There were two main headlines from the Berkshire Hathaway Annual Meeting held earlier this month:

• Buffett Sells Entire Stake in Airlines
• Berkshire a Net Seller of Stocks in First Quarter and April

These were interesting, but after seeing the event live on Yahoo! Finance and reviewing a transcript of the Meeting, I think there are at least 7 other headlines that deserve attention from investors:

• Disruption in Treasury Market Led Buffett to Hold Cash
• Greg Abel is Clearly Buffett Successor as Berkshire CEO
• FAANG Stocks Not a Bubble, Buffett Says
• Buffett Says Berkshire Size Makes It Hard to Beat S&P
• Buffett Cautions That Long-Term Bonds Are a Bad Investment
• College Often Not Worth the Cost, Buffett Says
• Buffett Supports Inclusive Board, Pushes Back at Governance Critics

Disruption in Treasury Market Led Buffett to Hold Cash

Some have criticized Berkshire Hathaway CEO Warren Buffett for not buying stocks when the market tumbled on concerns about the Covid-19 outbreak. Could he not find worthwhile opportunities?

Financial advisors usually recognize that investors have unique circumstances. Critics of Buffett don’t see that his position differs greatly from that of the typical investor. He has different potential risks and different potential opportunities.

As one of the largest writers of catastrophe insurance in the world, Berkshire must be able to make good on potentially billions of dollars in claims. Hurricanes, earthquakes, typhoons, wildfires and other disasters can lead to big losses. Timing is unpredictable, and a single year can have more than one major loss.

Even worse, if big catastrophe losses occur at a time of stress in the financial markets, it might be difficult for an insurer to sell investments in an orderly fashion so that it can pay claims. A large portfolio of Treasury bills is the safest thing for Berkshire to hold, and it provides peace of mind to insurance buyers.

The Meeting transcript [at 1 hour and 33 minutes] shows that in the latter part of March, Buffett had become alarmed by a disruption in the market for Treasury bonds. At that time, chief financial officers were borrowing heavily on their lines of credit in order to have liquidity as the economy was plunging.

Banks responded to this loan demand by liquidating large amounts of Treasury securities from their investment portfolio. This led to volatile trading in Treasuries and threatened the ability of borrowers to access credit.

And we came very close to having a total freeze of credit to the largest companies in the world who were depending on it.

[01:35:41 of transcript]

Here’s where Berkshire had a unique potential opportunity. During the financial crisis of 2008-09, Berkshire had been able to take advantage of a credit freeze by lending at high rates to prominent corporate borrowers, including Goldman Sachs, General Electric and Harley-Davidson.

In March, the emerging credit freeze suggested the possibility of repeating Berkshire’s lending success. During the Meeting, Buffett said one mistake he had made during the 2008-09 crisis was moving too fast. Had he waited for the momentum of that crisis to unfold, he said, he could have made better deals. [02:18:55]

But the opportunity to lend to good borrowers did not arrive this time. Fortunately for the country, said Buffett, the Federal Reserve stepped in and bought Treasuries aggressively. [1:35:41] Volatility eased, and creditworthy borrowers were able to get the funds they wanted.

Maybe things will change, and lending possibilities will emerge. No one knows how well the economy and financial system will do in the near future, Buffett says, so he still thinks it’s worth holding cash and T-bills.

Greg Abel is Clearly Buffett’s Successor as Berkshire CEO

In 2018, Berkshire announced that Ajit Jain, now 68, had been named Vice Chairman of Insurance Operations and Greg Abel, now 57, Vice Chairman of Non-Insurance Operations. The news led analysts to conclude that one of these would succeed Buffett as CEO.

In his 2014 Letter to Shareholders, Buffett had said that “the incoming CEO should be relatively young so that he or she can have a long run in the job.” That should have quelled speculation that Jain, already in his 60s, would succeed him, but writers persisted in saying that it would be Jain or Abel.

Also in the 2014 Letter, Buffett said that “Managing Berkshire is primarily a job of capital allocation, coupled with the selection and retention of outstanding managers to captain our operating subsidiaries.”

Buffett made comments during this year’s Meeting that could only mean that Abel is to be the next CEO. While lauding Jain for having one of the best minds in the world, Buffett said:

But his [Ajit’s] job is not capital allocation. It’s evaluating insurance risks…

[3:15:22 of transcript]

In contrast, Buffett noted that Abel, and executives Todd Combs and Ted Weschler are “extraordinarily good buyers in terms of capital allocation.” [2:56:15] And in introducing Abel at the Meeting, Buffett noted that he manages a business that has more than $150 billion in revenue across dozens of industries and has more than 300,000 employees.

Abel clearly meets Buffett’s criteria to be the next CEO.

FAANG Stocks Not a Bubble, Buffett Says

Before the Annual Meeting was broadcast, Yahoo! Finance aired an interview with Buffett that had been conducted in mid-March by their Editor-in-Chief, Andrew Serwer.

Serwer asked Buffett if he thought that the so-called FAANG stocks – Facebook, Apple, Amazon, Netflix and Google (Alphabet) – were a “bubble.” He said no.

