2023-05-09 08:00:13 ET
Summary
- Warren Buffett highlighted that "he doesn't know where bank shareholders are heading." Berkshire was also a net seller of stocks in Q1.
- Berkshire's pace of stock repurchases in April slowed markedly from its average pace in Q1.
- Buffett reminds us, "If the stock price is above intrinsic value, it's a no-brainer to not do a share repurchase program."
- Berkshire is earning nearly 5% on its treasuries. So Buffett's reluctance can be easily understood, considering the S&P 500's earnings yield of 5.5%.
- Buffett likely isn't seeing tremendous value in the markets right now, including in financials. So investors should take heed and reassess their optimism accordingly.
Berkshire Hathaway ( BRK.A ) ( BRK.B ) held its highly-anticipated annual meeting on May 6, as Berkshire shareholders peppered Warren Buffett and Charlie Munger with several pertinent questions relating to the recent market conditions.
Shareholders were concerned with the recent banking crisis, the advent of generative AI, and how Buffett's anointed successor Greg Abel would manage the company in the future.
Buffett and Munger also commented on why investors could have overstated Apple's ( AAPL ) exposure in Berkshire's overall portfolio, as investors need to account for their non-publicly traded portfolio.
Despite that, Berkshire remains highly confident about Apple's long-term future, which management considers more robust than it thinks about the Tesla-led ( TSLA ) EV transformation.
Buffett and Munger reminded investors that "the auto industry is too tough and not a business they find fascinating to be in." As such, Berkshire considers the business highly competitive, and "it's not a business where anyone can own the market permanently."
Hence, it's a timely reminder of what constitutes a wide economic moat, critical to underpin sustainable profitability of the leading businesses that Berkshire owns and invests in.
As such, Buffett and Munger reminded investors that investing in disruptive innovation is likely a highly challenging endeavor. Compared to Apple's more predictable business model of selling highly profitable hardware and services, management highlighted that Berkshire is "more confident about knowing where Apple will be in 5 or 10 years."
However, while they acknowledge that "the electric vehicles are coming in big time," even the Oracle of Omaha doesn't know "what the auto industry will look like in 5 or 10 years." As such, it does bring into mind how much faith Tesla bulls should place in forecasts about TSLA, similar to the one that Ark Invest ( ARKK ) promulgated, seeing a base case of a $2K expected value in 2027.
Based on TSLA's traded price of $172 at writing, it implies a CAGR of more than 100% through the end of 2027 if investors jump on board the TSLA train now. If you have high conviction in Cathie Wood's forecasts, that is.
So, where do Buffett and Munger still see opportunities investors can capitalize on if the market conditions present an attractive proposition?
While Berkshire still sees opportunities in its stock as it repurchased about $4.4B of its shares in Q1, the pace slowed in April. Accordingly, Berkshire bought back just $400M as its stock recovered from its March lows. It's also more than 25% above its October 2022 lows, likely discouraging Buffett from becoming more aggressive, given his value investing principles.
Buffett and Abel reminded investors of the importance of not overpaying (no matter the appeal of the strategy or moat) in the meeting. Buffett accentuated that "if the stock price is above intrinsic value, it's a no-brainer to not do a share repurchase program." Abel added that management "will want to be an active repurchaser of Berkshire shares when the opportunity presents itself."
Notably, Berkshire was a net seller of stock in Q1, worth about $10B, with $6B attributed to Chevron ( CVX ). Does Buffett see lesser value in the equity markets now, as Berkshire holds on to nearly $130B in cash and treasury bills on its balance sheet?
Most likely. It's easy to understand why. Berkshire is "earning close to 5% on its Treasury bills." As such, the company is "earning $5 billion annually on its cash, up from $40 million when rates were near zero."
If investors consider the earnings yield on the S&P 500 now, it isn't rocket science why Buffett was a net seller of stock in Q1. The S&P 500 ( SPX ) ( SPY ) last traded at a forward P/E of 18.2x. That translates to an earnings yield of about 5.5%, which likely isn't attractive for Buffett given what the treasuries are yielding him. Therefore, Buffett probably wasn't joking when he commented:
It isn't killing us to hold $130 billion of bills at 5% plus bond equivalent yields and everybody says, well, yields are going to go down in the future. I don't have the faintest idea what yields [ hold ] in the future - Berkshire Annual Meeting
Hence, Buffett likely isn't seeing attractive value in the overall market right now, suggesting investors should remain cautious. He also maintained his prudence over what is likely the most dislocated sector in the S&P 500: Financials, as he highlighted:
We don't know where the shareholders of the big banks necessarily or the regional banks or any bank are heading. But in terms of owning banks, events will determine their future and you've got politicians involved. You've got a whole -- a lot of people don't really understand how the system works. - Berkshire
Bloomberg's Matt Levine followed up on his previous " Nobody trusts the banks now" article with another opinion piece this week. He elaborated further on why the breakdown of "bank deposits [as] part of a long-term relationship" has significantly increased the banking business model's risks.
Notably, with bank deposits potentially much less sticky, it has significantly increased the asset-liability mismatch risks to the point that "banks are just highly levered investment funds that make illiquid risky hard-to-value investments using overnight funding." Levine added:
The whole relationship aspect of banking is devalued; rational economic decision-making based on mark-to-market asset values has become more important. This makes banks fragile. What makes banks something other than highly levered risky investment funds is their relationships, and that support is weakening. - Bloomberg
We assessed that Buffett probably knows more about banks than we do. Hence, his reticence about buying bank stocks aggressively when their valuations are "attractive" suggests Buffett probably doesn't think the risk/reward is appealing enough for him.
As a result, bank investors need to tread carefully, and acknowledge that something fundamental (relationships) might have changed, altering the sustainability of the banking model.
BRK.B quant factor ratings (Seeking Alpha)
BRK.B last traded at a forward adjusted P/E of 20.6x, in line with its 10Y average of 20.7x.
We also gleaned that Seeking Alpha Quant reflected a "D" valuation grade for BRK.B, suggesting it's likely not significantly overvalued.
Long-term investors might not be unduly concerned with the near-term risks and consider the current levels attractive.
However, we assessed that Berkshire shares seem fairly valued and thus would prefer a more considerable margin of safety, in line with Buffett's philosophy of buying "undervalued."
Rating: Hold (Revised from Buy).
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.
For further details see:
Berkshire Hathaway: Warren Buffett Is Not Greedy Now