Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Berkshire Hathaway's annual meeting is on Saturday. Joining me today to discuss some of Berkshire's recent moves, the firm's valuation, and questions he'd like to see answered during the meeting is Gregg Warren. Gregg is a senior analyst in Morningstar's Equity Research Group, specializing in asset managers. He is also Morningstar's analyst on Berkshire.
Hi, Gregg. Nice to see you today.
Greggory Warren: Thanks for having me.
Dziubinski: Berkshire has had a pretty busy year by Berkshire standards in 2022, putting cash to work. Tell us a little bit about how much cash was on the books coming into the year, and if you were surprised by the activity we've seen so far.
Warren: Well, when we look at Berkshire's cash availability, we tend to think about the dry powder they have available to put in investments, into acquisitions, and into share repurchases. And by that measure, they had about $112 billion coming into 2022. Now, that varies from the $147 billion that was on the balance sheet. But Buffett always like to keep about a $30 billion backstop there for the reinsurance business and the insurance businesses. And we've got some operating cash and some funding for near-term CAPEX. So, overall, that works us back down to $112 billion figure.
Now, as you said, they've been pretty busy this year. We've been a little bit surprised by that, especially with what they've bought. I mean, on the Occidental Petroleum OXY front, they put about $12 billion to work in shares spread out over the first quarter. That's interesting, because they have warrants to buy 84 million shares for just under $60 from OXY as a part of the investment they made a few years back, where they got $10 billion preferred stock in the company. At this point right now, I think they're sitting around about 17% of the company from an outstanding share perspective. So, it just seems a little bit odd. But again, I think they were, sort of, tapping into the rising oil prices, which are getting back up to where some expect might be more normalized levels.
HP HP was interesting, little bit over $4 billion. Seemed a little odd to us--not really the kind of stock that Buffett would typically invest in. I mean, I know he has holdings in Apple AAPL, but it seems to us to be a little bit more like IBM IBM, where they bought the stock a few years back, the company had good free cash flows, company paid a good dividend. I think that might be some of it.
The more interesting piece, though, was the Alleghany Y purchase, about $12 billion there. Pure Buffett. He'd met with management, he put a price down, and he told Alleghany to go out and see if they can get a better price. So, overall, we think it's a good deal. It's a good fit for Berkshire, reinsurance business, the specialty lines. Alleghany Capital is also a good part of that business, which kind of reminds us a little bit of sort of the MSR segment at Berkshire, the manufacturing, service, and retailing, and some of the capital-allocation stuff that Buffett does from corporate. So, a very interesting deal, and we feel it's a good lucrative deal for Berkshire to do.
Dziubinski: So, going back to OXY for a minute, how big is that position right now? And do you think that there's a chance that Berkshire will buy the whole company?
Warren: Yeah, at this point, like--I think I misspoke a little bit earlier. It's about a 15% stake. If they were to exercise the warrants, which is possible right now, because the stock is trading above $60, with the dilution that would come from that exercise, it would be about a 21% stake in the firm. This is a little bit contrary to what Berkshire and Buffett have liked to do in the past, where they were taking 5%, 10% equity stakes and rarely moving beyond that. I mean, yeah, Coke KO is higher than that, American Express AXP is higher than that, but a lot of that sort of legacy holdings, things they bought in the 70s and the 80s. So, from that perspective, it's just been attrition over time. And then, they did winnow down their bank holdings the past couple of years and put a lot more behind Bank of America BAC, pushed it above that 10% threshold. But it's rare to see them step in somewhat that aggressively.
And even though Buffett has had a poor track record of investing in energy or commodity-related securities, they've had a really good track record when it comes to buying companies outright. Berkshire Hathaway Energy is kind of a crown jewel within the portfolio overall. This is a slightly different business. But at the same time, it wouldn't surprise me if they were to go out and buy the firm. And I think based on what they've already got invested, they could do it for maybe another $40 billion. So, that would--they've plenty of cash on the books to do that.
Dziubinski: Let's probe a little bit more on Alleghany. What do you think of the purchase price there? What sort of value do you think this can add to Berkshire over time?
