While I always look forward to the Berkshire annual meeting, I was especially anticipating what Warren Buffett had to say about the recent economic crisis. With an empty arena, Buffett and Greg Abel (vice-chairman of non-insurance operations) gave insights to some of the pressing questions investors are wondering. I appreciated Becky Quick’s selection of questions, instead of the usual “how do I calculate the intrinsic value of Berkshire??” that someone always asks. In this post, I wanted to provide highlights of Berkshire shareholders meeting, choosing the top 5 questions and summarizing Buffett’s response.
Lender of Last Resort
In the last financial crisis, Berkshire acted as a lender of support for eight different deals. Despite the injection of expensive capital through preferred stocks and securing warrants, these companies were in fact paying for the sign of confidence from Berkshire in the midst of a crisis and that was invaluable. Today we have QE, infinity, low interest rates, and hungry hedge funds, even though the economy has deteriorated rapidly over the last few months. Why have we not acted as a lender of support?
This is an interesting question because it brings up some history lessons from the last financial crisis. During 2008, Berkshire was primarily supplying capital by means of preferred stocks and warrants, versus buying common stock over the market. These capital injections were on terms that were pretty generous to Berkshire. These companies knew that Buffett’s reputation carried weight, and Berkshire has a fortress balance sheet that could provide funding. Berkshire was literally able to do deals that no one was able to do.
Interestingly, Buffett admits his timing of deploying capital in 2008 was a bit early, that he would have been better off waiting a few months. Even the greatest investors can’t time the market.
As for the market panic in March, Buffett says the phone wasn’t ringing. The Federal Reserve quickly swooped to provide loans to support the financial system. Even marginal companies are able to access funds, so there is no need (for now) to come crawling to Berkshire. While many people are critical of these actions for various reasons, mainly because it prevented stocks to get very cheap, Buffett admits it was the right thing to do even though he got undercut. It is interesting to see Buffett support Jerome Powel’s efforts even though most investors are whining (which some of that is deserved).
COVID Impact on the Insurance Industry
Would you please help us understand the effects of COVID-19 are on our insurance businesses? Other insurance companies have reported losses from boosting reserves for future insurance claims that they expect to be paying as a result of Coronavirus. Yet in Berkshire’s 10Q released this morning, we do not appear to have reported much of these future expected losses. Can you tell us why this is the case? What kind of risks Berkshire is underwriting that allows us not to be affected by the pandemic or conversely, what we are writing that might be?
When it comes to insurance exposure to COVID19, Buffett warns there could be a huge amount of litigation. Many businesses that were forced to shut down operations are looking at their insurance policies to see if they can make a case for a payout. The potential for insurers to be liable is if they wrote commercial multiple peril (ie business interruption) policy.
Arguably, a pandemic caused business interruption. However, typically the policy relates to physical damage to a building that prevents business operations. Buffett gives the example that a strike at an auto plant would not trigger a business interruption policy. An example Warren provided where it would qualify is when a fire at a neighboring building spread to a Berkshire subsidiary building.
Luckily, Berkshire is mostly exposed to auto insurance, which should not have this problem. Buffett did mention that one large insurer had ambiguous policy language that could in fact have to cover pandemic losses. He didn’t name names, so it will be interesting to see who wrote this policy.
Thoughts on Negative Interest Rates
Interest rates are negative in much of Europe, also in Japan. Warren has written many times that the value of Berkshire’s insurance companies derive from the fact that policy holders pay up front creating insurance float on which Berkshire gets to earn interest. If interest rates are negative, then collecting money up front will be costly rather than profitable. If interest rates are negative, then the insurance float is no longer a benefit but a liability. Can you please discuss how Berkshire’s insurance companies would respond if interest rates became negative in the United States?
It is reassuring that Buffett is confounded by negative interest rates just as much as I am. He mentions his disbelief in how long negative rates have lasted in Japan and Europe. Interestingly, Buffett is surprised that these negative rates have not caused significant inflation. A humorous quip Warren gave was that if you could have negative rates, high debt, and no inflation, then civilizations would have figured this out a couple thousand years ago.
