No. of Recommendations: 18
The Kingdom I'm referring to is Berkshire Hathaway stock. It has been a long and glorious ride, but the nature of our beloved stock is irreversibly changing into a new and very different animal.
Historically, BRK is the product of arguably the greatest value investor of all times. He generated incredible returns, then found new ideas to absorb those profits, rinsed and repeated until we find ourselves where we are today. Painted into a corner.
It's a nice green corner, but a corner nonetheless, and it means the old model of reinvesting new profits into new ideas is no longer viable.
Consider this. What discount to IV should Warren Buffett require when repurchasing BRK stock? We closely watch his peak purchase price to date and assume this price represents some unknown discount to his estimate of Berkshire's intrinsic value. We know that discount has been shrinking over time but don't know exactly what it is. I argue it could be, and should be, zero. More specifically, I believe he should pay up to the full value of his best guess of IV, NOT conservatively measured. Why? Because both cash and IV are growing at an increasing rate. Intentionally erring on the low purchase price speeds up the excess cash problem, so minimize it by paying full IV.
The profits filling Berkshire's coffers every month are a big and difficult-to-solve problem. I think BHE was a great idea of Warrens to absorb copious amounts of cash and generate reliable, above-bond-market returns. It was a regulated industry where the regulators guaranteed reasonable returns -- until they didn't. They decided the costs associated with wildfires and climate change were not going to be covered, throwing a gigantic wrench into the works.
Elephant hunting has been much discussed here. Given the size and scarcity of the beasts required, maybe we should start calling it woolly mammoth hunting.
So what does that mean for the new kingdom? The keeps coming in at an increasing rate. Warren may not be out of tricks, but the law of large numbers means at some point the cash will outstrip his ability to use it. That time is now, or at least in the very near feature. He will need to be aggressive in his repurchase price and hope the market caps the stock price low enough. There may be long periods when the price stays above IV and he has to run higher cash balances than he'd like, but during corrections he'll be able to repurchase as much as he needs. I suspect that will be what happens during the next decade or so.
But as the cash balances and their fluctuations over the full market cycle keep increasing, the leadership will begin using dividends alongside repurchases to distribute the incoming cash. I don't think it will happen while WB is in charge, but I think it is in our future.
I'm viewing Berkshire more and more as a stock index. It's special in that each stock was selected by a master stock analyst, mostly targeting a forever holding period. As time passes, those stocks will on average become typical, but that should take a very long time. In my lifetime, I expect it to be a stock index with an above average return based on how the stocks were selected.
I also view Berkshire as turning into a cash cow and realize that cash will need to be returned to investors in a more typical fashion.
