Berkshire Hathaway and the Coronavirus Crash

Berkshire Hathaway is often referred to as a “fortress” due to Warren Buffett’s obsession with maintaining a massive margin of safety. With $125 billion of cash on hand as of December 31, 2019, there is no doubt that the company does not face any sort of near term liquidity crisis due to the worldwide Coronavirus pandemic. As plaintive calls for government bailouts emerge across industries, the lack of any worry about a liquidity crisis at Berkshire is something shareholders should find comforting. That being said, no company can possibly be immune to widespread government imposed shutdowns of economic activity as shelter-in-place orders become more common. At the present time, on March 22, 2020, at least one-quarter of Americans are living under orders to not leave their homes except for “essential” activities. The number of similar orders will no doubt increase in the days to come.

It is not possible to evaluate with any precision the extent of damage that has been done to Berkshire’s business interests in recent weeks, but there is no doubt that Berkshire’s many operating businesses have been affected. We can measure with somewhat more precision the market value change in Berkshire’s large portfolio of marketable securities, although there are important limitations in this exercise as well. In the one month that has passed since the 2019 Berkshire Hathaway annual report was released, the world has changed in extreme ways.1

As long term investors, we should focus on what happens over several years and decades rather than months or quarters. This is the approach that Warren Buffett and Charlie Munger have advocated for decades. However, we are in the midst of a historic event and it is not only rational but essential to think about how the current events that are unfolding impact the businesses we own.

In this article, I will examine various aspects of Berkshire Hathaway in an attempt to draw some high level conclusions regarding the company’s prospects as we proceed through this crisis and eventually emerge into an economic recovery. Specifically, I will examine Berkshire’s large portfolio of marketable equity securities, the impact of the crisis on company’s operating earnings, and the potential for opportunistic deployment of capital.

Due to the length of this article, links are provided to the various sections below:

Equity Portfolio
Operating Earnings
Capital Deployment
Conclusion


Equity Portfolio

Berkshire is required to report the majority of its holdings of equity securities every quarter on Form 13-F.2 A convenient and easy-to-read synthesis of the SEC filing can be found on the dataroma website.

As of December 31, 2019, Berkshire reported holding equity securities with market value of $242.1 billion. We have no idea whether the securities that were held on December 31, 2019 continue to be held today. It is very possible, and in fact extremely likely, that Warren Buffett, Todd Combs, or Ted Weschler have made changes to the portfolio amid recent volatility in the markets. That said, if we assume that the portfolio is mostly unchanged, at least for the large positions, we can update the quotes as of Friday, March 20, 2020 and draw some basic conclusions.

If the portfolio of December 31, 2019 was unchanged through the close of trading on March 20, 2020, the value of the securities have declined by 34.5 percent, or $83.4 billion. However, this decline in market value is partially offset by a commensurate decline in Berkshire’s deferred income tax liability. As of December 31, 2019, Berkshire carried a $32.1 billion deferred income tax liability attributable to unrealized capital gains. The gross market value decline of $83.4 billion should be partially offset by a $17.5 billion decline in the deferred tax liability assuming a 21 percent corporate tax rate. The would reduce the net decline in book value from $83.4 billion to $65.9 billion. A $65.9 billion decline in book value is equivalent to $40,555 per A share or $27.04 per B share based on shares outstanding on December 31, 2019.

Of course, whether this 34.5 percent decline in the market value of Berkshire’s equity portfolio is justified by a commensurate decline in the intrinsic value of the securities in the portfolio is a valid question. I will not enter into an analysis of each of the holdings in this article, but it does seem useful to at least list the top fifteen holdings, ranked as of the beginning of the year, since this accounts for 89 percent of the market value of the portfolio. In addition, a summary of Berkshire’s financial and airline investments will be interesting to examine briefly.

