Is Buffett Bearish?

Buffett continued to sell stocks and build cash in Q3. Cash increased $142 billion, or 87%, to $305 billion. That’s a lot of cash, by any measure. There are only 29 public companies in the US with a market cap greater than $300 billion (see them here). Note that my figure for cash equals cash and Treasury Bills, less amounts payable for Treasury Bills, and excludes cash held at the railroad, utilities, and energy segments (where the it is presumably working capital).

This the most cash Buffett has ever had on hand at Berkshire. But what about relative to the rest of Berkshire’s balance sheet?

The charts below show cash as a percentage of assets and equity. Cash as a percent of assets last peaked at 21% in 2004 and is 27% today. Cash as a percent of equity last peaked at 47% in 2004 and is 48% today.

Off the cuff, this seems bearish. But if you know anything about Warren Buffett, you know that he’s not a market timer. He buys when he sees bargains and builds cash when he doesn’t. It’s a bottom-up process, not top-down. Cash is an outcome, not a goal.

What we should conclude from Berkshire’s cash balance is that Buffett isn’t seeing many bargains right now. That’s no surprise considering that the S&P 500 is trading at 29x, almost twice its historical average. John Huber has pointed out that there are “probably only 30-40 stocks in the US and perhaps 100 or so worldwide that Berkshire can buy that will make a difference” in its portfolio. 

[One of the few stocks Berkshire is buying right now is SiriusXM, which we’ve written about several times, most recently here. It is almost assuredly Ted Weschler’s position. Berkshire now owns 33.2% of the company.]

Berkshire raised most of its cash by selling shares of Apple. Apple trades for 37x earnings and, with a market cap of $3.4 trillion, is too big to grow anywhere near its historic rate for long. 

Buffett’s Apple trade is a great case study in inactivity. Buffett bought Apple between 2016 Q1 and 2018 Q3, paying an average of $37 per share. Apple’s P/E ratio ranged from 10 to 20 times over this period. 

Since then, Berkshire mostly sat on its shares. Buffett tinkered with the position a little, selling about 10% in 2019 and 2020 and then buying a few percent back in 2022. This is remarkable inactivity compared to most portfolio managers.

Buffett began selling in 2023 Q4 and ramped up the pace in 2024. Apple’s average P/E during this period was 30x.

Berkshire’s Apple investment is a masterclass in inactivity. I have increasingly realized that when I am able to buy a piece of a wonderful business, I’m better off sitting on my hands and doing nothing until the market forces me to sell. Investors should only take action at the two extremes of valuation. Trimming and trading around a wonderful business is counterproductive. As Charlie Munger said at the 2023 annual meeting, “Just hold the goddamn stock.”

That doesn't mean to go sit on a beach and do nothing. You’ve got to keep up with the business. It means not to be overly reactive to the day-to-day nonsense of the stock market, newspaper headlines, and earnings reports. Buffett bought Apple around a 10-15x P/E and sold it at 30x+. Apple was actually cheaper when Buffet bought it because Apple had so much excess cash. Buffett only acted when Apple’s valuation was at an extreme. You don’t need an MBA or a CFA to know that 10x is cheap and that 30x is expensive. While Apple traded between 10x and 30x for five years (20 quarters) Buffett did nothing. Buffett only acts at the extremes, and then acts decisively. 

Brad Gerstner of Altimeter Capital drove this point home on a recent podcast, as recounted by Kingswell: 

 “I once asked [Warren] Buffett what he could have done to improve his performance,” Gerstner told Faber earlier this month. “He said, ‘Slept more and gone into the office less.’ He said when you do all the work as an investor and you do all this analysis, everything looks like signal. You want to do something. But, 95% of the time, you have to do all your homework, you have to study, you have to think — and, then, do nothing. It was that high-conviction, qualitative insight that led you into the investment [in the first place] so don’t let little data points along the way scare you out of the investment.”

Buffett’s big qualitative insight was that CEOs would sooner get rid of their corporate jets than their iPhone and that regular people would sooner get rid of their second cars. This loyalty made Apple’s ecosystem sticky and gave the company pricing power. Analysts, meanwhile, were busy forecasting how many iPhones the company would sell next year. They missed the forest for the trees. Buffett and the analysts were playing two entirely different games.

Buffett elaborated on this in his 1967 letter: 

The really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a "high-probability insight". This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side - the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.

David Abrams said something similar in 2019: 

“In the end, you're trying to form of judgment about something. And I don't think that the judgments are going to be found on an Excel spreadsheet.”

Munger, always pithy, said, “People calculate too much and think too little.”

The big money is made on the qualitative because that’s where it is easiest to have a differentiated opinion. The quantitive is still important though. No company is so qualitatively good that you can pay any price for it. Valuation always matters. Buffett’s Apple investment was wildly successful because it paired a differentiated (and correct) qualitative insight with a statistically cheap quantitative valuation. The quantitative protects the downside while the qualitative determines the upside.

Buffett held his investment for five years while the qualitative insight remained valid and the quantitative valuation remained in a broadly normal range.