Warren: I thought the purchase price was pretty good. I mean, it ended up being about 1.26 times book. The stock has traded maybe $110-ish, historically, a little bit higher maybe, on average. So, there is a premium there. I think the key here for Berkshire--I mean, they had a 25-day go-shop clause built into the deal, basically gave Alleghany the opportunity to go out and solicit bids. And they did go out and do more than 30 solicitations with their advisors. But nobody came back to the table with a bid that was going to match what Berkshire was doing. They were paying all cash. I think the valuation is attractive. And when we really sort of dug through the results and ran what our expectations would be for the different businesses as well as the investment portfolio, we think it's a pretty good deal for Berkshire. With our current change in fair value, it accounted for, I think, $16,000 of the Class A share increase and about $11 of the Class B. So, a decent contribution overall.
Overall, they've done a good job with those businesses. We're not really building in a whole lot of earned premium growth overall. Where we see the biggest opportunity for the underwriting side is on the expense side. I think being part of a larger organization that can sort of scale up some of these businesses and actually help improve their expense ratio, which would be good for them. Because reinsurance is at best a breakeven business. And the value you really get is from the investment portfolio. And that's where I think Berkshire can actually unlock a lot of additional value. If we look at the portfolio at Alleghany, it's been maybe 15%, 20% equities the past five years. Berkshire's portfolio is about 90%. So, they can sweep that--if they could just flip it on its head and do 75% equities, big incremental value-creator for them over time. I don't see any problem with regulators. The regulators have generally been OK with Berkshire investing heavily in equities because they have so much cash and additional fixed income on the books. So, overall, I think there's a big value-creator. And then, on the Alleghany Capital piece, taking a group that has historically been acquisitive and giving them access to the capital that Berkshire has available, we think that this could be one of those areas where we could finally start to see some bolt-on and additional acquisitions within the MSR segment where we feel it's been lacking in the past five, 10 years.
Dziubinski: You referred to a change in the fair value as a result of Alleghany. Talk a little bit about what affects these recent purchases and this activity in the first quarter has had on our fair value estimate. What do we think Berkshire is worth today?
Warren: Warren: Yeah. I mean, the fair value, like I said, we added $16,000 to the Class A shares and the total overall value increase was $25,000 on the Class As. So, the rest of it, the $9,000 there is coming from the investments in the equity securities, taking it from a cash pile and moving it into an actual investment part of the portfolio, but also sort of where values were on the security since the previous time we updated the fair value, because we had Apple, American Express, Bank of America actually increased in value for the time which we last updated the model overall. So, there's some contribution from that as well. So, that really helped. On an overall basis, we took the fair value from $525,000 on the Class As to $350 on the Class Bs to $550,000 and then $367 on the Class Bs overall. So, not a huge increase, but it is meaningful for a firm like Berkshire. I mean, the company of this size, getting that sort of benefit from what ended up being just sort of a handful of transactions.
Dziubinski: So, as we noted at the top of the video, this weekend, Berkshire is holding its annual meeting. It's the first time Berkshire is having an in-person meeting since the pandemic, and you're going. What do you expect to hear during this meeting?
Warren: Yeah, it will be interesting to see how the meeting goes, because prior to the COVID-19 outbreak, they had actually started to make some changes in how the meeting and the Q&A segment in particular was going to take place. Prior to that, they had an analyst panel and a journalist panel. So, three journalists, three analysts. And then, questions would also come from shareholders, and they would sort of run the round robin through the course of the meeting.
Now, prior to the 2020 meeting, Buffett had decided that he wanted to have Greg Abel, who is now as we know the next CEO, and Ajit Jain up there answering questions as well as him and Charlie. So, they changed the format for the staging and the intention was to still have the three journalists. But because of COVID-19 we kind of had to dial in for a couple of years there. I think Becky Quick is sort of now taking up the sole journalist position, asking questions. So, she's fielding questions from shareholders and other interested parties. And then we'll have shareholders at the meeting actually asking questions and then sort of rotating through that.