Top Fifteen Holdings

The following exhibit displays the top fifteen3 holdings:

Source: Berkshire’s 13-F and Dataroma.com

Berkshire’s large holdings in financial institutions and airlines have been particularly impacted by the current bear market. The overall damage to the portfolio would have been far greater if Apple had declined by more than 21.9 percent. Another bright spot in the portfolio is DaVita which declined only 13.4 percent, probably due to the non-discretionary nature of providing dialysis services to patients in any economic environment.4

Financials

Over half of Berkshire’s year-to-date losses are accounted for by the following ten financial institutions:

Source: Berkshire’s 13-F and Dataroma.com

With the exception of Visa and Mastercard, all of the top ten financials in Berkshire’s portfolio declined by roughly 40 to 50 percent, with Wells Fargo suffering the largest decline. As of March 20, this group of financial stocks make up 34.4 percent of Berkshire’s overall equity portfolio.

Obviously, a lengthy shut down of major sectors of the American economy will have devastating impacts on most businesses and we could expect to see bad debts skyrocket in the quarters to come. Analysis of these institutions is beyond the scope of this article but several of them are clearly systemically important and “too big to fail”. Berkshire has, in the past, come to the aid of large financial institutions and might have opportunities to deploy capital in the future on favorable terms. However, whether such opportunities will arise in the current crisis is not knowable at this time.

Airline Investments

In recent years, Berkshire has taken significant stakes in the U.S. airline industry. Perhaps due to some level of schadenfreude in the media, these investments have attracted much recent attention. Fortunately, they only accounted for 4.2 percent of Berkshire’s equity portfolio at the start of the year and 2.7 percent of the equity portfolio based on current quotes. The following exhibit shows the four airline stocks and how they have fared this year:

Source: Berkshire’s 13-F and Dataroma.com

To say that this is not a pretty picture is an understatement and the carnage would no doubt be worse for equity owners in the airlines if there was not active talk of a massive $50 billion government bailout of the airline industry. As a shareholder of airline stocks, Berkshire would obviously benefit from such a bailout in terms of the market value of existing equity stakes. However, in the absence of a government bailout, it is possible one or more of these companies might approach Warren Buffett for additional capital. Whether Buffett would be amenable to providing such capital, no doubt at a steep cost, is unknown. However, he has said that he will not be selling airline stocks.

During the 2008-09 financial crisis and in the years that followed, Berkshire made a number of opportunistic investments and it is not inconceivable that the same might be possible for airlines and other distressed industries in the current crisis. The “Buffett playbook” when approached by distressed companies has been to acquire preferred stock paying a substantial cash dividend along with cheap or free warrants to purchase equity in the future. Buffett may or may not be interested in doing so for the airlines, but he would have little reason to if the government steps in first.

Occidental Petroleum

In the March 11 issue of Rational Reflections, I examined Berkshire’s investment in Occidental Petroleum. In addition to the $10 billion preferred stock investment, which is not included in Berkshire’s 13-F filing, Berkshire owned 18,933,054 shares of Occidental common stock as of December 31, 2019. These shares were valued at $780.2 million on December 31, 2019 and declined by 75.2 percent year-to-date leaving Berkshire with an investment valued at $193.7 million.

As discussed in the Rational Reflections issue, the significant decline in the price of oil is the main factor behind Occidental’s crashing stock price. Occidental has substantial debt and Berkshire’s $10 billion preferred stock investment cannot be considered entirely secure at this point. Obviously, the $193.7 million common stock investment is a rounding error compared to Berkshire’s overall equity portfolio but the $10 billion preferred stock position is material.

In recent weeks, investor Carl Icahn has increased his stake in Occidental common stock and launched an activist campaign which is now nearing a settlement. Icahn has been highly critical of Occidental’s management for agreeing to the terms of Berkshire’s preferred stock investment which was needed in Occidental’s acquisition of Anadarko Petroleum last year. Icahn’s involvement and increased stake in the common stock is a positive sign for Berkshire shareholders, as the vast majority of Berkshire’s exposure to Occidental is senior to Icahn’s investment in the common stock. Icahn has every incentive to preserve value at Occidental in the months to come, but the price of oil, which is of course unknowable, is likely to be the determining factor in the end.


