We attended the 51st annual Berkshire Hathaway AGM in Omaha, Nebraska. In customary fashion, Warren and Charlie answered questions from shareholders for 6 hours on topics ranging from renewable energy to taxes on sugar. Below we highlight three key takeaways from the meeting;
In both Australia and the US, regulators are increasing the amount of capital that a bank must hold in order to strengthen their balance sheets. Warren’s comment to this was that it is “designed so that larger banks in the US will become less profitable than the smaller banks.” When a bank has to hold more capital in order to conduct its operations it has the effect of reducing return on equity (ROE). Warren stated that ROE’s for banks were previously very high and went on to illustrate the effect of holding more capital. “If a bank had to operate with 100% equity then they wouldn’t be able to make any return. If they had 1% of equity then returns would be huge.” In Australia APRA has been increasing the tier one ratios of our major banks, which has the effect of reducing returns as described above. This has in part contributed to the sell off we have seen in the bank sector share prices. Unfortunately, it doesn’t look like the regulators are done yet which could see bank returns hamstrung even further.
Low Interest Rates
There were numerous questions that tackled the topic of low interest rates and how they affect the investment landscape. The first of these relates to insurance, which has been the backbone of Berkshire Hathaway for many years, specifically due to the ‘float’ which is available for investment. ‘Float’ relates to the money that has been received from insurance premiums but has not yet been (and may not be) paid out for claims. This money is invested in fixed income, the returns on which are affected by interest rates. Warren commented that “the whole idea of float is to invest at a positive rate, but for a considerable period going forward that will not be the case. He thinks the re-insurance business specifically will not provide the same returns in the next 10 years as it has in the past 10.”
The second aspect mentioned regarding low interest rates was how it relates to prices being paid for stocks. “We have been dealing with low interest rates for a long time now. Without being too exact about it, very cheap money causes Berkshire to pay more for businesses.” Warren admitted to paying more for a recent acquisition, Precision Castparts than he would have if interest rates had been higher.
Buybacks have been a common feature in both the US and Australia recently despite some share prices being at elevated levels. Berkshire Hathaway has a policy that says they are happy to buy back shares at 1.2x book value. The reason for paying above book is the value of the business that can’t be seen in the tangible asset figure. Warren stressed that there are a lot of companies out there buying back stock, but none of them provide a proper reasoning or a price level they deem to be good value. Warren stated that “a lot of companies with large cash balances buy their own stock regardless of value. They also make acquisitions on this basis too. Buying back stock at too high a price is extremely detrimental to returns. You want companies who will buy back stock if their share price falls to a level they deem good value. Most of them just buy to keep because they feel they have to.”
Ben Rundle is Portfolio Manager of the NAOS Absolute Opportunities Company (ASX:NAC). Find out more about NAC here: (VIEW LINK)
Ben Rundle is a Portfolio Manager at NAOS Asset Management Limited. Ben has over 10 years’ experience in financial markets and prior to joining NAOS he held various roles within the Financial Services Industry including roles at Macquarie Bank.
Great Article Ben. Hope you enjoyed Omaha. I watch some of the live stream. These guys are my heroes, I find particularly relevant for example Warren notes that he would have brought back Berkshire at 1.2 PB or below but most notably like above companies by at their peaks .. I.e Caltex