mix”.
I was expecting to be one of the analysts the next year, and then the next year they changed the format and they brought in Jonathan Brandt who’s a sort of designated buy-side analyst. They had one of the insurance analysts and then they brought in Doug Cass who was this supposed bearer. The interesting thing was that we got bumped at the end of the line, so at that point, I wasn’t really expected to be on the panel until 2016. The issue was that Doug Cass’s performance was not viewed favorably by a lot of shareholders. So, the next year they started the process and they were looking for another bearer and it got to be April and I was – kid you not – literally packing up the car because my wife and I were going to Vietnam for two weeks and I get pinged on my email saying “Berkshire wants to know if you’d be willing to be on the analysts panel this year”. And at this point, it was the end of March and I was like “Well, absolutely!” and I turned to my wife and I said, “You’re going to hate me, I’m going to have to get the laptop and take it with me because I have to work on questions for the Berkshire meeting”. So that was how we ended up on the panel.
I looked at it as an opportunity for us as Morningstar with independent research so we have a sell-side analyst and also a buy-side analyst and then I thought we could carve out a seat for an independent analyst to come to the table. I did a good enough job the first year when they asked me back and I think the thing is, I look at it from the perspective of “It’s a job and I have to do a good job at it”. And I come to the table every year trying to bring better and better questions. Warren’s only ever told us that they want to talk about the business. The reason they brought in the journalist and the analyst in the first place is that they wanted to get more discussion going about the business itself, being able to talk about the operating companies, being able to talk about how they think about capital allocation within the company. Jonathan and I have basically been designated with the task of talking about everything non-insurance because the sell-side analyst that comes is generally an insurance-specific analyst.
So, now it’s been six years that I’ve been doing it. It’s a great honor, I think it’s fantastic that they keep asking me back but I also think that shows that I’m putting in the work, taking it seriously, and trying to come to the table with difficult questions for them every year and really not just make it a show. But I also come to the table trying to get information, because Berkshire amongst all the publicly traded companies is probably one of the most closed in. It’s very difficult to get any sort of face time or any sort of time with management overall, in fact, they discourage that. I think from that perspective it is one of those areas where we do get asked more direct questions.
[00:05:06] Tilman Versch: You said that Berkshire is pretty closed from giving public information if they don’t have to, so it maybe makes it hard to value the company, Berkshire. What would be your tips on how investors should approach the revaluation of a business?
[00:05:25] Greggory Warren: I think it makes it difficult in a lot of ways. It makes the meeting difficult because I found that it’s different than a lot of other meetings I go to. At a normal meeting with a CEO or CFO, I can interrupt, I can follow up questions, we can take things in a different direction so it’s more like a conversation. With that annual meeting, it’s like “Ask the question and it’s out there” and I kind of have to look with where it goes and where the answers go. I’ve learned over time that it’s about cutting off avenues of escape for Warren. Because if Warren can avoid answering a question directly, he will. I think part of that is also because he’s always cognizant of how he might impact the markets or securities. That’s why I always tell clients that it’s always sort of a fool’s errand for me to ask a question about a specific stock because he’s not going to say something, he’s either talking it up or talking it down. So, it’s better to frame it from an industry perspective and look at it from that way if you really want to get an answer out of him. Now as far as covering the firm, we take a slightly different approach than some firms. We do a sum of the parts, we strip it down, we strip everything that’s not insurance-related out of the financial statements. The energy business and the railroad business we can run through our DCF model and evaluation. On those businesses I work closely with the railroad analysts, I also work closely with the energy analysts, just to try and make sure that not only do our projections make sense for Berkshire but they’re in line with how they’re thinking about the industry overall. We’ve got that advantage there.
