Warren Buffett, the iconic investor who leads Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B), wrote in his annual letter to shareholders that he and Berkshire’s board are “enthusiastic” about the prospect of a new CEO to take the reins of the company. At 81, Buffett is painfully aware of his mortality.
And after lagging the market recently, investors are painfully aware that Berkshire hasn’t delivered quite the returns that it used to.
That begs the question: Are the best days of Buffett long behind him? And if so, does that mean Berkshire Hathaway is doomed to struggle without his steady hand at the helm?
Berkshire is one of the biggest success stories on Wall Street, no doubt about it. As an investment, it has delivered a compounded annual gain of 19.8% since 1964 — easily double the S&P 500’s 9.2% compounded return. More dramatically, Berkshire is up over 513,000% since 1965 vs. 6,400% for the S&P 500.
The last few years, however, haven’t been all that impressive.
- 2009: returns of 19.8% for Berkshire vs. 26.5% for the S&P 500
- 2010: returns of 13% for Berkshire vs. 15.1% for the S&P 500
- 2011: Returns of 4.6% vs. 2.1% for the S&P 500
- Total returns since 2009: Berkshire has added 20% in just over three years, while the S&P 500 is up 46.6%
Maybe a changing of the guard is in order.
Berkshire Earnings and Buffett’s Annual Report
Here are the earnings details from the annual report: For the fourth quarter, Berkshire’s net income declined to $3.05 billion from $4.38 billion a year earlier. That’s a 30% slide, blamed largely on derivatives bets from 2010 that juiced the earlier numbers. The company made $2 billion on the trades in Q4 last year, but has returned to the conventional Berkshire business of big investments and acquisitions as of late.
What’s more, as the profits dropped from derivatives, the losses from credit-default contracts rose. These are investments where Buffett and Berkshire bet on the ability (or inability) of borrowers to repay debt. Losses from credit-default contracts widened to $216 million from $157 million a year earlier.
On the plus side, Berkshire’s cash on hand surged to a mammoth $37.3 billion — adding $3 billion bucks in just three months. Unlike companies such as Apple (NASDAQ:AAPL) that notoriously hoard cash with no intention of acquisitions or dividends, Buffett and Berkshire actually tap this war chest for business moves — such as the $9 billion it used to buy Lubrizol in 2011, or recent equity stakes taken in tech and media companies like Liberty Media (NASDAQ:LMCA) and International Business Machines (NYSE:IBM).
Book value for Berkshire, a measure of assets minus liabilities, rose almost $5 billion from Q3 to Q4, totaling $164.9 billion from $160 billion.
But the headline number is, of course, the earnings. That’s because not only did Q4 profits slip, but full-year net income was also down about 30%, to $10.3 billion from $13 billion in fiscal 2010.
In short, there are a lot of positives. But profits — for Berkshire Hathaway or for its shareholders — just aren’t there.
Buffett and Berkshire Send Message of Patience
Here’s where things get interesting. The text of Buffett’s letter seems to acknowledge the inevitability of change — a change that may be coming sooner rather than later.
“The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow,” Buffett wrote. “As 2011 started, Todd Combs joined us as an investment manager, and shortly after year end Ted Weschler came aboard. Both of these men have outstanding investment skills and a deep commitment to Berkshire. Each will be handling a few billion dollars in 2012, but they have the brains, judgment and character to manage our entire portfolio when Charlie (Munger) and I are no longer running Berkshire.”
Combs has already left his mark with recent tech and media additions to the Berkshire portfolio, which in addition to Liberty Media and IBM also include DirecTV (NASDAQ:DTV) and Intel (NASDAQ:INTC). Those investments are definitely not in the same vein as mainstays of the consumer staple business and banking industry, which Buffett always gravitated to in years past.