As at any meeting, I always look for nuggets that might come out about the operating businesses, long-term strategies, competitive positioning, how they think about capital allocation--the things that we really sort of pressed on, the years that we were on the analyst panel, really tried to sort of get Buffett to give us some clarity on. I'm hopeful that that happens. I'm not crossing my fingers. But it'd be interesting to see what happens. I mean, I'm kind of curious to see how this meeting goes. When we look back, the reason that they actually brought the analysts in the first place and the journalists, too, was they felt like they weren't getting enough good questions about the businesses. And we're hopeful that we'll still keep getting a lot of good business-related questions that help us with our valuation and our understanding.
Dziubinski: Give me two or three questions that you'd like answered when you're there this weekend.
Warren: I mean, there's core operating issues that still kind of gnaw at me. And there's definitely some capital-allocation questions and definitely some questions, I think, related to Alleghany. But just like the core operating side, I've been on it for a long time about GEICO, and just why don't they have telematics. Why are they not committed to setting up a system that's going to allow them to underwrite better than they have been? Because we've started to really see sort of a spread in the performance between them and Progressive PGR, which is really their closest peer. Progressive has telematics.
It's the same thing with the BNSF on the railroad side. They're the lone holdout on adopting precision-scheduled railroading. Their peers right now are expanding their operating ratios, are looking a lot better than BNSF. And what worries me in the long run with both companies is, you end up getting priced out of policies or priced out of volume, because your peers have margin that they can basically sort of turn back on you and use it to undercut you on price. So, I think that there's some real issues there that I think need to be answered, and they've never really given full, good, serious answers to. And I think, again, I feel it's the kind of question that need to be hammered again and again and again.
On the capital-allocation front, I'd really be curious to see how they feel about cash reserves. Is that $30 billion now enough? With Alleghany in the portfolio, does it need to go to $40 billion, because Alleghany is predominantly reinsurance, which is a lot lumpier, a lot more volatile. You have big losses in any given period of time. Do we need to up that? And then, on the cash-management front, how do we think about--so far share repurchases, it really sort of helped them. It really helped them sort of whittle down the cash balances, keep them from getting above that $150 billion threshold that Buffett said he's not comfortable with. But it seems like this year, they might buy themselves some time with these investments they've done and with the deals that they've done. But if you think about HP, OXY, and Alleghany combined, that's less than the amount of free cash flow they're going to generate this year. So they have a cash problem. It just keeps building and building and building, unless they find effective ways to get it put to work.
Dziubinski: Do you see the share repurchases continuing? And do you think we're ever going to see a dividend from Berkshire?
Warren: Absolutely on the share repurchases; that's really their only legitimate outlet. When valuations are too high, and they can't invest in anything, it's the only way they can put money to work. And they've actually been slightly above what my run rate was for a while there. They were doing about $6 billion, $6.5 billion a quarter the past two years. My original estimation was about $5 billion to $7 billion. I've since increased that to about $6 billion to $8 billion a quarter that they could easily do. I think in periods when they have investment activities, probably be at the lower end of that, maybe even below that. But I think that, over time, the expectation should be they're going to do that kind of level of share purchase. That's about $25 billion a year, give or take, that we sort of build into our forecast.
But we'll have to see. I mean, it is something that's palatable to Buffett. He will never pay a dividend. It will never happen as long as he is alive. I think part of that is because he is just dead set against it. He doesn't like to give away something and not get something in return. And I think the other thing is that I think he still wants to leave that as a tool for the next guys. Because they're going to have to have something to sort of placate longer-term investors to convince them to continue to stay with the firm, while they figure out how best to handle capital allocation over the long run.
Dziubinski: That's interesting. Let's talk a little bit specifically about Warren Buffett as an investor. How would you in a couple of sentences really define his approach? And what are the things that really matter to him as an investor?