On the insurance business, I’m running the investment portfolio and then the insurance operations through there. You might work on the asset matter; it sort of helps to figure out what you can expect your returns are going to be for the investment portfolio over time. And then the MSR is probably the most difficult part of the business, that’s the manufacturing service and retailing operations. To say that Berkshire is opaque, I think it underscores it. For the most part, if they can get away with not disclosing information, they will. And I think in some respects that’s to protect the businesses themselves. We have as much information as we do about Burlington Northern and the energy business because they had to file 10k and 10qs so that’s a little bit more transparent. Overall, there is enough there. And if you do a good enough diligent job of forecasting out those businesses and you’re conservative, that’s the way we look at it. Because we’re stripping it apart, we tend to be more prudent, more conservative with our forecast and how we’re thinking about different things.
One of the things on the insurance side is we always build in a year mid-cycle where we have supercut losses. Whenever we’re looking at expectations and triangulating outcomes for fair value estimates for different parts of the business with the rest of our coverage, a company like Berkshire energy, should trade a premium to a lot of the utilities because they are in a unique competitive position being under the umbrella. They don’t have to pay out a dividend, they can spend a lot more in CAPEX, they can do a lot of things that a lot of their peers can’t do. We’re trying to make sure that all of those things make sense and that they work.
How to value Berkshire Hathaway?
[00:09:06] Tilman Versch: In the insurance business, one main question which always comes up is a float of a business. How do you approach this specific value question of Berkshire? How to value the increasing float? Some people say it’s like cost, where you get money?
[00:09:32] Greggory Warren: I think Buffett’s created a side business and float. It’s an area where we don’t necessarily agree completely with how it’s portrayed. Float is still a liability at the end of the day. It’s the money you take in to pay out for claims. Basically, at the end of the day, you end up with a profit basis there with whatever your combined ratio is plus whatever you earn on that capital, as long as you have it. If you have a short tail business like Geico, that’s a six-month to one-year business. So, your ability to earn excess returns on that is very limited. The key to success there is just being a better underwriter overall. Geico traditionally has been pretty good; their combined ratio has typically been 94-95%. If we talk in normal terms that’s like a 5-6% operating margin. It doesn’t seem like much but basically, that’s free money on top of other people’s money. Overall, it’s a good business as long as you’re running it well. That’s just the thing; I try not to take float and try to use it to value the firm because I think that that’s kind of the wrong way to look at it. Our DCF model for the insurance side does a pretty good job of incorporating all of that into it and we’re much more focused on underwriting profitability over an extended period of time plus whatever gains we expect to come from the investment portfolio overall.
[00:11:15] Tilman Versch: How would you describe the culture of Berkshire besides the things you’ve already told us?
[00:11:19] Greggory Warren: It’s a unique culture overall. Because I go to the annual meeting, but also because I go to the brunch the day after, I get the chance to meet a lot of different business heads. It seems more like a family; everybody’s like-minded and I don’t mean in a Stepford Wives kind of way, I mean more like they understand and appreciate the value of how they exist, operating under an umbrella with Berkshire where they can do a lot the right things for the businesses for the long run. Some of the guys that have been heads of the public, the trader firms that have been acquired over the years have told me outright they love working under Berkshire because they can make tough decisions even if it means impacting short-term profitability because it’s the right thing to do for the business in the long run.
They have access to tons of capital at relatively low rates if they wanted to, to do deals, to do transactions to make investment improvements and everything else. Even though there’s not a whole lot of synergies across the spectrum, it seems to work. When we look at the history of conglomerates, I think Berkshire is the only one that has survived and has thrived over the years because it’s been run on a completely decentralized business. Buffett’s not concerned with what the managers are doing on their businesses from a day-to-day business. His primary concern is how much capital is coming up through the system and what opportunities it had to put it to work. He’s letting those managers run their businesses like it’s theirs and holding them accountable when things aren’t good. So, I think from that perspective, it’s a bottle that has worked. Whenever we think about Berkshire for the long run, I always tell people that Buffet’s important but the model on the culture is just as important and it needs to survive him. We think that over the long run it’s probably going to do fine, as long as the next management team doesn’t go in and do anything to disrupt that or nitpick on every different decision or micromanage the different managers through the system.