Operating Earnings

Berkshire is fortunate to have a widely diversified group of operating businesses with vastly different economic characteristics. In normal times, this diversification can smooth overall results with difficulties in one area being offset by strong results in another. The following exhibit displays Berkshire’s operating earnings on an after-tax basis for the past five years:

Source: Earnings press releases and annual reports

Of course, the 2015-2019 period was one characterized by economic growth, which in retrospect was the tail end of the decade-long expansion following the 2008-2009 financial crisis. The results Berkshire’s subsidiaries will post in 2020 will almost certainly be far worse than the numbers posted in recent years.

We can attempt to look at how Berkshire withstood the 2008-2009 financial crisis, but this has limited utility for two major reasons. First, Berkshire was a different company twelve years ago. Many of the non-insurance subsidiaries that Berkshire has today were not yet acquired in 2008 with BNSF being the most notable (acquired in Q1 2010). Second, the 2008-2009 financial crisis, while severe, did not involve a mandated government shut-down of major sectors of the United States economy.

Nevertheless, despite these limitations, let us take a brief look at how Berkshire’s operating results fared on a quarter-by-quarter basis from 2008 through 2010. The exhibit below, utilizing quarterly data I have long maintained for Berkshire, is on a pre-tax basis and is broken down differently than the more recent data due to segment reporting changes:

Source: Berkshire Hathaway 10-Q and 10-K Reports

We can see the most significant impact of the recession in the “other business” line of the exhibit. This diversified group of manufacturing, service, and retailing businesses hit a trough of $201 million of pre-tax earnings in Q2 2009, down from a high of $956 million in Q2 2008. While there are certainly variations in the other line items, which I will not delve into in detail here, suffice it to say that Berkshire’s overall operating earnings never came close to dropping into negative territory during the 2008-2009 financial crisis and recession.

As noted previously, we cannot expect the current crisis to mirror 2008-2009 so let’s take a brief and necessarily mostly qualitative look at Berkshire’s sources of operating earnings to see which might be at most risk of impairment in the quarters ahead.

Insurance – Underwriting

Berkshire has posted a remarkable run of underwriting results in recent years with underwriting profits in sixteen of the past seventeen years. The most immediate question being asked is the degree to which Berkshire has exposure to the Coronavirus pandemic itself. Has Berkshire written policies that explicitly cover pandemics? And how will the pandemic’s second and third order effects impact other lines of coverage?

I have not been able to locate specific information on Berkshire’s exposure to policies explicitly covering pandemics. However, Warren Buffett is clearly quite aware of the risk of pandemics and he has been for a very long period of time. The following excerpt is from an article published by Reuters May 2009:

Berkshire would consider writing insurance policies for pandemics, including one that Buffett said assumes the U.S. mortality rate rises by 25 percent in 2010, equivalent to roughly an additional 600,000 deaths.

“You could get us to quote a policy on the present potential pandemic,” Buffett said, though “you may not like” how much Berkshire would charge. “You need someone with a real sense of the probabilities” to write such policies, he said.

Three thoughts come to mind when reading these comments. First, Berkshire could very well have specific pandemic coverage on its books since Buffett has said that Berkshire would be willing to write coverage at the right price. Second, if such coverage has been offered by Berkshire, it is likely that the aggregate premiums received over the past decade have been substantial. Third, this event was not a “black swan” in Buffett’s mind and therefore there is no chance that he and Ajit Jain would have allowed uncapped liability for pandemic coverage to accumulate. Any coverage provided by Berkshire is certain to be capped.

Although this opinion is purely speculative, I doubt that Berkshire’s exposure to the pandemic itself would exceed its exposure to a typical summer hurricane in the Gulf of Mexico or the Atlantic. This could mean that Berkshire has a few billion dollars of exposure but probably not ten billion.

Does Berkshire have exposure due to second and third order effects of the pandemic? In particular, what about business interruption coverage? Again, Berkshire specific information is not available at this point but the general consensus within the industry seems to be that pandemic coverage is typically excluded.5 Does this mean Berkshire is in the clear entirely? Probably not, although it does not appear that the industry has been willing to include pandemic coverage in general lines as a matter of course. With Berkshire being one of the most sophisticated underwriters in the industry, the chance of being inadvertently exposed seems minimal.

