Summary
- Buybacks accelerate as Buffett continues to view the stock as cheap.
- Shareholder votes will test Berkshire’s operational model after Buffett.
- Berkshire’s executive compensation is unique and best for lower growth companies.
- Berkshire is being eaten by index funds.
- I’m still sleeping well at night owning Berkshire.
Stock buybacks accelerate as Buffett continues to view Berkshire stock as cheap
In 2020, Berkshire repurchased almost $25B worth of its own shares. The report on the first quarter of 2021 indicates two trends:
1. Buybacks continue to accelerate, with about $6.5B worth of stock repurchased in the quarter.
2. The average repurchase price is increasing. Shares were purchased at an average price of $251 per B share in March 2021, up from an average price of $225 in December 2020.
This indicates that Buffett and Munger view their stock as undervalued – even at a price of $251 per B share.
Shareholder votes as a harbinger of market pressures after Buffett
Two shareholders proposals were brought to a vote this year: one requesting Berkshire to disclose climate change risks to its business, the other centered on Berkshire disclosing its approach and metrics on diversity and inclusion.
Such proposals are not unique in the history of Berkshire. For example, in 2011 there was a shareholder proposal for Berkshire to report on how it would meet new EPA guidelines around greenhouse gas emissions. In 2021, and in years past, Buffett and the Berkshire board recommended against supporting these proposals and shareholders followed their recommendations. All proposals were voted down.
Buffett’s position on such proposals is that Berkshire is a collection of companies that operate independently in different countries and different businesses with different social norms. For Berkshire’s central management – a team of a few dozen employees in Omaha – to impose a one-size-fits-all approach for these independently operated businesses with over 300,000 employees would would reduce rather than improve the ability of the business to address questions of diversity and inclusion at a local level.
Berkshire’s approach to allowing its businesses operate independently is unique among corporations. Indeed, it is a major part of Buffett’s pitch in buying privately owned businesses when he can credibly say that – unlike many private equity firms – he won’t be radically cutting staffing, changing management or saddling the company with debt.
There are other philosophical differences on these proxy votes that warrant a brief mention:
On climate change
Buffett’s position is that climate change is a threat to the environment and to Berkshire’s business, hence the shift of Berkshire Hathaway Energy out of fossil fuels and towards renewables. However, Buffett believes that fossil fuels will be important to the economy for the foreseeable future, and that companies like Chevron – who he recently invested in – serve a positive social purpose.
On diversity and inclusion
One view is that increasing the measurement and reporting of inclusion and diversity metrics is an effective means for increasing inclusion/diversity. Reading between the lines, Berkshire’s view is that, where you introduce global metrics, you introduce incentives that can lead to problems as well as solutions – particularly in dealing with issues of inclusion that can be difficult to quantify and address. Berkshire’s preferred approach is that metrics and approaches are therefore best developed by individual businesses at a more local level.
Berkshire stands alone in how it pays executives
There has been criticism from pension funds and index funds of Berkshire’s abnormal executive remuneration policy. As with the other shareholder proposals, I see Berkshire’s unique approach as a good rather than a bad thing. Here is the exhibit of executive pay. Pay particular attention to the pay of Greg Abel and Ajit Jain who, for all intensive purposes, are the operating CEOs of Berkshire:
Notice that, of the $19M in annual compensation each receive, the vast majority is in the form of a guaranteed salary. $3M is provided as a bonus and there are no stock options. Institutional Shareholder Services criticises this as a lack of incentive based compensation.
However, this lack of incentive based compensation can be a feature rather than a bug. Contrast Berkshire with a typical public company where CEOs are remunerated with large blocks of stock options that they cash in on when the market rises. This can make sense for high growth companies where the CEO has a big influence on company growth and stock price. However, for lower growth companies, where stock price depends much more on the overall market, stock option compensation makes a lot less sense (even though it sounds good when you call it “incentive based”).
Further, paying a high base salary is more transparent for investors examining financial statements. While a salary appears clearly as an expense in the profit and loss statement, the treatment of stock options is a lot harder to understand because the cost to the company is one of dilution of shareholders rather than a clear cash expense. This can allow management to hide the true costs of compensation in stock option arrangements.
For a relatively low growth company like Berkshire, I’m happier for Berkshire to pay a high salary than paying incentive stock options.
Index Funds are eating Berkshire Hathaway
Over the past decade, Warren Buffett has espoused the virtues of investing in index funds like the S&P500 – even to the point of recommending the S&P500 over buying Berkshire Hathaway stock. Buffett is one of Jack Bogle’s biggest fans (the founder of Vanguard Index funds).
Buffett has recommended that, upon his death, the ~0.3% of his wealth that will accrue to his wife (the remainder going to charity) be converted by her from Berkshire stock into shares in an S&P500 index fund. This is not exactly a vote of confidence in Berkshire stock, although I would temper this by adding that Charlie Munger – Buffett’s side kick – is clear in saying that he believes Berkshire will outperform the overall market over the long term.
I’m unsure if this is ironic or not, but when Buffett passes away, Berkshire will increasingly come under control of the index funds he espouses – as index funds take up an increasing percentage of the overall market. You can see here lists of the top shareholders in Berkshire today – taken from marketscreener.com :
As I have previously written, I see the rise of index funds (e.g. Vanguard, Blackrock and Statestreet (SSgA) together owning almost 20% of Berkshire) as a net negative because it encourages retail investors to own a little bit of everything they know nothing about rather than own a few stocks they know something about. By buying into index funds, we have dedicated responsibility for governing our corporations to yet another layer of corporations like Blackrock, State Street and Vanguard – rather than directly owning and voting our shares ourselves.
Final Thoughts on Berkshire’s 2021 AGM
I continue to believe that Berkshire is a wisely and conservatively managed collection of high quality businesses. Further, Buffett points out that he is seeing price inflation in the economy, and I see ownership of Berkshire as a way to hedge out that inflation risk to some degree because they own contracts (via their energy and railroad and insurance businesses) where prices can adjust to inflation.
That said, I am concerned about Berkshire post-Buffett. Greg Abel as future CEO stands a chance of preserving the Berkshire culture of operating its businesses independently. However, it will become increasingly difficult without Buffet’s large vote, and, with the rise of index investing to resist short term pressures index investment groups. For now, I will continue to hold 30% of my liquid net worth in Berkshire and sleep well.