That said, we also think that there has been potentially a time and need for some of that. Charlie’s always famous for saying it’s decentralized to the point of abdication. That’s good, but we’ve seen some examples the past few years were perhaps having a little bit more oversight or at least public-traded terms like progressive or the railroads have analysts out there with progressive and Allstate and travelers saying “What are you doing with telematics and how is this changing your business?” And there is just not as much pressure on Geico. It would be questioned every so often, but there just hasn’t been the same sort of pressure on them to adopt the technology and work into their system. We’re seeing the same sort of thing with precision railroading scheduling on the railroad side; basically, at this point, almost all of the North American railroads have adopted in one form or another and Berkshire’s still a lone holdout. So, it’s those kinds of situations where you look at it and say “Okay, these are huge advantages that come from operating under the umbrella”. But every so often there will come these issues where you wish they were just a little bit more forceful with pushing the businesses along. But again, that’s not Buffett’s style, so I don’t think it’s going to happen during his tenure but the next management team, I’m not so sure that’s going to be the case. There have to change; there have to be some changes in reporting structures and how they assess the businesses over the long run.
Berkshire Hathaway’s cash position
[00:15:06] Tilman Versch: What happens with the cash at Berkshire Berkshire Hathaway and how much is really deposable?
[00:15:12] Greggory Warren: About this point, it’s sitting on a 128 billion at the end of September. There’s 20 billion that he’s always said is the backstop for the insurance business. I don’t think that’s a joke, that really is there because Berkshire has a lot more equities on the portfolio, and having that extra cash improves the liquidity for the holdings that are dedicated to the insurance business. But it also placates the regulators to some extent, allows them to carry a bit more equities than not. But if you look at it from the perspective about upfront CAPEX spending and probably about 2% of revenue held back for just operating cash needs, that 128 billion is probably somewhere closer to 100 billion. What we consider to be dry powder – money they can spend on acquisitions, stock investments, shared purchases, or a dividend if they were interested in doing that – there is basically 100 billion dollars in cash that’s sitting there ready to be deployed.
Acquisition targets for Berkshire Hathaway
[00:16:16] Tilman Versch: If you could guess, what would be a target for that?
[00:16:20] Greggory Warren: I think it’s harder right now just because of where the market valuations are. I know Berkshire has historically been interested in acquiring more utilities and transmission assets. When I talk to our utility guys about this, the general consensus in the industry is if you go out 15-20 years from now in North America, there will probably only be five large utilities and Berkshire will likely be one of them. The problem with utilities is that they’re so expensive right now. Because of historically low-interest rates people have poured into utilities and other income-generating equities to get the yield. Right now, most of our utility coverage is trading about 120% of our fare values and it’s about 25 times earnings. It’s harder to justify a deal where you’re getting probably a 9-11% allowable return from the regulators for the business by paying 25 times earnings. It’s hard from a valuation perspective to really justify that.
As far as other companies they are looking to buy, there are a lot of industrial-type firms that I think would be on their shopping list. I think that the issue right now, from a pricing perspective, is also at elevated multiples here. We’ve had quite a few firms being shifted in a sort of wider moats over the past six months to a year within our coverage and just looking at how much they’ve improved post-financial crisis, they’re much leaner, much better operations than they ever have been, historically. I think that they fit the profile of what I think Buffett’s looking for.
He doesn’t mind buying capital-intensive businesses because that helps get some cash off the books, but he likes companies that are in good competitive positions and I think it’s getting harder and harder to find companies where that is truly the case. Retail is having a tough time with Amazon. On the package good side of the business, we’re going through this period where brands may not have the same power they’ve had historically. Then there are other parts of the business they probably wouldn’t really shop; I couldn’t see Buffett going out and buying a technology firm tomorrow because it’s just not a business they understand and it’s more of a business that’s built on creative destruction as opposed to a long-term sustainable business.
[00:18:58] Tilman Versch: If you look at the value at Berkshire, maybe it would be an idea for Berkshire to share repurchases by itself?
