Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
February 2, 2021 – By Samantha Bailey
Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) might simultaneously have the easiest and most difficult bull case theses for prospective shareholders.
Easy: Warren Buffett allocates capital more intelligently than any other investor of the last 100 years. Under his leadership, Berkshire Hathaway shareholders have enjoyed nearly unparalleled success over the last 50 years. With the greatest investor of all-time at the helm, shareholders can sit back and trust him to guide the ship.
Difficult: Berkshire Hathaway is an American conglomerate that owns large insurance businesses, railroads, and utilities outright, along with large stakes in American banks, Apple Inc (NASDAQ:AAPL), and Coca-Cola (NYSE:KO).
Here to help us cut through the noise and wrap our heads around the incredibly complex business model of the world’s largest holding company is Kyler Hasson, a portfolio manager at Delta Investment Management. Hasson can be found at his blog, Concentrated Compounding, and on Twitter with takes that I always find both entertaining and thoughtful.
Hasson discovered Buffett’s annual shareholder letters early in his investment journey and has been a shareholder for years. Of Berkshire Hathaway, he says the best way to think of it might be as “a collection of generally high-quality businesses financed in a quite conservative manner … with the common theme sort of being that conservative structure and intelligent capital allocation.”
As for valuing such a large and intricate business, Hasson admits to keeping a large spreadsheet summing up the value of all its parts, but that many shareholders seem to be able to get just as good of a sense of knowing when shares are particularly expensive or cheap by tracking the company’s price-to-book ratio.
We also discuss why Buffett missed out on the tech sector’s incredible gains of the last decade and what the future might hold for Berkshire Hathaway shareholders after Buffett and Munger are no longer leading the company.
01:24 – Kyler’s Ownership in Berkshire
03:19 – How Should Investors View Berkshire
09:03 – How Buffett Uses Berkshire to Fund His Investments
25:25 – Warren Buffett and the Tech Boom
36:27 – Berkshire after Buffett
53:50 – The Next Berkshire
Matt Cochrane 0:00
Greetings, fellow investors. I’m Matthew Cochrane, a Lead Advisor at 7investing where it is our mission to empower you to invest in your future. We do that by providing monthly stock recommendations to our premium members and educational content that is freely available to everyone. Listeners., today I am very excited to introduce Kyler Hasson, who acts as the Portfolio Manager for Delta Investment Management. He can be found with his occasional blog post at ConcentratedCompounding.com and on Twitter where I find his takes both entertaining and thoughtful. More specific to todays show, he’s an investor in Berkshire Hathaway, the American multinational conglomerate holding company, famously helmed by Mr. Warren Buffett. Warren Buffett, as basically everyone knows, is probably like the GOAT of investing. The greatest of all time. His track record is almost unparalleled. I personally find Berkshire Hathaway fascinating, though we don’t talk about it too much at 7investing where we often focus on more growth-ier type companies. If you’re a listener of the show, you’re probably familiar with the company though. But if you’re not, Berkshire owns everything from insurance companies and railroads to utilities and candy companies. Oh, yeah, it’s also one of the largest shareholders of several large banks, Coca Cola, and Apple. So let’s get to it. Kyler, welcome to the show.
Kyler Hasson 1:22
Thanks for having me on.
Matt Cochrane 1:24
Of course. So many investors discovered investing through the sage wisdom found in Buffett’s letters. And because of that, they grow up as value investor. So I’m just curious if this includes you. How long have you owned shares in Berkshire, and how did you first discover Buffett?
Kyler Hasson 1:46
I actually got interested in investing probably my senior year in high school. We were playing kind of a stock picking game, and I started to want to look at stocks after that, and kind of understand where they’re moving. Sort of a friend of my father’s who recommended some reading material. I think it was Intelligent Investor, maybe Random Walk Down Wall Street. I started to read some of these books and get familiar, and then I think a first really natural place to go after that was to read Buffett’s letters. You know, this was 2008. Roughly, he was already the most famous investor in the world. And, you know, so I went on Berkshires website and started going through the letters, oldest to newest. And I would say that was that was probably the biggest source of information for me as a new investor, like it is for many other people. So that’s where I kind of got got my start with that sort of quality investing that he does. Professionally, how long have I owned it? I’ve owned it since about 2013 – was our initial purchase. You know, new clients new money, and we’ve added from time to time since then. But yeah, it’s been about seven, seven and a half years now, and it’s been a pretty good result.
Matt Cochrane 3:19
Sure. Absolutely. Absolutely. I briefly mentioned, like, everything is owned in such a wide variety of companies and holdings. How should investors think of Berkshire? Like, is it more Geico, which it owns? Or is it more Apple, which I think it’s the largest stakeholder in apple?
Kyler Hasson 3:43
You know, I really do think of it as a conglomerate. You know, there’s some major pieces and some things that are fairly big on their own, but don’t really matter, just given how big Berkshire is. You could say, Berkshire might be worth, maybe call it $500 – 600 billion. You know, the Apple stake is, well, depends on the exact price, but you know, 100 billion, a little more. They’ve got a railroad that’s worth, you know, maybe about $100 billion, could be a little more. The insurance is similarly big, and then they have some smaller divisions that are still quite big by themselves. Unless he sells it at some point, I think of Apple is sort of just as important as the railroad, given their similar values. So I think of it as a collection of generally high quality businesses financed in a quite conservative manner. You know, little debt, some of the insurance liabilities that they have are generally matched to treasury bills. So I think, for me, it’s a large company with many parts with the common theme sort of being that conservative structure and the intelligent capital allocation.
