Is Warren Buffett irreplaceable? Can Berkshire Hathaway Inc. (NYSE:BRK.B) continue thriving without its genius leader? Buffett is clearly a unique person and an exceptional business leader, and he will be missed by all those who love the markets and investing … even more by Berkshire investors.
However, given the size of the company, and its current approach to investing, Berkshire Hathaway Inc. (NYSE:BRK.B) will most likely continue making great investments and increasing shareholder value in the long term, even without Warren Buffett.
Warren Buffett is already 82 years old. Even if he is in excellent health for his age, and he hopefully has many long years of healthy life ahead of him, investors need pay close attention to succession plans and what they mean for Berkshire.
Berkshire Hathaway Inc. (NYSE:BRK.B)´s operating subsidiaries are managed quite independently by their respective CEOs, so there won´t be many changes there after Buffett is gone. But investment management is obviously a critical area in which Buffett has been enormously valuable for Berkshire over the decades, and this raises the question whether the company will continue making those profitable investments when the legendary investor is not calling the shots anymore.
There is one important thing to consider about this discussion: when Buffett was managing small amounts of money and flying under the radar, he was achieving returns that would be practically impossible to replicate by any other investment manager. By simply making opportunistic investments at bargain prices, Buffett was making a killing when managing small amounts of money.
But now that he is investing billions of dollars, things are dramatically different. Buffett needs to go after big companies nowadays, and that makes it much harder to buy high-quality businesses at attractive valuations. In his own words:
“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
It´s the financing, stupid
Size has its disadvantages when it comes to investing returns, but Berkshire Hathaway Inc. (NYSE:BRK.B) has adapted to the challenge and the company has found ways to increase performance by capitalizing the financing side of the equation. To begin with, it’s worth noting that the Berkshire has access to leverage at amazingly low costs thanks to the company´s insurance operations, and this is a big positive when it comes to increasing returns on investments.
A research paper by Andrea Frazzini and David Kabiller from AQR Capital Management examined the amazing performance that Berkshire Hathaway Inc. (NYSE:BRK.B) has obtained over the decades, and the authors find that leverage is a big plus for the company. The article estimates that Berkshire´s average annual leverage ratio has been in the 1.6 to 1 zone. But Buffett´s secret source when it comes to leverage consists of paying an almost ridiculously low cost on those funds. The estimated average annual cost of Berkshire’s insurance float has been only 2.2%, more than 3 percentage points below the average T-bill rate, according to the authors.
Besides, Buffett has been putting a lot of attention on the financing terms of the deals in which he gets Berkshire involved lately, with the Heinz acquisition being a good example to consider. At a valuation of 20 times earnings estimates for next year, the purchase price for Heinz doesn´t look particularly attractive. But Buffett is not only getting an equity stake in the company.