[00:19:05] Greggory Warren: That would be the best use of capital right now. In fact, when we look at the buckets and when we look at where the cash is, Buffett said a few years ago that he couldn’t have cash on the balance sheet 150 billion dollars and come back to shareholders and justify it. The problem for him right now is that we’re very close to that and the company is generating about 20 billion in free cash flow.
So, the next two years we’re probably going to hit that level if he doesn’t go out and work some of that capital down. But so far, shared repurchases have been minimal. I’ve been underwhelmed by the level of shared repurchases since they modified the program in the third quarter of last year. We look at it from a perspective where they could buy back a billion to two and a half billion a quarter in stock and it really wouldn’t diminish anything. Because when you add that up, that’s probably equivalent to what they’re getting from Burlington Northern every year as a cash dividend. They can afford to do that. Our run rate over the next five years is 10-15 billion on an annualized basis but that’s because we have a 25 billion dollars shared repurchase built-in into the mid-part of the cycle. That’s basically a stopgap for our valuation because we look at it from a perspective of “They get to that point and they are going to have to do something”. And if they haven’t acquired anything or haven’t made big stock investments, there really aren’t too many other options available.
The interesting thing too, the other night I was looking through the queue again and it looked like they probably netted out on stock purchases during the third quarter about 10 billion, so they put another 10 billion to work, and still, the cash balance went up six billion. That just tells you the scale of things and it just gets harder and harder for them to whittle down that cash if they don’t have the opportunities. I think that’s been the story of the past ten years; the opportunities for Berkshire have been a few and far between, the competition for assets has also been much more difficult and then sort of the traditionary where they could have money where they work in the stock market, it’s been harder and harder to find value or good quality names that they can get at a reasonable price. And I think they’ve kind of limited themselves too because they’re not willing now to own more than 10% of any company stock. When you look at the universe of potential stocks, that narrows it down significantly. Because they’ve got to own these mega-cap firms. The problem with mega-cap firms is that they’re not always growth companies. In some cases, they’re diminishing companies.
I think from that perspective that opportunity has gotten smaller overall to your point. To me, the logical conclusion is to buy back your own stock and when we look at it on a fair value basis, when we put out our report on the company in mid-August – when we talked about five reasons why investors should be looking to buy Berkshire – the valuation was about a 20-25% discount to our fair value. Right now, it’s about 15. So, it had a nice run but it’s still attractive in our book, relative to book value. I think probably by the end of the year it’s going to be about 1.3 times book overall.
High quality parts of Berkshire Hathaway
[00:22:29] Tilman Versch: Which part of Berkshire’s businesses should get more attention because of the quality they have? And which part of the businesses might be disrupted in the coming years?
[00:22:42] Greggory Warren: It’s hard because a lot of the publicly traded firms that they’ve acquired plus the insurance business account for so much more of the valuation and so much more of the pre-tax earnings and the contribution to overall valuation. There are a lot of smaller companies out there within Berkshire that if they went away, you wouldn’t really notice. Because there are much, much smaller players, so they don’t get the level of attention.
Jonathan Brandt, who’s on the panel with me, is really good about finding nuggets about a lot of these smaller businesses and approaching them and bringing them up at the meeting. But I still think Burlington Northern is unsung. We still look at railroads as being very wide-moat businesses. They need to do some things operationally to improve things but I think it is still an important business.
I don’t think Berkshire Energy gets as much credit for what they’ve done and the strength of the moat that they have in the positioning that they have. And then on the insurance side, everybody talks about Geico, everybody talks about the reinsurance business, but the most profitable fastest-growing piece of Berkshire’s insurance business has been the primary group, which is a hodgepodge of a lot of different collected businesses. For a while, they were running combined ratios in the upper 80’s, which is unheard of for the industry. And they’ve just done a much, much better job with underwriting historically. And when I look at that business going longer term, reinsurance is probably not going to be a higher growth business from a premium basis. The thing they need to do with that business is probably just run it at a 100% combined ratio because pricing is so difficult in that market but it gives me encouragement to see that the two faster-growing businesses are Geico in the primary group, where margins in profitability are much better than what they are getting from the reinsurance.