Matt Cochrane 5:07
Sure. So how do you how do you begin to value this company? Do you have to add up all the different pieces to come to a smart valuation? Are there shortcuts? Do you look at price to earnings or price to book? Like, how do you approach valuing a company like this?
Kyler Hasson 5:25
Yeah that’s a good and very interesting question that I thought about a lot. I’ve got a sort of a big spreadsheet. I’m not one for for big, complex models, but I have a big spreadsheet and I do a sum of the parts. I take every single business unit, I’d say what I think it’s worth, and I add it all up. I don’t think there’s not tremendous complexity inside Berkshire. There are a lot of parts. But you know, the 10-K is going to come out pretty soon, I think. And if you just sort of slowly go through it and and read it all, you can get a handle for for every business that Berkshire owns, or rather, the big businesses and the big groups. They group some of them towards the bottom, but you can kind of get a handle on the whole thing. That’s how I do it. What’s funny is I have some friends that own it. And, you know, one of them just kind of looks at price to book, doesn’t do all the math, and we pretty much think it’s cheap at the exact same times. If you’re on Twitter as well, I always find it really fascinating. It’s like all of Twitter knows, no matter how how they value it, they all know when burgers cheap and when it’s not. I look at my model that I’ve spent all this time on, and there’ll be certain times when I say, oh, man, I think this is really cheap and looks really interesting. And you know, all of fintwit is like, “oh, wow, Berkshire looks really interesting right now” and they’re mostly just using price to book.
Matt Cochrane 7:13
Yeah, that’s what I do. Like, I would just when you say that, after looking at your really nice, fancy model, I’ll go to Morningstar for five seconds and look at the price to book and be like, ‘oh, yeah, you’re right.”
Kyler Hasson 7:25
I think for me, now that I have the model, the upkeep is not too difficult. Just update the parts when they move. But I think one thing for me is I want to understand, well, you know, might what I think is a good value on a price to book basis change over time. And I think the only the only way to really see that is to do all the underlying work. And so who knows? Maybe Berkshire’s sort of fair value on a price to book basis could stay pretty constant over time, and there would be some complex underlying reasons for that. But maybe not. And I just want to make sure, you know, hey, in three or four years, maybe today’s 1.3 times Bbok is yesterday’s 1.2. So I want to make sure that if that is the case, that I know it and I can take advantage. So that’s my big reason to do it like this. And, you know, maybe add some error, maybe some of the parts isn’t really right in the first place. So perhaps I’m not getting anything, but I think it’s a good exercise to do at least.
Matt Cochrane 8:39
Sure. Absolutely. Is it fair to say though – this is my like sky high view of Berkshire – is it fair to say the insurance, like Geico and the other insurance aspects of it, is it fair to think of the insurance units as kind of like the backbone of the company?
Kyler Hasson 9:01
Yeah, I think that’s right.
Matt Cochrane 9:03
Can you explain like, maybe walk us through just real quick how Buffett uses the insurance to kind of fund everything else.
Kyler Hasson 9:13
Yeah, it’s funny that you ask that. This is probably where I view things most differently than everybody else. So with that caveat, the general model that pretty much any investor has of Berkshire Hathaway is the following. They own a lot of very large insurance businesses, and insurance is a negative working capital business. So your customers pay you up front, and then you pay them all that money or most of it back in claims costs over time, but there’s a gap. So we’ve got they call that float in insurance. And so Berkshire has a whole has a float today, as of Q3 2020, is about $135 billion. So Berkshire can make use of that float to invest. And most people will say, Well, you know, Buffett takes all that money, and uses it to buy stocks and other businesses. It’s effectively, you know, since it’s just negative working capital, and as the insurance companies grow, its company that isn’t really gonna get paid back. So it’s perpetual capital to Berkshire. It’s very cheap. It costs as long as they underwrite at a profit, it costs nothing or less. And so hey, you know, he can go out and buy utilities, businesses, or railroad or whatever it is, and can earn 10 or 12% on that money. And the money he’s using cost nothing. That’s the traditional view. I don’t think that’s quite right just looking through the financials, and the reason is because in the last 20 years, which is when you can actually kind of look at the balance sheets, he has generally kept sort of fixed maturity securities – which would be cash, government bonds, corporate bonds, and sometimes some preferred stock – it least equal to the value of the float. So today, the floats 135 billion. And the cash, he has some preferred and Occidental Petroleum, and the fixed income is $153 billion.