The bottom line is that we can only make qualitative judgments at this point regarding Berkshire’s potential insurance exposure but a reasonable worst-case scenario might be thought of as equivalent to a large-scale natural disaster if Berkshire has written pandemic-specific coverage.

Insurance – Investment Income

The impact on investment income is likely to be significant but over a period of several quarters rather than all at once. In 2019, dividend income made up 69 percent of pre-tax investment income and some level of dividend cuts are inevitable in Berkshire’s portfolio of equity investments. Additionally, interest rates have plummeted in recent weeks which will dramatically reduce the income Berkshire can earn on its massive cash balance. This effect will be felt over the next quarter as treasury bills that mature that were likely earnings 1.5 – 2 percent are reinvested at rates not far above zero.

Railroad

Berkshire did not own BNSF during the 2008-09 financial crisis, but we can look at BNSF’s results as a stand-alone business during that timeframe to see how results evolved around that time:

Source: BNSF 10-K reports

The exhibit contains data I collected around the time of the acquisition and reveals that net income remained strongly positive during the downturn. Of course, that has little bearing on how the railroad will respond to an unprecedented shutdown of a large segment of the U.S. economy if the current situation persists for many more weeks or months. It seems doubtful that the shipment of essential agricultural, industrial, and food products will entirely halt for any length of time. That being said, a railroad has high fixed costs and inherent operating leverage that could result in negative cash flow if the worst estimates of the shut-downs come to pass. Any quantitative guess would be just that – a guess on my part.

Utilities and Energy

Berkshire Hathaway Energy is comprised of a diverse set of subsidiaries as shown in the exhibit below:

Source: Berkshire Hathaway 10-K reports

Electricity and gas consumption is obviously a mix of residential and industrial uses and will be impacted to some degree by a major economic slowdown. As of mid-February, Reuters reported that China experienced a drop in electricity demand during their recent shutdown which represented about 1.5 percent of industrial power consumption. As the U.S. economy slows down, industrial power demand will fall, but this may be partially offset by residential power demand rising as more people are quarantined and spending more time in their homes.

Berkshire Hathaway Home Services, which is included in the Utility segment, is likely to experience major disruption because real estate activity will slow to a crawl if people are unable to tour homes. Even after lockdowns are lifted, people will be more reluctant to make a major home purchase at a time of economic uncertainty.

In aggregate, it seems unlikely that Berkshire Hathaway Energy will post operating losses due to the Coronavirus crisis and the overall impact should be relatively muted.

Manufacturing, Service, and Retailing

Berkshire’s widely diversified group of manufacturing, service, and retailing companies are likely to experience significant impact from the Coronavirus pandemic. The following exhibit shows the record of this segment over the past three years:

Source: Berkshire Hathaway’s 2019 10-K, p. K-45

Let’s drill down further into the manufacturing businesses:

Source: Berkshire Hathaway’s 2019 10-K, p. K-45

The industrial products group would be heavily impacted by an overall slowdown in economic activity. Companies such as Lubrizol, Precision Castparts, IMC International (Iscar), and Marmon can all be viewed as cyclical businesses correlated with GDP growth. Precision Castparts is significantly exposed to the struggles of the airplane industry.

The building products group includes Clayton Homes, Shaw, Johns Manville, Acme Brick, Benjamin Moore and other companies that would be impacted by a slowing housing market. At a time when millions of Americans are likely to face unemployment, there is no doubt that the businesses in this group will be heavily impacted. However, Clayton Homes operates in the lower priced segment of the home market and its affordable products could fare relatively well in an era of tighter household budgets.

The consumer products group includes Forest River (RV products), apparel and footwear companies, and various smaller subsidiaries. To the extent that these businesses manufacture discretionary products, especially RVs, the impact of a major recession will be unmistakably negative. Some of the basic apparel companies such as Fruit of the Loom and Garan could face less severe impacts.