The reinsurance is still an attractive business, back to your concept again about comments about float, you get long-term contracts and you get the capital for a longer frame of time. That allows you a longer duration in order to generate outsized returns. With that business you’re still looking at probably a breakeven, you want an underwriting profitability perspective. So, the real gain from that business is getting the returns.
The investment in Apple and Amazon
[00:25:06] Tilman Versch: What’s the rationale behind the investment in Apple and Amazon?
[00:25:12] Greggory Warren: I think it’s a changing opportunity set within Berkshire. I think having Ted and Todd, Ted Weschler, and Todd Combs, overseeing the investment portfolio, and helping these guys out I think has been important and has been additive. I don’t think they would have bought Apple had those guys not been around. And I think the thing is – and Buffett has even said this – they were willing to put more money into Apple because Ted convinced Warren that Apple was a consumer products firm. He’s like “Stop thinking about it as a hardware firm, think about it as a retailer and a consumer products firm. Look at the base of clients that they have and the stickiness of the customer base”.
I think that allowed Buffett to look past the technology aspect. That said, technology is disruptive, there’s nothing saying that Apple is going to be the same company 10 years from now as it has been the last 10 years. That’s why we still have a narrow moat rating on it as opposed to a wide moat. We think it’s a great company and they’ve done a great job but technology is just that way. And Amazon is just another one where they’d probably been in it a lot sooner if they would have been cognizant of the disruption that they were creating, same thing with Google.
Buffett’s always said about Google that we knew what they were doing with ads, we knew what they were doing with pricing and should have put two and two together and figured it out sooner. But again, there’s been an inversion on their part to go down that path with technology. Because again, it’s more complicated and it’s more difficult to understand the sustainability of the advantages. I think that when it gets put in terms that they can get behind, that’s when they’re willing to pull the trigger and step in. I think that’s what’s happened with Amazon.
Who might follow Warren Buffett as CEO?
[00:27:06] Tilman Versch: You already mentioned the great culture at Berkshire. The question that always comes up is: Who will be the successor of Warren Buffett? How will the management be in the future? Will it be very similar or do you expect bigger changes?
[00:27:23] Greggory Warren: It’s interesting, there’s always the horse race to see who’s potentially going to be the next CEO and it’s changed hands a few times since I’ve been covering the firm. I think at this point they signal by making Greg head of all the non-insurance businesses and Ajit head of the insurance business, who are their two preferred candidates would be to take the helm. I think Warren would love to have Ajit take the helm. I like Ajit, I think he’s fantastic, I think he’s done a great job with the insurance business. I think the changes that have taken place at January and the changes we’re starting to see at Geico since he took over have been additive overall to the insurance operations at Berkshire. But I don’t think Ajit wants the job. In plain terms, he just doesn’t want to be in that same spotlight, which is fine. I would prefer he stayed and oversaw the insurance operations because it’s something that he loves doing, something he has a passion about, so from that perspective I think that’s a good thing.
But still, have him available to advise the next CEO and we still think that Greg Able is probably the most likely candidate to fill that role. He’s a little bit more of an alpha-personality, a little bit different than Buffett but he’s also done a lot of deals over the past 20 years; he’s done straight acquisitions, he’s done acquisitions out of bankruptcy, he’s been involved in heavy capital spending within the utility sectors, so he’s the kind of guy that is used to thinking about capital allocation, where we are going to get the best return over the long run. And as long as he got Todd and Ted working closely with him, I’ll think they’ll do a good job. I think that tells you the dynamics, it takes three guys to do the job, when it was one guy previously. But again, I think the business has changed and I think during the time I’ve covered it and the 10 years before that when I did own it and kept track of it, it’s sort of that state where it’s evolving; it’s becoming a much more mature company.