Kyler Hasson 11:48
So what does that mean? You know, to my eye, he’s always been very, very conservative. And regulatorily, he’d be allowed to deploy some of that money that’s for the float into these productive investments. But over the last 20 years, he’s generally kept fixed income, at least equal to the value of that float. So it’s not like, you know, he’s mostly just investing the shareholders equity – keeping the float a little safer, you can argue, well, and around the financial crisis. If you count some of his some of his preferred investments as equity then he was using a little bit of float. I think it’s terribly complex. I don’t think there’s one right answer. I think back in maybe the 70’s, 80’s, and 90s, he probably used a little more than float for equity investments these days. I think he’s just more conservative. And I haven’t seen him use it like people usually say, but what he will do is take the profits from his insurance business, and invest them in Apple or stocks or businesses or what have you.
Matt Cochrane 13:11
Is holding all that cash smart? What if you were put in charge of Berkshire tomorrow? Would you hold that cash back? Or how would you spend that cash?
Kyler Hasson 13:25
Well one, I trust Buffett to do the right thing.
Matt Cochrane 13:30
Sure. Sure. I mean, he has a pretty decent track record.
Kyler Hasson 13:33
What I will say is I think Berkshire has gone through a few periods. Early days, up until the late 90s, roughly, when I bought general re. He was buying common stocks predominantly, that’s that’s where Berkshire made most of its money. They bought some wholly owned businesses, but not a lot. And of course, that’s where he made most of the excess return of his career. So you know, he made really terrific returns and things like Geico, in Washington Post, Capital Cities, Coca Cola, those were sort of the big traditional investments that many people who studied Buffett remember and kind of understand as being incredible. In the late 90s, Chris, Chris Bloomstan, who writes really terrific letters, Semper Augustus, you can find them and I would encourage everybody to read them, sort of makes the point that he bought generally in the late 90s. He had a lot of excess cash due to that, and then it sort of changed Berkshire’s balance sheet from being sort of over levered to stocks to under levered. So at that time, in the late 90s, there were some operating businesses, some boring ones that weren’t tech related, that were sort of cheap. And so he started to buy some operating businesses from the late 90s. Up until maybe three or four years ago, a much higher proportion of Berkshires cash went to buying companies whole. And so you know, they’ve made some decent stock investments here and there, but mostly they’ve bought companies. They’ve done a lot in the utility space. They bought Burlington, Northern Santa Fe, Kraft and Heinz, and then that, I guess, that’s still public, but you know, they bought Heinz whole or took it private. So I think if you look at the rate of return that Berkshire Hathaway has earned, on these bigger wholly owned businesses, you know, for one, they’re not nearly as good as his returns were on the stocks and the early days, that’s to be expected is Berkshire size grew and the opportunity set because, you know, went down. Probably after Burlington, Northern Santa Fe. You know, Precision Castparts hasn’t worked out very well. Kraft and Heinz haven’t worked out very well. You know, it’s really hard to buy very large businesses these days for somebody like Berkshire, because there’s lots of competition, private equity can pay a lot because they use debt that’s quite cheap. Strategic buyers should be able to pay more than Berkshire because they’ll have synergies where Berkshire doesn’t. So I think and when you add on the fact that Berkshire needs to deploy capital, $10 billion, or $20 billion for it to matter at all. That’s a very challenging environment for Buffett to make good returns. So we’ve started to see last year and this year as well, an increase in share buybacks, which I personally fully support. I think he has an advantage in that he has a big conglomerate. And I think it trades at a sort of typical conglomerate discount. It’s not huge, but there’s a discount there. And so, you know, if you say his options for capital deployment are stocks, well, you know, there’s only a few stocks he can buy full businesses. There’s not that many full businesses he can buy. And he’d have to pay high prices or share buybacks. I think share buybacks look really attractive, Berkshire, you know, it’s a big collection of attractive assets, and it trades for less than they’re worth. And so I think he can put out hopefully $10 or $15 or $20 billion a year at really good rates of return, and he doesn’t face the same business risk that you would have when he bought Precision Castparts. You know, if the aerospace market turns down, or they have some competitive difficulties, your return return might not be very good. With Berkshire, it’s so diversified that maybe one business doesn’t do as well, maybe another business does. And when you’re buying that whole big group, you’re going to get a more average result. But it should be pretty good on average. So that’s what I hope for, and I think many shareholders agree. I fully trust that at Berkshire they’ll do the right thing on that, if that makes sense.
Kyler Hasson 16:51
So given how like how large they are, are they too big for their own good? Is it maybe not share buybacks while also bad share buybacks? Should they start maybe spinning things off? Or are they just almost so big and unwieldly now that it’s just hard for wall street to value? Are they always going to have this like conglomerate discount, so to speak? They can only buy so many stocks, like you said, because it has to be a large liquid stock like Apple, where look, Buffett made a killing on Apple the last few years. He bought at a great time, but there’s only going to be so many opportunities like that in a large cap stock that’s so widely followed, yet was so undervalued at a certain point. Like should they spin things off? Are they too big for for their own good?