In aggregate, the manufacturing group is likely to face significant headwinds in a protracted economic downturn. While it may be tempting to make quantitative guesses, there are too many unknowns at this point for that exercise to be productive.

A summary of the past three years of results for Berkshire’s service and retailing operations appears below:

Source: Berkshire Hathaway 2019 10-K, p. K-49

The service group includes NetJets, FlightSafety, TTI, Dairy Queen, XTRA, CORT, BusinessWire, and some smaller operations. Each business will face different challenges. Demand for private aviation appears to be up as the super-rich avoid flying commercial airlines and this could help NetJets results in the near term. However, in the long run, private aviation will not be helped if stock markets enter a multi-year bear market decimating the net worth of the rich. Dairy Queen is a franchiser of quick service restaurants and the franchisees are likely to be in severe financial distress in the weeks to come as governments order the shutdown of restaurant operations in more states.

The retailing group includes Berkshire Hathaway Automotive, home furnishing retailers, jewelry retailers, See’s Candies, and other small subsidiaries. Although not a material source of earnings for Berkshire anymore, the retail group is obviously going to be heavily impacted by shutdowns that prevent people from visiting retail outlets. The severity of the situation will increase the longer large segments of the population are sheltering in place and unable to shop. It is plausible that once restrictions are lifted there will be pent-up demand, but that is contingent on the economy avoiding large-scale unemployment in the aftermath of the pandemic.

Operating Earnings – Concluding Thoughts

The discussion of Berkshire’s operating earnings presented here may seem unsatisfactory to many readers hoping for quantitative predictions regarding potential damage from Coronavirus. The inability to make precise estimates is unsatisfactory to me as well but it seem like there is inadequate information at this point to avoid simply making guesses beyond assessing the directional impact and making qualitative comments. We will certainly get more clues regarding the impact in Berkshire’s Q1 2020 results which will be published in early May.

Despite the inability to be precise, it seems to me that it is highly unlikely for Berkshire’s operating earnings to be negative or operations, in aggregate, to consume cash for any length of time. If there are quarters in which there are operating losses for the group as a whole, Berkshire certainly has ample cash resources to avoid any kind of financial distress.

The real long term risk for Berkshire’s operating earnings is the same as the risk for the overall economy. If we emerge from the pandemic with a much diminished GDP which does not bounce back quickly, then we will face many years before 2019 GDP is again achieved. We cannot expect Berkshire’s operating companies, in aggregate, to achieve 2019 level results under conditions of economic depression, should that be the outcome of the pandemic.


Capital Deployment

Berkshire Hathaway shareholders have been watching the company’s cash balance grow for many years and some of us have been impatient for opportunities to deploy this cash. Berkshire now will have major opportunities to deploy its cash, although under circumstances that I am sure Warren Buffett and Charlie Munger wish had never come to pass. However, in a capitalist system, those who have the ability to deploy capital in times of crisis play a constructive and essential role in the recovery process.

How might Berkshire allocate the $100+ billion that is available for investment beyond the $20 billion minimum reserve that the company has pledged to always maintain? We do not know, but the potential set of opportunities include investment in marketable securities, business acquisitions, opportunistic rescues of sound businesses facing liquidity problems, and repurchase of Berkshire stock.

Repurchases

There is no point in speculating regarding what Berkshire might do in terms of marketable securities, acquisitions, or “rescues” of distressed companies. However, we will continue the long tradition of repurchase speculation that has been a frequent subject on this website in recent years, most recently in February. Readers interested in the history of repurchase activity should review that article, which contains a full history of repurchase activity from 2011 to 2019, before proceeding.

We know that Berkshire has continued repurchasing stock in 2020. Berkshire’s 2020 proxy statement indicates that there were 1,620,691 Class A share equivalents outstanding on March 4, 2020 compared to 1,624,958 Class A share equivalents outstanding on December 31, 2019. We will not know the average cost of the repurchased shares until Berkshire files its 10-Q report in May but it is likely that at least $1.3 billion was allocated toward the buybacks.