It is fascinating to hear Buffett make these comments that are along the same line of thinking as all the Perma Bears have been screaming about for years, however he isn’t whining about how the system is rigged and ripe for collapse. The only advice he gives to navigate the negative rate world is to hold equities since negative yielding bonds only serve as speculation, not an investment.
Are Buybacks Evil?
Berkshire has invested in many companies with stock buy-back programs. Recently there’s been a backlash against buy-backs. What are your views on this subject?
During the response to this question, I felt like I was repeatedly yelling “boo ya!”. Buffett opens up his remarks by saying it is politically correct to be against buybacks. Stock buybacks have gained a bad stigma because some corporations take on debt for the buyback, or use their profits to purchase stock instead of spending it on R&D or increasing wages. While I don’t want to get into the nuances of the pros and cons of buybacks in this post, the key thing is that buybacks are another form of returning cash to shareholders.
Instead of paying a dividend, businesses can buy shares from those who wish to sell their shares, thereby increasing the continuing shareholders stake in the company. An example Buffett makes is the scenario when three partners run a business that reinvests all of its profits. One partner needs cash so he asks the other partners for a dividend. But the other partners don’t want the cash from a dividend, don’t want to pay taxes on it, and want to leave that cash in the business to grow. Instead, the two partners decide to buy some shares from the other partner. Now the partner gets their cash, and the other two grow their stake in the business.
This sounds all well and good, but most companies overpay on the shares they buy back. Buffett has long stated that he loves when companies (including Berkshire) buy back its own shares when it is trading below how much the business is actually worth. This is an especially efficient way to deploy capital if there are no other better investment prospects for the company to engage in. The problem is that buybacks have become a fad. Recently corporations are doing massive buybacks at the height of a bull market instead of when their stock is cheap.
Another point Buffett makes is that it is dumb to commit to buy $X amount of stock each year. He favors being opportunistic about it, not mechanical. An analogy Warren makes is that it is like saying you’re going to buy a $5B company without knowing what you are getting.
Bad buyback policies can make the company vulnerable during a crisis. This is the situation we are seeing with the airlines, they spend a ton on buybacks and now they need bailed out. This is an example of poor capital allocation, not proof that buybacks are evil.
While I do agree that many companies botch the execution of their buybacks, Buffett summarizes my thoughts on the matter by saying: “Some do it stupid but that doesn’t make it immoral”. Mic drop.
Q1 BRK Buyback
Can you ask Warren why he didn’t repurchase Berkshire shares in March when they dropped to a price that was 30% lower than the price that he had repurchased shares for in January and February?
One thing Berkshire followers have been wondering is whether or not Buffett bought any shares during the first quarter. The price of Berkshire B shares got down to around $165 during March, where it was trading between $200-220 last year. With Berkshires large cash holding, many have been hoping Buffett would reward shareholders with a large buyback.
When asked about the matter, Buffett confirmed he did not perform any buybacks during the quarter. Even though Berkshire appeared cheap, Warren said that it is not any more compelling than it was 6 months ago. Yes Berkshire has gotten cheaper, but the value of the business has decreased as well. For instance, Buffett’s airline investments suffered a loss that materially hurts Berkshire.
Additionally Buffett believes there will be better opportunities ahead than performing share buybacks. The large cash reserve that Berkshire sits on provides optionality, which is valuable during uncertain times like these. While I do not currently own Berkshire (which could change), I would much rather see Buffett have one last glorious buying opportunity instead of boringly buyback stock.
Conclusion
In my opinion, this was one of the best shareholder meetings. Buffett answered some hard hitting questions, and was more candid than usual. While he had to be careful not to sound too pessimistic, he definitely has concerns with the economy. These were just the highlights of the Berkshire shareholders meeting, but I highly recommend watching the meeting or reading the transcripts.
Here is the video of the full meeting.
A full transcript of the meeting can be found here.
My recent investing history can be found in this post.