Kyler Hasson 19:52
It depends on what you’re trying to solve for, in my opinion. If they broke up Berkshire, I’m pretty much certain that the value of all the companies would be a decent bit higher than what Berkshire stock trades for today. I’s a group of high quality companies. They could do that. If you were trying to unlock the value, as they say, then that would work. I think there’s a couple ways in which all those companies being a part of Berkshire are good and important. One, on the insurance side, they write some really interesting, reinsurance policies. They’re basically the insurers for other insurers, and having a silly amount of extra capital is very beneficial for that. If me, and you go into a contract and say, “hey, you know, if something crazy happens to me, I need you to pay me a million dollars in 20 years. It matters if your net worth is $1 million, or $1 billion,
Matt Cochrane 21:16
Kyler Hasson 21:17
So that’s a big benefit on the reinsurance side. Also, given how much capital they’ve built up in their insurance business, really excess capital, they can be more aggressive with how they invest in many insurance companies. So an insurance company might have assets of let’s say, $3. And the float that we discussed might be $2. And shareholders equity might be $1. That would be a combination structure for an insurance company. And so like I said, Berkshire, you know, they invest their float, the $2, and that roughly in government bonds, or fixed income or cash. And they invest about the dollar in productive things like stocks and businesses, many insurance companies, given that they don’t hold as much excess capital as Berkshire does, they might only invest 20% of their shareholders equity in productive assets. So out of their $3 capital stack, it might be 20 cents in productive assets, and $2.80 of bonds. So Berkshire is they’re able to invest more of their capital, their shareholders equity in stocks, which you know, should earn a higher return over time. So I think that’s a big benefit and benefits to Berkshire scale. There’s there’s some benefits. Many of Berkshire’s operational businesses are are quite under levered, almost no debt and frankly very few liabilities even. If they spun those companies off, there’d be shareholder pressure to have a more efficient capital structure. So, if what you’re looking for, as investors, you know, I want to make sure I make a good return with as little risk as possible. That can happen in Berkshire, if they split off the businesses, you know, I don’t think that can happen. And then lastly the people that run the businesses don’t face outside pressures for the next quarter or the next six months, which I think is also a positive, and probably, I would say more important than many people think. So those are all benefits to Berkshire staying together an added benefit if you’re long term shareholder. You know, listen, if if Berkshire Hathaway’s worth $500 billion, and it trades for 550, and it trades at $450 billion on the market, and Berkshire has a lot of excess capital and can buy out some partners for less than the stakes worth, then that’s very good for you. It’s a it’s a very low risk way to deploy lots of capital at a good rate of return, and it will increase your return as a shareholder over time. So you know, you won’t get the initial valuation pop, but your rate of intrinsic value growth over time should be higher. So if you’re in it for the long haul, I think you want it together for all those reasons. You know, there’s some downsides. Maybe you could say that not all the subsidiaries are the best run in their industries, and maybe having some public company pressure could be positive for that. It’s a hard needle to thread and it’s hard to say if Geico was was public, it might be run a little bit better. It’s hard to say. But that’s a that’s a possibility. And I don’t think we should dismiss it out of hand. But I think on aggregate, again, if you’re long term shareholder, the weight of Berkshire staying together is clearly a positive.
Matt Cochrane 25:25
Let’s talk about, like, I guess maybe a common criticism of Buffett is that he’s missed the boat on a lot of the tech boom, right. I think there’s a quote, I’m gonna paraphrase it, but I think it’s taken a little out of context, a little too much where he said he didn’t get technology back in like, 2000. You know, besides Apple, I mean, his other big investment in a tech company was IBM, which did not work out well. Has has the world past Buffett by? Has Berkshire missed the boat on tech?
Kyler Hasson 26:07
I think there’s a few ways to attack that question. First off, I think when he says he doesn’t understand technology, my guess, and it’s not even really guess, I pretty much guarantee you that if you look at the big tech companies, that Buffett understands that economics better than pretty much anybody else. I think when he says he doesn’t understand them, I think part of that is his perception, whatever. Maybe I shouldn’t speak for him, but but I think his perception might be, hey, some of these aren’t quite as predictable as people think.
Matt Cochrane 26:50
I always took it to mean, like the durability of the boat, maybe. Take your pick – Alphabet now or Facebook now. But like, he didn’t. And I mean, I think it’s a fair point that he didn’t understand how long could it stay dominant in that field? Maybe?
Kyler Hasson 27:16
Yes. And so, you know, what’s funny is that in 2011 when he bought IBM, and sure enough, you know, if there were five or six big tech companies, and IBM was one of them. That was the one that didn’t wildly succeed. You know, the other ones were predictable. That one kind of wasn’t. So is he the best tech investor out there? No. He’s probably made more money on Apple and tech than pretty much anybody. Any other investor I can think of besides a couple, but he started off with a lot. So it’s cheating a little bit? Sure, of course, but I think, you know, I think they’re not as predictable as some other businesses he looks at. I’ve been thinking about this. One thing that’s interesting is he’s talked about Google and said, well, it’s hard to see anybody displacing them. And that was a few years ago. And it’s been inexpensive from time to time since, in my opinion, and I own Google. And so, you know, that’s one he said, well, I understand it. He’s on the record as saying he thinks it’s predictable. Sometimes what he says on the record might be a little different than what he thinks. And it has gotten to a spot where it seems like you could get good IRR’s is on it. They haven’t bought it. So you know, I don’t know, I think from what I’ve seen, the investments I’ve seen him make, and maybe more importantly, investments I’ve seen him not make, I think one thing that I’ve noticed is he has tended to buy things, sort of at fairly low kind of price to free cash flow ratios. So cheap on that metric, which in 10 years, has led to some underperformance. It’s not clear to me tthat’s always going to be the case. That said, you know, you would have rather bought, you know, take your pick Google or Microsoft over six years ago then.