There have been twelve trading days since March 4 and trading volume of Berkshire’s Class A and Class B shares has been far greater than average amid tremendous overall market volatility:

  • Average volume of 1,000 Class A shares per day between March 5 and March 20 compared to average daily volume of 272 shares in 2019.
  • Average volume of 13.6 million Class B shares per day between March 5 and March 20 compared to average daily volume of 3.8 million shares in 2019.6

With about 3.5 times as much volume as typical, Warren Buffett could have dramatically increased his repurchases of Berkshire stock on the public market. In addition, he advertised a willingness to consider private transactions of $20 million or more in the 2019 annual letter. Berkshire’s shares have been hammered since March 5 with a high of $318,605 per A share reached on that day and a low of $251,000 reached on March 20.

Berkshire’s book value per A share was $261,417 on December 31, 2019 but clearly book value is far lower than that today due to the significant decline in the equity portfolio. Using the data presented earlier in this article, we can estimate that the hit to book value is likely to be at least $40,000 per A share. Although Berkshire is likely to have posted at least some net income this quarter-to-date, let’s ignore that and simply deduct $40,000 from December 31, 2019 book value to estimate current book value at roughly $221,417. Based on Berkshire’s closing price of $257,346 on March 20, the shares trade at around 1.16x this very rough estimate of current book value.

The fact that Berkshire’s current price-to-book ratio is historically very low does not necessarily mean that Warren Buffett is repurchasing stock because he could have current or anticipated future opportunities that he considers superior to repurchases. However, given Berkshire’s recent repurchase activity, it seems likely that several billion dollars have been utilized to repurchase stock in recent days. We will not know for certain until the 10-Q is published in early May.


Conclusion

For the few readers who have reached the end of this unreasonably long article, hopefully the discussion has provided some level of insight regarding Berkshire’s prospects as we continue navigating an unprecedented shutdown of major sectors of the economy that has no clear end in sight.

Although we cannot make precise quantitative estimates, the damage to the equity portfolio presented above is probably in the ballpark given that Berkshire does not have much turnover, at least in the largest holdings. The discussion of the operating businesses serves the purpose of trying to grapple with whether they will start to post operating losses or bleed cash in this situation. I view a lengthy period of operating losses or negative cash flow to be unlikely in the aggregate although it is certain that individual subsidiaries will be heavily impacted in the weeks and months to come.

Berkshire is positioned as well as any company could be facing this type of exogenous shock to the system. While survival of the company is not in question, the long term intrinsic value of the business certainly is in question because we could be in the early stages of an economic depression. If that occurs, then the long term value of nearly every business in the country will be impaired.

Hopefully, intelligent government policy will prevent the worst from happening and we will enter a “V shaped recovery” that will return overall GDP to 2019 levels within the next year or two. If that occurs, the intrinsic value of Berkshire will still be somewhat lower than if Coronavirus had never happened, but the damage will not be severe. But if the 2020s is a repeat of the 1930s, Berkshire will struggle through and almost certainly do better than most large corporations, but its value at the end of the decade will be significantly diminished relative to what we expected just a couple of months ago.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway. Nothing in this article constitutes investment advice of any kind.


  1. A special issue of the Rational Reflections newsletter covered the 2019 annual report release. []
  2. Equity securities traded on U.S. exchanges, including foreign securities traded on U.S. exchanges in the form of American Depository Receipts (ADRs) are reported on Form 13-F. Foreign securities traded on foreign exchanges are not reported on Form 13-F. For our purposes, analyzing Berkshire’s 13-F is sufficient given that the vast majority of its holdings are included in this filing. []
  3. Note that the companies shown in the exhibit are the top fifteen based on ranking as of 12/31/19. However, as of 3/20/20, Charter Communications, Verisign, and Visa would replace Delta Air Lines, Southwest Airlines, and General Motors in the top 15 ranking due to market value changes between 12/31/19 and 3/20/20. []
  4. We profiled DaVita’s business several years ago. []
  5. A number articles regarding pandemic exclusions in insurance policies have been published by various organizations in recent days. A sample of such articles include:
    It’s too late for this pandemic. But everyone wants insurance against the next one (CNN 3/19/2020)
    Why Are Insurance Companies Denying Restaurant Claims in Wake of Pandemic? (Eater.com 3/20/2020)
    Can insurance lessen the economic costs of the coronavirus pandemic? (The Hill 3/20/2020)
    Can Insurance Really Save Retail and Hospitality from the Coronavirus Pandemic? (Risk and Insurance 3/16/2020) []
  6. Volume data was obtained from Yahoo! Finance. []

