Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We are here at the Value Investor Conference ahead of the Berkshire Hathaway Annual Meeting. I had a chance to sit down with Warren Buffett expert, Bob Miles, to talk about how Buffett's new lieutenants are performing and also if Berkshire should be paying a dividend.
Bob, thanks for joining me today.
Bob Miles: Thanks for inviting me.
Glaser: One of the hot Berkshire topics is always who is going to succeed Buffett after he leaves, and we’ve gotten a little bit more information there with Ted Weschler and Todd Combs taking over part of the portfolio. Talk to us a little bit about how you would rate their performance in their relatively short tenure so far?
Miles: Well, short-term performance has been outstanding for them to beat the S&P 500, I think, by about 8 percentage points. But it's a very short period of time, and their compensation is really based on a rolling three-year average. And their outperformance of the S&P 500 is how they're compensated. Warren’s looking at it over three years.
Glaser: Do you see them as being good stewards of that role of the investment side of the business? It seems like that's working out so far.
Miles: Yeah, I think they are continuing what they did before they joined Berkshire: small, concentrated portfolios in industries that are scalable that they can put a lot of money to work. They're beating their boss and their predecessor, Lou Simpson, who basically resigned creating the position for Ted and Todd. He beat his boss over 25 years by a 6.8% margin.
Glaser: So if we look at one of the biggest deals that Buffett made this year was Heinz, and there were some discussions that maybe [Weschler and Combs] also had some role in that. But it was a little bit different, [with Berkshire] teaming up with a private equity firm, getting Heinz preferred shares. These kind of unusual deals have cropped up a lot for Berkshire since the financial crisis. Would you expect more of those going forward versus kind of straight-up buyouts?
Miles: Yeah, I think that's the advantage that Warren has, and now Ted and Todd have. They have cash available as permanent capital. So, they have a combination of insurance flow, which is up to $73 billion and climbing, as well as a corporate structure where when the market goes down, the capital doesn't flee. They still have to allocate, I think, it's up to $60 million a day into some investments.
Glaser: So after Buffett leaves, though, will they still get those opportunities? Are people still going to come to them with those special deals without the Buffett stamp of approval on it?
Miles: Well, he said that he would be very disappointed that if Berkshire didn't last another 100 years because they write insurance and those insurance policies people are counting on are many decades into the future. So we hope they get the same deals. I believe they will because of their access to cash and who has capital when the market declines.
Glaser: So speaking of having to invest all of that money, all of the time, Buffett spent a lot of time talking about dividends in his annual letter and why he doesn't think it's appropriate for him to pay one right now. Do you think that this is something that makes sense, that his math kind of works there, that Berkshire will be able to get better returns there? Or should they be thinking about giving at least some of that cash back in a dividend with an expanded buyback program?
Miles: Well, I think he explained it, that if they retain a dollar of earnings, they should be able to create more than a dollar of market value. As long as they meet that test on a rolling five-year basis, Berkshire is not going to be paying the dividend. But as soon as that test doesn't work over a rolling five-year basis, then Berkshire may start returning money. Although, my preference as a shareholder would be a share buyback, which he’s done at 110%, now 120% of book value. That's a better, more tax-efficient way of returning capital back to the shareholders.
Glaser: Buffett did raise that ceiling. Could you see that going up again, or do you think that 120% is a pretty stable number?
Miles: I think 120%--I was actually surprised that it was 110%, and then even more surprised when it became 120%. So, if he is buying his own stock back, I'm amazed that there are people out there who are willing to sell it to him.
Glaser: When you see that the company is getting bigger--and you mentioned that, if those returns start to slow down they'll have to do something with this capital--how big is that? When do they get to the point where they can't find any more elephants, and that elephant gun here doesn't really do them a lot of good anymore?
Miles: Well, right now they are the third-largest corporation based on market capitalization in the United States. But they still have quite far away to go to overtake, I think it's Apple and ExxonMobil. So, I could easily see them doubling the market cap from where they are now. And after that I'm sure they will just keep buying more businesses, but they’ll be bigger deals.
Glaser: Well, Bob, I really appreciate you taking the time today.
Miles: Well, my pleasure and thanks for inviting me.