Matt Cochrane 29:46
No, I hate throwing criticism at Buffett because he is in every single way imaginable a better investor than me and a better track record than I will ever have. So it almost feels silly, but at the same time, it almost feels like he’s – for instance, when he bought Kraft, you know, a large investment in Kraft Heinz, that was like in, for lack of a better term, in an old school mode, right? Like it’s consumer brands where that moat was eroding. Whereas the same time it seems like he didn’t understand the economic moat that Alphabet or Facebook sported around that same time. And look. He’s old, you know, and he grew up in a different time. And I just wonder if I just actually I just think that kind of has hurt him in the last decade, as I don’t know, I guess, Berkshire has underperformed the market? I don’t know. But maybe the last five years, I think, give or take. And I think those kinds of investments have I’ve heard him because he’s, you know, he’s still looking for, oh, well, this bank, Wells Fargo, I, you know, even IBM, it was a cheap tech stock. Wells Fargo was a cheap bank, Kraft Heinz, you know, it looked, you know, it had that old consumer goods MO with brand recognition and things like that. Where at the same time the world was being taken over. Software was eating the world at that time. Do you think that’s fair?
Kyler Hasson 31:40
Yeah, you know, I’m reticent to say, “well, listen, you know, he hasn’t had the best five years in the world. So that’s this big terrible crime.” Right? I don’t think it’s, you know, first of all, it’s not unacceptable for him to make a few mistakes. Could he have made some decisions better? Sure. Could I have made some decisions much better than last five years too? Yes. And, you know, and to a greater extent as well, I also think the structure of Berkshire, the idea of it, is for him to put out money, you know, his time horizon is, is a lot longer than maybe mine or most investors is, and I personally think I have a long time horizon. You know, if you’re going to buy a whole business, you got to own it for 50 years. Did Kraft Heinz work out? Not really, but, you know, that’s okay, we all make mistakes. But I think what he’s trying to do is just stockpile assets that are going to be worth a lot more than they are over 40 or 50 years. And, you know, if in a 5 or 10 year period, those things don’t work out the best, I think that’s fine.
Matt Cochrane 33:10
I think that’s a fair point. Fair point.
Kyler Hasson 33:13
Yeah, I think if you look at the intrinsic value of Berkshire Hathaway in 2005, or 2006, so whatever you want to pick, call it mid cycle in the mid 2000s, and what it is today, in my opinion, the rate of intrinsic value growth of Berkshire Hathaway is greater than the rate of intrinsic value growth of the stock market. Most people will compare well how to Berkshire stock do compared to the S&P, you have two large confounding variables in there, which is one, Berkshire went from trading at a premium to the sum of the parts to a discount. I don’t think that’s Buffett’s fault, the market, the valuation, the market went up in that time period, it got more expensive. So you have valuation if you’re comparing Berkshire stock return to the S&P, you know, you have Berkshires valuation working against it. And that’s S&P’s valuation helping. If we’re talking about Berkshire of the 80’s, that wouldn’t have mattered because they were creating so much value. Berkshire Hathaway from the early 2000s to now to the future, is not likely going to be smashing the performance of the S&P 500 such that if there’s a headwind of three or four percentage points a year on valuation that you’re still gonna beat the market. So I think, you know, I think if you look at that, and that’s what you should judge him on. Well, listen, you know, he created 10 or 11% of value a year for 15 years with effectively no risk. You know, he was matched on the one place he had some liability’s in insurance, he pretty much just match them to T bills, used no debt, and the intrinsic value of the company went up more than that at the stock market, I think that’s a pretty good achievement. I think if you look at the assets he owns, I think we have to be a little careful, because there could be a world, in which case, the assets that he owns might do quite well, in comparison to the assets that have done well over the last five or 10 years. So if real interest rates were much higher, and nominal rates as well, you know, some of the some of the growth names could have some problems. And something like an insurance company where you have $150 billion of short term fixed income securities are going to making a lot more money than they are, and some bank holdings are going to be doing well. So, you know, the time horizons long. Were there things that he could have gotten that probably would have made sense? Yeah, but I think that’s true for everyone. Some people have an argument against this, but I would say from 2005 to 2020, he did pretty damn good. So, you know.
Matt Cochrane 36:27
Fair enough, fair enough. What does the future look like for Berkshire after Buffett? I think it was last year, they made some headlines, because they made some unusual investments. Like, you know, miniscule on the scale of the entire, you know, entire Berkshire but like still large dollar amounts. They made an investment in Stoneco, an investment in Snowflake. What does the future look like for Berkshire after Buffett’s gone?
