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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.

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.

One possibility is Occidental. If they loved OXY at $60, they probably like it quite a bit at $55. Since I am riding the coattails on that one, I just sold some more puts on OXY, now I have some 57.5s, some 55s, and some 52.5s. I assume the higher strike ones are likely to be exercised and I will own some more shares in the coming months. It'll be interesting to see what happens if Berkshire makes a move to acquire the whole thing. But EVEN if they do acquire the whole thing, it'll only make a small dent in the huge pile of cash because OXY is relatively small at a market cap just over $50B and about $20B in debt.

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.

This would be a very sad day for many long-time Berkshire holders. Many people choose to hold Berkshire specifically because it doesn't ever result in taxable distributions of any kind. It is one of those VERY rare investments that both perform reasonably well AND allows for the investor to decide exactly when a taxable event is realized. It is specifically this feature that allowed someone like Ruth Gottesman to donate such a large amount to the charitable endeavor of her choice.

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

I've long considered it an index. An index of companies which actually make money, rather than companies that hope to make money. Both can be good investments, one lets me sleep better.

A thoughtful post.

A couple of random thoughts---

If you combine these two comments
"...assume this price represents some unknown discount to his estimate of Berkshire's intrinsic value. We know that discount has been shrinking over time..."
and
".... 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."
...then there is a thought that occurs to me: I think perhaps Mr Buffett expects the utilities division to recover fully, or almost fully, to its prior level of profitability. And one indicatino of that is that the buybacks are at valuation multiples that did not previously make a whole lot of sense. I value the operating subs based on a multiple of recent earnings, which gives a pretty low value lately...but if valued at something near historical net margins, you get a much bigger number.

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.
There is no real reason that Berkshire's way of dealing with the cash has to be particularly typical--it never has been, really. As long it's a method in the acceptable range. For example, if it really is deemed excess to requirements then a tender offer can work very well, as Markel has shown.


The interesting question regards the implicit assumption of your post, that there won't be, any time soon, a time that large piles of ready cash are scarce and therefore valuable, more than justifying a wait. We haven't seen many weeks like that in the last 20 years, but that is not an absolute guarantee that such times won't appear once again. Maybe everything will be pretty smooth and richly valued almost all the time in future, who knows? But I would not assume that to be the case.

Jim

“Maybe everything will be pretty smooth and richly valued almost all the time in future, who knows? But I would not assume that to be the case.”

I recall Warren saying in the recent past AGM that he Still feels satisfactory opportunities will arise often unexpectedly, and therefore he is neither eager to start a dividend nor compromise on his buyback discount threshold. I hope he is right, esp. to add a few gems of solid wholly owned companies.

Maybe the US election or geopolitical turbulence might create some volatility and pretty good opportunities, despite causing us some short term indigestion?

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