When Warren Buffett’s Berkshire Hathaway (BRK/A, BRK/B) reported earnings on Friday, there were no real surprises. Profit of $6.4 Billion on revenue of $49.8 billion was roughly in line with consensus forecasts. When you stop and think about it, the fact that a 41 percent increase in net profit, a huge achievement for any business, is “no real surprise” tells you a lot about Berkshire Hathaway’s record, but that was not what struck me about the report.
The most noticeable thing was that Buffett et al are sitting on a record pile of cash… over $55 Billion of it. This has been noticed by others too, and is beginning to draw comment. Some have concluded that one of the country’s best known and most successful investors sitting on a record pile of unused money is a bad sign. Surely, the logic goes, if valuations weren’t high then Berkshire would have found a use for that money; the fact that they have all of that cash indicates that they can’t find anything worth buying, therefore everything is overvalued, therefore we are about to collapse, therefore we should all be selling in panic!
There is so much faulty logic and so many false assumptions in that argument that I don’t know where to begin. First and foremost it should be pointed out that around half of that amount is what Buffett has said he likes to keep on hand in order to guard against the possibility of outsized claims at the company’s core insurance division, so, in reality, we are looking at a cash accumulation of $25-30 Billion. That is no small amount, for sure, but should be looked at in context.
Berkshire’s existing holdings have been adding to that cash at the rate of around $1 Billion per month, so it doesn’t take long to amass a large cash position. This is especially true given that Buffett is not a fan of either share buybacks or dividend payments. In his opinion investors get a better return if they just let him invest the money, and so far in the history of the company he has been proven right. $50 Billion sound like a lot of money, and indeed it is, but at $1 Billion a month and from a base of $25 Billion, it represents only a couple of years of inactivity.
Given some of the acquisitions the company did make over the last fifteen years, though, that desirable cash reserve could now be even larger. Berkshire Hathaway has invested heavily in utilities and energy, as well as the 2010 buyout of the Burlington Northern Santa Fe railroad. All of these businesses are capital intensive and in an environment where rate rises must come someday, the ability to finance capital expenditure from cash amounts to a significant competitive advantage. It would seem to me that we should be getting used to Berkshire holding a lot more cash.
Even so, it would come as no surprise to see some kind of significant acquisition or investment in the near future, the question is “where?” Mr. Buffett is on record as saying that he intends to continue to invest in alternative energy. That would make sense for a company with large cash reserves and great cash flow too. Once again, in a cash starved industry a company with those things would have an enormous advantage over the competition.
It is quite possible, then, that the piling up of cash by Berkshire Hathaway is not a sign that the market is overvalued. It is undoubtedly true that bargains are few and far between at the moment, but if you didn’t realize that after the last few years of gains in stocks then you haven’t been paying attention. I have no doubt that Mr. Buffett can find things to buy even in that environment, but if, as I suspect, those potential targets are in capital intensive or cash starved sectors then building a big pile of cash before acting makes perfect sense.
In other words, don’t read disaster into the fact that Berkshire Hathaway is accumulating a lot of cash. It doesn’t mean that a collapse in stocks is imminent; it simply means that Berkshire Hathaway is making a lot of money every month. Given the nature of the businesses that they have shown interest in, it should also be evident that allowing that cash position to build before acting could well be both deliberate and prudent.