Kyler Hasson 36:58
A good question. I wish I knew the answer. Todd Weschler and Todd Combs have definitely made some investments that Buffett and Munger would not make. So, you know, to our point, maybe they will. Maybe they’ll get some things that Buffett and Munger would have missed. So that could be a positive. I don’t know much about many SaaS names. I’m not an expert there. I’ve seen a couple investments. Maybe those will turn out great. Maybe they won’t. But, you know, it’s hard to say I think the only thing you can say is things will be a little different. I hope that if the stock continues to trade at a discount, that the new managers will be aggressive and buying it in. That’s my one big hope. I’m hoping that Buffett’s doing that this year. They bought back a good amount of stock, sort of gives new management license to do that, if that makes sense. But besides that, listen, they owned two stocks I own. I don’t exactly always know who which one of the Todd’s Westland did what, but you know I was just talking to a friend and he mentioned one of them, had owned Visa for a while and I think Visa is one that Berkshire could have probably made a lot of money on. It’s been cheap enough from time to time. He owns a lot of Amex. He knows the space.
Matt Cochrane 38:52
I actually, like I think I’ve said this on Twitter before, I think missing on MasterCard and Visa. I mean, I know he had small stakes in them, but I almost think that’s like him that would we can talk about how he missed the tech companies and everything like that. But I think missing our MasterCard and Visa because they were in the space like he was familiar with might be like his biggest mistake. And again, like I feel like too much of the show we’re throwing shade at or I’m throwing shade at Buffett so I’m not i’m not trying to. I do think he’s an amazing investor. But I think like, you know, if you were trying to pick apart his career, like missing on MasterCard and Visa 10 years ago, when they first went public, or almost anytime since really, like, because they’re in that space that he’s familiar with might have been maybe like a worst crime of omission than a than missing on like the big tech companies.
Kyler Hasson 39:51
It’s hard to say. Man, I was talking to somebody today and he was talking about this and think Munger was worried about, I don’t remember exactly what it was, but some competition, and maybe some regulation. They were pretty cheap. I want to say it was in 2011 or 12. I think they traded at a very undemanding price to free cash flow multiple. Certainly how things have turned out for them to not have put a lot of money in those? Yeah, they knew the space. Things could have been different. But on an unexpected value that were probably quite, quite good ideas. So yeah, I mean, that could have gone better. But you know what, so those small positions was it was one of Wechsler/Combs, you know, who knows, if they were in charge of Berkshire? 10 years ago, maybe they would have put $20 billion into Visa. You don’t really know. I own Charter and I really like that business. And, and one of the two of them, or both owns Charter. So, you know, they’ve also done some weird things like GM, which, who knows if that really makes sense. But point being the new people that run it, there’ll be different. Maybe they’ll want a little more SaaS, but you know, maybe they would also put a lot of money in Visa, it’s hard to say.
Matt Cochrane 41:19
As a shareholder, what are what will you be looking for as a real positive sign? Well, I mean, you mentioned buybacks, but like, what would you consider a red flag after, you know post Buffett, post Munger Berkshire? Like what are red flags you would be looking for from the new management team that you’d be like, maybe make you a little hesitant about continuing owning shares?
Kyler Hasson 41:47
Yeah, that’s a great question. I think what can be really difficult? So one of the ideas with Berkshire is how do you lose? You know, how do you lose in an entity with, again, their liabilities are matched T bills, that there’s pretty much no debt. They’ve got this big diverse collection of businesses that are, you know, mostly pretty good. And they trade at a price where if all the cash was distributed, you probably make 10% returns or more, you know, given where the market is, that to me looks pretty attractive. The best way that I can think of that you lose as well when they’re deploying new capital. They deploy at it, you know, not so good rates of return. What’s interesting is a lot of the businesses that Berkshire owns, like the utilities sort of specifically, and some of their assorted other manufacturing businesses, may have actually services and retailing, a lot of those businesses invest a lot back into the business. And so you’ll see the capital expenditures run above depreciation expense by a good amount, most every year. So some of the value in Berkshire is just reinvested into the business. And there’s not as much true free cash flow as you might think, because they’re investing for growth. So it turns out, if you say, well, the businesses would make 10%, if you know, you paid out all the money, what if they deploy all their free cash flow at 8% for 10 years. It’s like, instead of making 10, you make 9. So you’re only going to start to really get in trouble if they start deploying capital at zero, or two or four, you know, some pretty low rate of return. And so I think you give the new people some slack, you know, if they make if they make an investmentin the first six months, that you’re like, that’s a little iffy. I don’t know how I feel about it. I don’t think I’m selling shares then. If over a few years they do a few things that they don’t seem to have the long term in mind. Or that, you know, they make some just completely obvious blunders, and then I’m going to be worried. I think the culture of the place is too long term oriented, and too rational. Sure, let one or two people that are in charge of say stocks from really running wild with the place No, I think that’s wrong. But I would – that’s hard for me to see. So that’s what what I would need to see – is just real obvious misallocation of capital. You know, a good one could be, let’s say instead of Berkshire trading at 80 or 90% of what it’s worth let’s say, for some reason trades at 60. You know, in that case, you should be spending every dollar you have on buying back stock. Let’s say they just go out and buy, you know, some sort of expensive company, that could be okay. But like, you know, your 10 or 20 year rate of return probably isn’t gonna be that attractive, then I could have a problem with that, that one can be a little more concrete.
