In a recent interview with CNBC, Warren Buffett declared that the next 10-20 years would be much better to equity investors than bond investors. His belief was laid out under the simple thesis that interest rates are at record lows, yet high-quality dividend-paying stocks are hardly trading at a very lofty premium to historical levels. A combination of earnings growth and better capital allocation should drive stocks.
Buffett put his money where his mouth is. In a $5.6 billion, all-cash deal, Berkshire Hathaway Inc. (NYSE:BRK.A) announced that it would acquire NV Energy, Inc. (NYSE:NVE) for its MidAmerican Energy subsidiary.
Buffett’s changing style
The old Warren Buffett would have never purchased a boring, old utility company. That’s something that his mentor, Benjamin Graham would do. Utilities are too safe, too easily predicted, and generate low returns on invested capital that are restricted by state regulators.
Buffett previously had a preference for companies that could generate high returns on invested capital. Companies that needed only a modest amount of new investment to grow earnings. In his portfolio were names like American Express Company (NYSE:AXP), The Coca-Cola Company (NYSE:KO), and Wells Fargo & Co (NYSE:WFC), which generate impressive double-digit returns on incremental cash investments.
Only a few companies can generate above-economic returns on capital forever, though. Buffett’s simply running out of ideas, which one could see in his billion-dollar elephant hunts for companies like H.J. Heinz Company (NYSE:HNZ), NV Energy, Inc. (NYSE:NVE), and Burlington Northern Santa Fe, LLC (NYSE:BNI).
Buffett’s few remaining options
Buffett can only find so many great ideas – and with a growing insurance float worth nearly $100 billion to Berkshire Hathaway Inc. (NYSE:BRK.A), he needs to start coming up with more and more of them. Berkshire Hathaway Inc. (NYSE:BRK.A) can make only a few big investments with its insurance float. It could invest in corporate debt and earn sub-3% yields on 10-year securities, or it could instead go long in capital-intensive businesses ranging from railroads to utilities.
Given the options available, billion-dollar investments in companies like NV Energy, Inc. (NYSE:NVE) (which earns under 10% returns on shareholder equity), a sub-10% return on a stable utility still looks much better than bond yields measured in the basis points.
Plus, Berkshire Hathaway Inc. (NYSE:BRK.A) doesn’t need extraordinary returns on its float for the company to generate excess returns. The insurance company’s free float is money that costs Berkshire absolutely nothing. The insurance businesses that generate the float do so while posting impressive underwriting profits. For Berkshire, the cost of capital is as close as zero as you can get.