Dan and I ask ourselves two questions when we are monitoring an existing investment:

1. Is the moat widening or narrowing?

2. Would we happily own this business privately?

The first question forces us to think about the business independently of its current EPS or stock price. Some of the best investments arise when earnings dip and the stock falls even though the company’s moat is widening. For example, a business reinvesting to widen its moat may temporarily report lower earnings. This is what Tom Russo calls “the capacity to suffer.” Earnings could also fall due to factors outside of a company’s control. The best companies continue to invest through downturns and ultimately emerge stronger.

The second question forces us to think like owners. Do we understand this business? Do we like it? Are the forward business returns (growth + yield) acceptable, or are we betting on multiple expansion to drive our investment returns? We always hope for multiple expansion, but don’t want to rely on it alone to generate acceptable returns. We want our bread and butter to come from growth, dividends, and buybacks.

Later in that same podcast Brad Gerstner offered an insight about Buffett’s investment in Apple and his aversion to what I’ll call capital allocation risk: 

““What [Buffett] always gets scared about around technology is that technologists find a gold mine, but then they take all the gold out of the mine and they go make another bet with it and lose it all in the second bet. He says, ‘Pull the gold out of the gold mine and send me my share [through] buybacks and dividends.’ When Apple made a decision that they were going to send upwards of 100% of their free cash flow on an annual basis back to shareholders, I’m sure Buffett said, ‘Where do I wire the money?’”

Monish Pabrai told a similar story about Charlie Munger: 

One time, I was talking to (Charlie Munger) and he mentioned that he would love to have an investment in Exxon if he could get a commitment from the management that they would do no more cap-ex and they would simply run all the oil fields with the cash flows going to the shareholders. He had calculated that it would be a tremendous investment.

And, of course, oil companies don't think that way.

But Oxy thinks that way.

If you study Occidental, what you'll find is they don't really have exploration going on ... Oxy basically has no speculative drilling going on. So, in effect, it looks like a CD. They're clipping coupons.

What Oxy is doing is they have a huge gusher of cash flows coming out and that huge gusher of cash flows is only going into buybacks and dividends. It's all being pumped out to shareholders - and Warren Buffett loves that.

He looks at Oxy as U.S. Treasuries on steroids.

David Einhorn has also retooled his investment philosophy around yield. He reasons that if a company makes a bunch of money and returns it to shareholders at an attractive yield, investors don’t need an expanding P/E multiple to do well.

I’ve come to prize predictable capital allocation, especially when it focuses on dividends and buybacks. Companies like AutoZone, AutoNation, and Altria (the best performing stock of all time) have proven that yield is a relatively low-risk way to create shareholder value over long periods of time.

Speaking of repurchases, Berkshire did not repurchase any shares this quarter after consistently buying for the last couple of years. This likely signals that Buffett does not believe Berkshire trades at a meaningful discount to its intrinsic value. Berkshire’s is up 25% year to date and, at 1.5x book value, trades at the higher end of its historical valuation range. 

It may also reflect concern about the intrinsic value of Berkshire Hathaway Energy (BHE). In September Berkshire repurchased the 8% of BHE it did not already own from the estate of Walter Scott Jr. for $2.37 billion in cash, a $600 million promissory note, and $1 billion in Class B stock. Buffett had pretty much sworn off ever issuing stock after the Dexter Shoe debacle, so this was a surprise. It's either a favor to an old friend’s estate or a sign that Buffett thinks Berkshire shares are fully valued. It could be both. 

Even more surprising than how Buffett paid is what he paid. The transaction values BHE at $49 billion, 44% less than the valuation Greg Able sold his 1% stake at in 2022. The hair cut is due to the wildfire litigation Buffett wrote about in this year’s letter to shareholders.

Ajit Jain, who oversees Berkshire’s insurance division, was also a seller this quarter. He sold over half of his class A shares for $139 million. Together Buffett and Jain’s actions probably indicate that Berkshire stock is not a screaming bargain. That doesn’t necessarily mean it is a sell though. As Munger would say, “Just hold the goddamn stock.”

The folks at Berkshire aren’t the only ones who seem to prefer cash these days. Howard Marks’ latest memo took the usual step of making an overt investment recommendation for more credit and less equity exposure.

In my view, the thought process set forth in this memo leads to the conclusion that investors should increase their allocations in this area if they are (a) attracted by returns of 7-10% or so, (b) desirous of limiting uncertainty and volatility, and (c) willing to forgo upside potential beyond today’s yields to do so. For me, that should include a lot of investors, even if not everyone.

My recommendation at this time is that investors do the research required to increase their allocation to credit, establish a “program” for doing so, and take a partial step to implement it. While today’s potential returns are attractive in the absolute, higher returns were available on credit a year or two ago, and we could see them again if markets come to be less ruled by optimism. I believe there will be such a time.

Sure, he’s talking his book, but that doesn’t invalidate his logic.

At EPC we believe cash should be an outcome of a bottoms-up investment process, not a top-down goal. So long as we can find simple, predictable, and profitable businesses with attractive forward returns well in excess of the yield on cash, we’ll own them. Fortunately, our investment universe is a lot larger then Berkshire’s, which makes finding bargains a lot easier.

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