Note: This video is part of Morningstar's coverage of the 2015 Berkshire Hathaway Annual Meeting.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. It's been 50 years since Warren Buffett took over Berkshire Hathaway (BRK.A/BRK.B), but can the company repeat its success over the next 50 years? I'm here today with Gregg Warren--he is a senior stock analyst at Morningstar who covers Berkshire Hathaway--for his thoughts.
Gregg, thanks for joining me today.
Gregg Warren: Thanks for having me.
Glaser: Let's start with that succession question. That's obviously been on a lot of people's minds for years now as Warren Buffett gets older. We got a little bit more clarity on who the successor could be in the letter this year. Can you talk to us about that?
Warren: I'm not sure if we've necessarily gotten more clarity. We've been down this path before. At one time, Joseph Brandon was the heir apparent; another time David Sokol was the heir apparent. And we've seen both of those guys leave the firm under a cloud. Brandon left in 2008 in relation to the AIG scandal, and Sokol left due to his own personal failings in 2011. So, to pinpoint one guy who is leading one of the subsidiaries as being the heir apparent has proven to be a little bit difficult over the years. That said, I think there are probably five really good candidates for the top job. Ajit Jain, who runs Berkshire Hathaway Reinsurance; Greg Abel, who runs Berkshire Hathaway Energy; Matt Rose, who heads up BNSF; and then you have Tony Nicely at GEICO and Tad Montross over at General Re.
Now, of those five, Ajit Jain has probably gotten the most attention over the last decade or so. Greg Abel, the spotlight has been put on him this year. He got some glowing praise from Munger--both he and Jain did in the annual report. So, they've sort of become the two that everybody is focusing on right now, but I think it's a bit more of a media-led frenzy here. I think, overall, our top pick continues to be Jain. We think if the board is looking exclusively for a capital allocator to replace Warren, we couldn't think of a better person than Jain. He has done a fantastic job with Berkshire Hathaway Reinsurance, and he potentially has what it takes to look at risks and returns and make better investment decisions over the long run.
That's not to say that Abel is not qualified. We think that he is definitely on the board's mind. He is also a great capital allocator. He has done a great job at Berkshire Hathaway Energy over the last 10 or 15 years. We also think that he brings operations experience to the table--something that Jain is not necessarily lacking, but doesn't really have on the same scale. So, we think if the board is looking for somebody who is a bit more of an operator, then we could see them going with Abel; but at this point, it is sort of a two-horse race between those guys.
Glaser: So, we obviously don't know exactly who will take over. We're not sure who is going to take over; but when Buffett does finally stop running the company, what will some of those biggest challenges be? What will the new CEO have to do?
Warren: Well, I think the role itself, since they've sort of delineated out the different jobs that Warren does, the top job is no longer going to be looking at the investment portfolio. That's already been sort of segregated off to Todd Combs and Ted Weschler. So, that's less of an issue for them. Their whole focus is going to be just on taking the cash that the company brings in and investing it wisely. From what we've seen historically, the firm has been completely decentralized. It's probably the best example of a conglomerate we've ever seen, and it doesn't require a whole lot of hands-on management from that perspective. So, the job is not really going to change all that much.
I think the pressure is going to be on the next CEO, though, probably from the get-go to pay a dividend. It's something that Warren has spoken out against for many years, and up until now, he has had shareholder support for them retaining the capital that would normally go out as a dividend. But I think with a change in leadership, there will be a greater call for the company to pay out a dividend. You are looking at a company that, at the end of last year, was holding onto $63 billion in cash. It's earning relatively little in this environment. So, I think if those cash levels stay at an elevated rate once leadership changes hands, I think there will be a greater call for them to pay a dividend.
Glaser: Will it make sense to keep the firm together after Buffett is gone? You mentioned it's a conglomerate that works now, but is he the glue that makes that work?
Warren: I'm not sure if it's necessary that. I mean, he has never really been an operator from that perspective. He has built this company into something that's far more reliant on operations than it has been historically. The first, say, 30 or 40 years, it was really the investments that drove the returns. So, here is a situation now where it is more of an operations-built company, but it is still decentralized.
I think that's sort of the beauty of the business, overall. I think that you could make a case, longer term, for potentially breaking it up; but I think it'd have to be a situation where the company itself was being valued by the market much below where the intrinsic value was of the operations. It would be easier to split apart because it is decentralized, but I don't think there is really a compelling reason to split it apart. It is not like Jack Welch at GE, where he's got his hands in just about every piece of the business. It's really a purely decentralized force.
Glaser: You mentioned investments as being a big driver of performance in the early part of Berkshire's history. A lot of those were deals that were kind of brought to Warren personally. He was able to act quickly on it. When he's gone, is Berkshire still going to have access to that kind of deal flow? And what does that mean for the kinds of acquisitions, the kinds of financial deals that they are going to be able to do in the coming years?
Warren: I don't think they lose any of the capacity, the capabilities to do the deals. Like I have said, they've got $63 billion in cash on the books right now. They really don't have much debt at all, so they can really tap the financial markets if they needed to do anything bigger. Buffett has definitely built up a cache. He has built up relationships and contacts over the years that are a benefit to Berkshire and always have been.
We think that some of that goes away once he is gone. We also wonder if that quick decision-making on his part might take a little bit longer because the next CEO, the next management team, per se--because I know Todd and Ted are probably going to be helping out the next CEO with any sort of investment decisions that come along--are going to want to make sure they get it right because they know they are going to be under the microscope when it comes to making larger acquisitions.
Glaser: So, when you think about a post-Buffett Berkshire and you think about its competitive advantage or economic moat, do you think that Berkshire's moat could degrade from a wide without Buffett at the helm? Do you think that having a management team instead of one person is going to be able to continue those competitive advantages?
Warren: Well, our key thought on moats, overall, is that they decline over time. Everything fades. A company the size of Berkshire, as it gets bigger and bigger, it's really going to be harder and harder for them to generate excess returns. If you look back over the last 50 years, Berkshire has been able to grow the book value per share at a 19.4% compound annual growth rate. That's unlikely going forward. The past five to 10 years, it's been somewhere between 10% and 12%, on an annual rate. We think that's probably doable in the near to midterm; but we think longer term, you're probably looking at a high-single-digit rate, maybe even a mid-single-digit rate, which isn't that bad when you compare it with the fact that their cost of capital is much lower than a lot of other firms. It's not just the advantages that they have with debt in the market. It's also the fact that they've got low- to no-cost float; it has actually been negative for the last 15 years, being provided by the insurance business. So, we don't think that those advantages go away. We just think that the returns are just going to be a little bit harder to get by. And if you look at our assessment of moats as being an ability to earn excess returns over your cost of capital over time, we think that it does diminish.
Glaser: So, no matter who is at the helm over the next 50 years, it's probably not going to look quite as good as the first 50?
Warren: Exactly. And I think even with Warren Buffett at the helm over the next 50 years--if he were able to live another 50 years--I think it would be hard for them, just based on the size and the scale of the operations now, for them to be able to consistently generate excess returns of the level we've seen in the past.
Glaser: Gregg, thanks for your thoughts today.
Warren: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.