The Sage of The Plains is hanging up his Hewlett-Packard 12C financial calculator and is calling it a day. Yep, after decades of being considered one of the most astute stock pickers in the market, he’s increasingly admitting that he can’t add more value to Berkshire Hathaway Inc (NYSE:BKR.B) by making more stock choices.
Maybe it’s time for everyday investors to do the same.
The Road to Riches
Warren Buffett came into the stock market long ago after coming to his epiphany that you could find great stocks by focusing on their internal valuation as businesses that were being mispriced by the market. Led by the tutelage of the famed Benjamin Graham, Buffett found stock after stock of small- to mid-sized businesses that provided stellar opportunities to unlock ignored value.
Be it solid streams of ready cash flows, or assets often including investment portfolios that were worth more than the market capitalization, Buffet knew how to pick them. And he began to gain the attention of investors — including Benjamin Graham himself, who hired him to work at his firm.
One of Buffett’s more infamous buys was a textile and manufacturing conglomerate in New England called Berkshire Hathaway that was formed after a long series of mergers of local companies. Buffett used the company as an investment conduit for his stock picking that was openned to new investors beyond his past operation of running small partnerships. He would later admit that Berkshire was a terrible buy that cost plenty of investment opportunity, but that the upside was that it did give him access to the public capital markets.
That led to his waves of stock picking. He would go on to buy a series of smaller insurance companies, retailers, manufacturers and financials that would lead to swift gains of millions of dollars for BRK.B stock holders.
He was then relatively small compared to the major fund managers. That enabled him to make a big impact on Berkshire Hathaway’s shares by purchasing under-the-radar stocks that met his criteria of cash generation and were mispriced by the stock market.
The Plan Worked, Out With The Plan
That went very well for Buffett and his investors in BRK.B. Then during the beginning of this decade, Buffett recognized that he just couldn’t pick stocks successfully as he’d done for decades.
Berkshire Hathaway was so big, and commanded so much capital, that many of his ideal picks might only end up as a rounding error on the book value of the stock. So he changed course. He hired two “young guns,” as he called them, and turned over two small portions of Berkshire Hathaway’s capital to manage.
Todd Combs and Ted Weschler continue to out-gun their boss, not by being particularly better, but rather by doing what Buffett used to do when Berkshire Hathaway was new and small. They bought stocks that were classic Buffett. And since their funds were relatively small — at a billion dollars or so — they could at least make an impact on their portion of Berkshire’s stock value.
Buffett continued to be impressed. He said in his 2012 letter to shareholders that “they left me in the dust” at picking stocks.
Changing Times for BRK
But now, Buffett as well as Combs and Weschler are changing course. The new course will be to de-emphasize stock selection and in turn run the company as a collection of its operating businesses. This will effectively make Berkshire Hathaway more of a traditional big conglomerate company rather than a stock-picking investment company.
For BRK.B stock holders, this means relying more on regulated businesses that come with heavy demands for maintenance cash, as well as plenty of potentially expensive demands for new capital expenditures to build and develop businesses.
This is a far cry from the former mission of picking stocks and businesses like insurers that just threw off cash flow from their operations to feed new stock investments by Buffett. And it should represent a greater challenge to maintain Berkshire’s ability to generate returns than it was to build it in decades past.
With Berkshire as a conglomerate made up of insurers, rail and transportation companies — as well as energy transmission and petrol pipelines as well as other operating units — the market will have a challenge placing a premium valuation on Berkshire stock. That’s because the market continues to question valuations of many other similar conglomerates, including General Electric Company (NYSE:GE), which has been the subject of repeated calls for an operational breakup.
Future of Stock Investing?
While Buffett and his young guns surrender their stock picking genius, perhaps they are just coming to the conclusion that the stock market is on its way out. Stocks continue to fall as a primary focus by an increasing number of investors. From the peak in the 1990s, the number of publicly traded U.S. stocks has almost been halved. The number of new stocks coming to the stock market via public IPOs has plummeted by some 65% in just the past three years.
Replacing them is a rising number of indices and index-related investments, such as exchange-traded funds (ETFs) and exchange-traded notes (ETNs). These now outnumber the number of publicly listed stocks in the U.S. stock market.
Buffett sees even more trouble for stocks. He has said he is concerned that increasingly more stock picking fund managers can’t beat the S&P 500 and other key indexes, especially after their fees and expenses. That’s confirmed by a recent study by Standard & Poor’s that says that as few as 1 in 20 fund managers beat the general stock market index.
So, with Buffett and Berkshire Hathaway increasingly skipping stock picking as a losing cause and stocks going the way of indexing, what’s left for the individual stock investor?
Perhaps fewer big stocks and another look at the index market. Or to learn from Warren Buffett in his salad days and focus on the smaller cash-rich stocks that perform under the wire of the giant market indices.
As of this writing, Neil George did not hold a position in any of the aforementioned securities.