Warren: I think he looks at--we always think about the stock investments, but he at the end of the day would prefer to buy a company outright. He'd rather have the whole kit and caboodle. He doesn't want to--he doesn't really want to mess around with partial ownership, mainly, because there's a lot of reporting requirements and other things that go on, and just things that he is not comfortable with. Or he feels sometimes he is not getting a meaningful enough piece of the pie to have an impact on Berkshire overall. And if you think about, like, Apple--Apple is their single largest holding in the investment portfolio. It's 45% of the equities. It's only about 5% of Apple's stake, outstanding shares. So, there's a situation where they could put a ton of money to work and not have a big dent. Now, there's a lot of companies, if they were to put that amount of capital to work, it would be the whole company. So, it's kind of hard for them to do from that respect.
But I think when he looks at companies, he's always trying to find any other investments or acquisitions that are going to be meaningful for them, companies that have a consistent track record of generating good results, good returns on equity, little to no debt, highly qualified management in place, and then a good reasonable price based on how they're looking at the business for them to sort of step into. And those types of investments he would prefer to buy and hold forever. Again, he likes to have the outright, but from the stock perspective, a few securities in the portfolio have been there for a very, very long time. We have seen things come and go over the years. So, he is not adverse to selling when conditions change, or when the contribution they're getting from that business no longer is what they had expected it to be in the past. Or a good interesting case in point, they had P&G PG for a very long time. It came out of the Gillette stake that they had acquired many years ago. And they actually swapped the stock for the Duracell business. So, they got a cash-flow-generating business, brought it in outright, and then they sold off a lot of the rest because they were trying to raise capital for Ted Weschler and Todd Combs to work with.
So, I think from that perspective, there's opportunities for them to sort of take money off the table when the holding itself doesn't necessarily mean as much to them as it did in the past, or where it's not as integral, it's not as big of a piece. I mean, we saw that also with the bank companies. At one time, I think they had stakes in 10 different banks. They since sold off most of those and funneled the proceeds into Bank of America. They increased it above the 10% threshold, mainly because the Fed had changed their policies upon bank holding company reporting and everything else. It's made a big gray area beyond 10%, in that 10% to 20% realm where Buffett has actually been able to build the best stake and not have the Feds come in and require more them from a reporting perspective.
Dziubinski: So, given all that, what would you say are some few key takeaways or key principles that an individual stock investor, say, can take away from Warren Buffett and learn from Warren Buffett?
Warren: Just quick quirky comments over the years. I mean, I think the key one is, be greedy when others are fearful and fearful when others are greedy, is probably one of his more recent and more famous ones. I think basically stick to companies with sustainable competitive advantages, which is what we call economic moats. I think he is big on compounding, reinvesting your profits, keeping them and letting compounding do its work. As I said earlier, little to no debt is basically your friend. Just a lot of little things that seems simple, but they've actually helped them sort of build what they have over the years. And the thing is, Buffett, if anything, they've really stuck to their discipline. And I think we saw this with the Alleghany deal more recently.
I think one of my biggest complaints about Berkshire over the years is that they have this very strict investment discipline where they put the bid on the table, they won't do any auctions, they won't engage in bidding wars, they won't come back with the second offer. And that's great if nobody else can top your bid. But Buffett always likes a deal. And we've kind of made the point that lack of a dividend and the lack of share repurchase for many, many years allowed so much cash to build up on the balance sheet. But it also works. It keeps them from overpaying for things. It keeps them from getting into a bidding war, where they end up not getting the same sort of return they're expecting in the first place. And right now, there's so much capital out there, especially private capital, that's bidding for assets, that it doesn't make any sense to get into bidding wars, especially with valuations where they are. So I think from that perspective, he's been very good and very consistent. I'd still like to see some wiggle room longer-term; I’ll talk to Greg Abel and see what he thinks about that. But I think there's opportunities definitely where you can, sort of, step in and tweak the deal a little bit and still be true to your discipline.
Dziubinski: Gregg, thank you so much for your time today and your insights. I know you've been following Berkshire for a long time. I hope you get your questions answered at the meeting this coming weekend. And I look forward to reading your recap after you've been there. We appreciate your time.
Warren: Thanks for having me.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.
Read more: How to Invest Like Warren Buffett