No investment clears the bar for me, without a thorough evaluation of the bear case. To turn the process on its head: Without knowing how, why, and where your investment thesis goes wrong, it’s nearly impossible to assess how likely it is to be right.
Color me interested, then, at what Berkshire Hathaway Inc. (NYSE:BRK.A)‘s annual meeting holds. I — along with Inside Value advisor Joe Magyer, Scott Phillips of Fool Australia, Brendan Mathews of MDP and Stock Advisor fame, and Matt Koppenheffer of Fool.com — am headed to this value-investing mecca this weekend. In an attempt to spice up the dialogue around the shareholder Q&A, Buffett has decided to appoint a “qualified bear” — Seabreeze Partners’ Doug Kass — to shoot 10 hardball questions about Berkshire, and the stock, at The Oracle himself. The usual theatrics and sense of camaraderie aside, it adds yet another layer of enjoyment to “Woodstock for Capitalists.” It’s also a testament to Buffett’s transparency.
In the spirit of the debate, here’s my best guess at three potential Kass targets — and, as a happy owner of Berkshire Hathaway Inc. (NYSE:BRK.A) shares, I’ll also offer my rebuttal.
1. Berkshire’s expensive price tag
A commonly bandied-about challenge to owning Berkshire Hathaway Inc. (NYSE:BRK.A) shares is its valuation. There are about 55 ways to value Berkshire and its prospects, but let’s cut through the noise. Keep it simple, stupid.
For a given price, the market expects a certain performance threshold. So, let’s assume that Berkshire is able to grow at just 3%. At 1.4 times book value, we can figure that out pretty easily (via the justified price-to-book) — the market expects Berkshire Hathaway Inc. (NYSE:BRK.A) to earn about 13% returns on equity, and grow its earnings at 3%, in perpetuity. A little perspective: For the 13-year period ended in May 2011, the S&P’s ROE averaged 22%. Now, this measure isn’t without its flaws, and it’s not a perfect apples-to-apples comparison. But, with such tremendous franchises as GEICO, Burlington Northern, MidAmerican, and Lubrizol, do we think it’s possible? Yessir. They’re best-in-class companies, priced as if they’ll generate sub-market returns. Not screaming cheap, but I’ll take that bet.
2. The Elephant Syndrome
The big elephant is the dominant herd member, until its size actually becomes a liability. And so the argument goes that Berkshire Hathaway Inc. (NYSE:BRK.A)’s biggest enemy is itself. It generates too much cash, and has too few opportunities to profitably deploy it. That’s all fine and good, but yet again, a bit of context is in order. Over the past 20 years, investments as a percentage of total assets at Berkshire have declined from 80% to 30%. In essence, we’re paying a lot less for capital redeployed, and more for a collection of splendid operating businesses.