Matt Cochrane 45:37
Sure. If the stock was trading at 110, or 120%, of fair value, and so buying back stocks was not attractive. What would you want to see? Would you want to see a dividend? Or how would you want capital to be deployed in a scenario like that?
Kyler Hasson 46:00
Yes, that this is, okay, another disclaimer. This is another place where I feel a little bit differently than most investors. So Traveler’s is a really interesting company.
Matt Cochrane 46:18
The insurance company?
Kyler Hasson 46:20
Yeah. Sorry. They’re a great insurance company. So they’ve operated almost financially, almost the opposite of Berkshire Hathaway. So when I was talking about an insurance company with $3 of assets and say 20 cents of, of the three investments being in productive assets and rest bonds, that pretty much describes travelers. They have just a big portfolio of high quality bonds, they’ve got a good insurance under operation. Sorry, a good insurance operation that underwrites profitably, you know, most every year, it grows a little bit, nothing crazy. But financially, they take any excess capital they have, and they buy back stock, and they don’t really worry about what the price is. And it hasn’t often been at a price that’s silly high. But you know, sometimes it’s seems a little expensive. But the idea is, okay, listen, you know, one, we don’t exactly know when our stocks will expensive, a little cheap. But if we buy back our stock, that’s 10% too expensive, that might be better than keeping the moneyin short term bonds to earn 1%. And to try to wait four years until our stock gets a little bit of cheap. You know, it’s like, if the IRR on our buyback is seven or eight instead of 10, or 11. That’s going to be better than holding cash and trying to deploy it later, perhaps. So they’ve just said, “hey, we’re gonna get rid of our excess capital.” Turns out, if you look at the intrinsic value of that, and I haven’t checked on this in the last maybe six or eight months, you can make an argument that the intrinsic value has grown faster than at Berkshire. And I believe their stocks outperformed. It’s an interesting financial philosophy, which is just make sure your capital structures – I don’t always like to use this word but efficient. And they they’ve done pretty well for themselves. So you know, let’s say Berkshire is at 110% of their intrinsic value. Let’s say I’m not going to sell it for some reason, the whole position, maybe it’s taxes. Let’s say their choices are keep capital on the balance sheet, pay dividend, buy back stock. With Berkshire, I don’t mind so much, especially compared to other companies, if they keep a little excess capital from time to time. You know, I think it’s good. I think it makes the company safe. It obviously gives them great opportunities if the markets melt down. So I’m relatively more okay than other places with them keeping a little bit of extra cash around. I think that’s generally good. If they get way too much cash, if they pay me a dividend, I mostly run money for people that live in California and pay taxes. So you know, even the taxes on dividends can get kind of high. Even again, so this is this is where I’m gonna say something that people won’t all agree with. Even if the stocks a little expensive, I would prefer a buyback and if it’s expensive to me that I can sell proportionate into the buyback and I’ll pay less tax and I paid on a dividend. If I think it’s at fair value, maybe I won’t some of the buyback but it you know, just gives me the the option to do whatever I want with it. Sure. So you know, Whenever that’s that’s not finance one on one people tell you well if your stock price, right, don’t buy it back and I’ll say, you know what, I’m a shareholder, I can make that choice myself.
Matt Cochrane 50:10
So I actually agree with that. If I had to pick one investor, you know, who I’ve learned, or who I try to model myself after in some ways, it’s a Pat Dorsey, right. It’s not Warren Buffett. And he’s very big on though, like, on making buybacks when it’s like, undervalued and like deploying that capital wisely. But I’ve always felt like you can make a case for any company. We tell investors you can dollar cost average into stocks, when you’re unsure about the valuation, but you think it’s a great company? You know, I think you can make the same case for companies to buy back their stocks -you take any company that regularly buys back stocks, and I think you can make a good case you know, if you regularly buy back tsocks, like, yes, sometimes you might be buying it back when it’s a little overvalued or a little undervalued, but I still think that’s a can be a wise decision to allocate capital.
Kyler Hasson 51:12
Yeah. And I mean, I really think that Travelers example, I think that’s an example that all investors should study deeply. In contrast to Berkshire Hathaway, you can come to your own conclusions, you can say, well, the risk profile is different. Under some circumstances, things would be different. It is interesting to me that a company that allocated its capital very differently than Berkshire did a little better in a similar industry. It’s not like insurance shot the lights out over the last 15 years either. So I think that’s important. Keep in mind, you know, I owned for a long time, I owned AutoZone, and AutoZone-
Matt Cochrane 52:00
Bought back a lot of shares.
Kyler Hasson 52:01
Yeah, they buy back a lot of shares. And in the last five years -it’s actually one of the more interesting business cases I’m aware of – I don’t know if this is still true, but as of a few years ago, since the late 90s, I believe the amount of transactions done in an AutoZone store had been kind of flattish over those 17 years and the stock is up, I don’t know if it’s 50X or 100X, but some huge amount. The reason is because the price of the parts went up a little bit, their margins went up a little bit. You know, they bought back stock, they built a lot of new shares and took market share, they use a little bit of leverage, it’s like every other piece worked in the same direction, and you made a tremendous amount of money. But in the past few years, that business, the margin expansion has slowed or stopped. They’re gonna run out of new stores at some point. You could have paid at high multiples 20 years ago. That’s not been the case recently. And so you don’t want it anymore. But there were a few times when AutoZone traded what I thought were a little too high, you know, they bought back some stock, and I sold proportionately into the buyback. And that was fine. You know, I paid less tax than I would have if it was a dividend. So just as long as I think that company has a consistent financial policy – you don’t want a company that runs at zero net leverage to say, “hey, we’re gonna lever up for X to buy back a huge portion of our stock when it’s overvalued.” If they’re doing it in a sort of normal way with normal leverage targets, then buy back the stock, I’ll sell it if it’s cheap. That’s what I prefer. .