On the contrary, Buffett said, this group is vastly more profitable than leading companies had been over the past several decades. Apple, Google and Amazon earn big returns and don’t require the same degree of capital investment that the old AT&T, General Motors or Standard Oil of New Jersey did. I note that while he extolled the FAANG group, he did specifically exclude Netflix because it requires so much capital to operate.

It’s also notable that Buffett said he had met with Google’s founders, Larry Page and Sergey Brin before the company came public. He said that he knew about search before the meeting because their GEICO subsidiary used it extensively.

Nevertheless, Buffett said he passed on investing in Google because he thought a competitor might be able to out-do them. He added that he’s always been a step behind when it comes to the company. He doesn’t beat himself up about it, though, noting that baseball legend Ted Williams made it to the Hall of Fame despite getting a hit only four times in ten at-bats during his best year.

Buffett Says Berkshire Size Makes It Hard to Beat S&P

Buffett acknowledged at the Meeting that Berkshire’s size makes it difficult to earn returns that exceed the S&P 500. Even if they find a way to double a billion-dollar investment, he said, it doesn’t make much difference compared to their market cap of $450 billion. [03:14:04]

If it’s hard to find really attractive investments, Berkshire has to be willing to accept some average returns. They’ve done so via investments in rail and energy. On occasion, their size and liquidity can be an advantage, as it was in 2008-09 and nearly became in March.

Buffett Cautions That Long-Term Bonds Are a Bad Investment

Buffett observed that the 30-year Treasury was then yielding 1.25%. That rate, already paltry, is subject to tax. Still worse, the Federal Reserve aims to create 2% inflation, which would lead to a negative real return.

“Equities are going to outperform that bond. They’re going to outperfrom Treasury bills. They’re going to outperform that money you’ve stuck under your mattress.” [01:10:52]

Buffett expressed concern that recent monetary and fiscal stimulus will lead to inflation. He added that not providing such stimulus would also have been a problem. Just don’t count on low or even negative interest rates to last:

I would say this, if you’re going to have negative interest rates and pour out money and incur more and more debt relative to productive capacity, you’d think the world would have discovered it in the first couple thousand years rather than just coming on it now.

{03:39:04

College Often Not Worth the Cost, Buffett Says

In the interview with Andrew Serwer of Yahoo! Finance, Buffett was asked if he’s concerned about student loan debt. Buffett said he’s not sure he would go to college today if it meant going hundreds of thousands of dollars in debt.

Buffett said he wasn’t sure about going to college when he graduated from high school. He said he learned by reading and could’ve spent his four years of college and graduate school doing something at least as productive.

I don’t think it makes sense for everyone to go to college, and I’m not sure it made sense for me to go to college.

[40:25 of Yahoo! Finance interview]

It was during his time at Columbia University that he met Benjamin Graham, author of Securities Analysis. There is a legend among Buffett-ologists that this encounter with Graham was the turning point in Buffett’s career.

Yet in the interview, Buffett says that he had already read Graham and knew what he was going to say. Taking Graham’s class was “inspirational more than it was educational.”

Buffett Supports Inclusive Board, Pushes Back at Governance Critics

In an earlier post, I noted that Berkshire Hathaway had received terrible grades for corporate governance from Institutional Shareholder Services (ISS) and other proxy-voting advisors. ISS said of Berkshire:

• Directors are too old.
• Directors have served too long.
• There is not a 50-50 representation of men and women.
• There is insufficient detail that shows how executive pay is determined. ISS does note that Buffett is paid less than 98% of his peers.

It didn’t matter to the proxy-voting advisors that Berkshire had actually been an astonishing success story, and that Buffett has been the most prominent advocate of good governance. Judging a board mostly on demographic characteristics leads to some absurd results:

This suggests that the governance experts might assign a higher rating to a company where a board loots the treasury and drives it into bankruptcy. If the directors are young and haven’t been on the job too long, why not?

Throughout the Annual Meeting, Buffett made it clear that he supports the goal of a company and country that is inclusive. His long recitation of US economic history noted that women and minorities had long been excluded from full participation in the economy and society.

The most important criteria for directors, according to the Berkshire proxy, are integrity, business-savvy, an “owner-responsive mindset and a deep personal interest in Berkshire.” These characteristics were also mentioned by director Ronald Olson before the Meeting.

As an interesting aside, the proxy shows that the ten non-management directors of Berkshire were paid a combined $40,900 in 2019 – an average of $4,090 each. It’s good value for shareholders when the average pay of some of the best business leaders in history is less than a third of what my teenage son earned as a part-time cashier at Walmart.

Buffett said he had hoped that the sponsors of a proxy resolution on inclusion would be able to attend the Meeting so that they could discuss the board’s position. The Covid outbreak made it impossible for representatives to travel to Omaha, but Buffett had Marc Hamburg, CFO & Corporate Secretary of Berkshire read a statement from the sponsors in support of their resolution.

Barry Dunaway, CFA®
Managing Director
America First Investment Advisors, LLC

This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.