I think the days of Berkshire going out and doing a ton of deals are probably behind it. I think there will still be opportunistic acquires, especially on bolt-on deals that help improve different parts of the business, but I think – going back to our point earlier – there are certain aspects of the business like the reporting structure and things that we take for granted with most companies that I think still need to be solidified within Berkshire. Buffett’s been unique in how he has run the business historically. I’m not sure the next guy can do it the same way. I think there has to be more collaboration and I think the biggest risk for the firm going forward is that culture, maintaining that culture and improving some aspects of the business, putting some restraints in but at the same time not spooking the managers that are running the businesses down the line who are accustomed of doing things a certain way. I think from that perspective, that’s really going to be the biggest challenge, that and keeping shareholders on board with what they’re doing.
How Greggory Warren generates his ideas for questions for Warren & Charlie
[00:30:40] Tilman Versch: Let’s go back for the end of our interview to the annual meeting with two questions: how do you generate your ideas and do you think we will see Warren and Charlie alone again on the stage or will it change next year?
[00:30:57] Greggory Warren: To answer your second question, I think there’s been more of a clamor to have Ajit and Greg answering more questions and participating more. I think people would love to see Ted and Todd up there too. I think Ted and Todd are a little bit more difficult, though. Because again, the setup of the meeting and how things are staged, I think it’s harder to ask questions about direct stock investments and I think that’s where Ted and Todd are a little bit more involved.
So, you’re not going to get the kinds of answers you’d want to that maybe you’d get in a one-on-one interview. As far as the idea generation from the meeting, it is interesting because I remember that first year when I was going to the panel, I came to the table with more than 50 questions. It’s because at first, I didn’t realize I only had six during the course of the meeting. And second, I was under the expectation that I’m going to lose questions along the way and I probably checked off 30 of those questions when we went through that and I’m like “Well, I have to be better about my process”. So, the next year I came to the table and did a much more thorough job. I think I had about 30-35 questions that second year. I started to lean more towards asking more direct questions on the railroad and the utility business because we get a lot of good research coming up through our group that highlights a lot of the different things we’re saying. And again, if my role at the meeting is to give Warren and Charlie an opportunity to talk about the business or to get Greg – Ajit is a little more difficult because Jonathan and I aren’t necessarily allowed to ask insurance-related questions – but getting Greg or Matt Rose from the railroad to answer questions, trying to drive questions that either Warren was more comfortable deferring to them that they give more detailed answers or he and Charlie were fine addressing the question at hand, but a little mix of that and then more of a focus on how you think about capital, how you think about capital allocation, how do you think about succession and the longer-term run of the business.
I think the most interesting thing that’s happened over time is Jonathan Brandt and I, who are fishing in the same seat, have stayed out of each other’s lanes. He tends to focus a lot more on the MSR, the manufacturing servicing retailing businesses. I tend to focus more on the utilities and energy and we both get in capital allocation but it’s funny because I’ve noticed over the past several years that we’ve stolen questions from each other on a far fewer basis. That’s kind of a challenge, you know you are going to the meeting, you know you’re going to lose questions and the real strategy is to avoid the obvious questions, so like the hot topic issue going to the meeting, it’s usually going to come up from the shareholders or the journalists. Unless you have an opportunity to follow up on a question or an answer that they’ve given, it’s generally not worth even writing the question out. I mean, you can put the topic off to the side but I try to delve more into areas where I think I can get them an opportunity to talk more in-depth. And again, for me as an analyst, it gives me more insight into how I should be thinking about the profitability of this business, or I should be thinking about the volume growth or where things are likely to go over time. It’s an interesting process overall. And as I was saying earlier, when you think about asking questions at the meeting, it’s more art than science. I sit there and go through my questions over and over and over again, in fact, the day before the meeting I generally lock myself up in the hotel room and that’s all I’m doing, I’m cleaning up questions: “Does this work right? Am I taking too much time? Am I getting to the crux of the question?”
Or the other point is if I’m cutting off enough avenues of escape where I’m actually going to get a good answer as opposed to a more generalized, broader answer that doesn’t really get to the heart of the matter.
[00:35:03] Tilman Versch: Do you have something to add for the end of the interview?
[00:35:06] Greggory Warren: No, I’m good.
[00:35:07] Tilman Versch: Thank you very much.