Matt Cochrane 53:50
Sure, sure. Last question. Is there a next Berkshire on the horizon? Sometimes people talk about Markel or Boston, Omaha, I almost think you can make a case for a Constellation Software or Roper, where they like roll up companies in kind of similar businesses and try to realize synergies. Is there a company out there that you think could be like the next quote unquote, mini Berkshire that could grow into become the next Berkshire?
Kyler Hasson 54:24
There are some acquisitive industrial business to business companies that have quite good track records. You mentioned a couple of them Constellation Software is, to my eye, probably the best, and I own that as well. I was again, just talking to somebody about this. And I think Constellation Software’s odds to match Berkshires intrinsic value growth over, you know, 30 or 40 or 50 years are maybe better than anybody else.
Kyler Hasson 55:01
So yeah, there’s some companies that have that acquisitive gene and are very good at it, and have some big advantages. I think the sort the mini Berkshire’s in insurance have generally been a disappointment. You mentioned Markel. That’s, I think that’s been the best managed company in that space. Sure, we have a few others that the pitch was, well this is a mini Berkshire Hathaway, they didn’t work out well. At all. And in some cases I think Buffett doesn’t get enough credit for how good of an insurance executive he is. If you look at how, you know, before Berkshire became as big as it is now, with all these non insurance businesses, and all this extra capital, if you look at a normal insurance business that’s well run, you can compound the intrinsic value much faster than the return on your equity portfolio. And the way you do it is, let’s go back to that example, you have $3 in assets $2, in float $1 in shareholders equity. So just say, you know, you invest the one dollars in shareholders equity in stocks, and you earn 12% a year, you’re really good stock picker. And so, you know, if nothing else happens, your book value goes up to a percent here. Well, the second piece is you have $2 of bonds, and they’re going to earn some interest. And so let’s say, you know, that could add depending on where interest rates are, that’s going to add some income. And so the first year, you know, your book value is on about 12% of yours can go up a little more than that. And then lastly, if you underwrite it a profit, that’s going to increase your earnings, and you’re gaining book value as well, what happens is, let’s take that insurance company, you know, the first year, if your stocks make 12, your intrinsic value, and your book value might go up 17%, when you add in the income from the bonds and underwriting if you’re if you underwrite $100, of sorry, $1 of insurance business, and the next year, you still underwrite $1 of insurance business. You know, the income from the bonds is going to be pretty much the same, say the income from the underwriting is going to be pretty much the same, but you’re going to have a bigger base of shareholders equity. So those two little boosts to your growth are going to matter less. So as the insurance business gets bigger, if it’s just now more of your turns income from stocks, and you’re gaining trinsic value is going to be closer to 12 than your hypothetical 17. So what you really need to turbocharge growth and compounding is you need the underwriting to grow sort of along with your book value, because that keeps your leverage of the bond income and underwriting income high and can boost your returns. And so if you look back at Berkshire, what he did incredibly well was grow and grow and grow that insurance business so that he didn’t just end up with all this extra capital. You know, he kept increasing the amount of the float, which you know, he could invest and earn income on and his underwriting income. So that it was like, you know, he maybe earned 13% on stocks. But he got another large boost to his return on equity, because the insurance business grew along with it. And that is something that few insurance companies have been able to do. And the ones that have been able to do it haven’t pursued a Berkshire model. They’re sort of more of a payout model. So you need both of those things. You need really good investing. And you need that sort of incredible performance from insurance business. And I haven’t seen those two things married since Berkshire. Many people have tried, but it’s difficult.
Matt Cochrane 59:22
No, absolutely. It’s a pretty impressive track record that has not been matched too often, if ever. Kyler, where can people find you if they’re interested in following you?
Kyler Hasson 59:34
Yes, best places on twitter @kylerhasson. Tyler with a K. Last name is H A S S O N. I’m on it a lot, maybe a little too much. I respond to direct messages there. I’m on the company. I work for Stealth Investment Management. You can find us online there if you’d prefer and reach out. Those would be the two best places
Matt Cochrane 59:59
Alright. Great! Kyler thank you so much for joining us. Again. I’m Matthew Cochrane. We’re 7investing and we’re here to empower you to invest in your future. Have a great day, everyone.
Kyler Hasson 1:00:10
Thanks for having me.
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Anirban and Matthew were joined by Alex Morris, creator of the TSOH Investment Research Service, to look at seven former market darlings that have taken severe dives from...
On episode 5 of No Limit, Krzysztof won’t let politics stand in the way of a good discussion - among many other topics!