The Surreal Weekend

The world has changed over the past few weeks in ways that are likely to leave lasting scars for years to come. In the United States, the atmosphere can only be described as surreal. The Coronavirus pandemic has almost completely consumed all the oxygen in the mainstream media and on social media yet, as of the weekend of March 14-15, there are still plenty of people out and about celebrating St. Patrick’s Day with an attitude that can only be summed up as “carpe diem”, or to use its modern equivalent: “you only live once”. Young people, who have probably been looking forward to spring break for months, flocked to traditional hot spots like Ft. Lauderdale, seemingly oblivious to the risks. The scene repeated in many major cities. YOLO.

Although the statistics at this point are constantly in flux and are heavily dependent on accurate reporting, it has been apparent for weeks that Coronavirus is most deadly for the elderly and those with pre-existing medical conditions. The limiting factor for death rate statistics at this point is that different countries have wildly different rates of testing and both the numerator (number of deaths correctly attributed to Coronavirus) and the denominator (number of cases of Coronavirus accurately diagnosed) can be incorrect. However, the death rate for those under fifty is believed to be well under one percent.

Does this mean that young people should not worry about contracting Coronavirus and spreading it to other young people? Clearly, those out partying this weekend feel that way, and many of them might just not know any better. No harm, no foul, right?

Clearly, this attitude is wrong on many levels. For one thing, Coronavirus may carry long term health consequences that we do not yet fully understand. However, of more immediate concern is the overall rate of spread within communities because the contagion will necessarily impact older and vulnerable people the more it spreads through the country.

While naive ignorance is not an excuse, it is at least understandable that many younger people might feel that they are not doing any harm. However, plenty of people who have access to good information and should know better are perpetuating the idea that it is perfectly acceptable to risk contracting the virus and spreading it to others. Thirty year old Katie Williams, a Nevada politician, had the following to say in response to a tweet by Alexandria Ocasio-Cortez:

This type of attitude can be described as nothing other than sociopathic and should, in any rational world, end a political career. As Nassim Nicholas Taleb wrote in a paper published today, people who take this attitude are risking the overall safety of society based on a narrow view of their own immediate self-interest:

Hence one must “panic” individually (i.e., produce what seems to an exaggerated response) in order to avoid systemic problems, even where the immediate individual payoff does not appear to warrant it.

Ethics of Precaution: Individual and Systemic Risk

It is important to avoid condemning an entire generation for the selfish actions of certain members of the group and there are no doubt plenty of responsible young people who are not out partying in an oblivious manner, but they might be less visible. Young people out partying are going to take photos and post them to social media. The young person at home reading a book will not post photos of his or her evening. As Hanlon’s Razor suggests, we should not attribute to malice what can be more easily explained by neglect or stupidity.

It is considerably more difficult to understand the behavior of politicians who, contrary to the opinion of experts such as Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, are urging people to go out to restaurants and bars. For example, Rep. Devin Nunes, in the video below, encourages Americans to visit restaurants and bars this weekend, seemingly oblivious to the risk of community spread:

What is going on?

In a rapidly changing situation, there is bound to be confusion and a cacophony of contradictory opinions and information, but we have the benefit in the United States of seeing how the Coronavirus epidemic unfolded in other countries, such as South Korea and Italy. It strains credulity to think that Rep. Nunes is unaware of the risk of community spread. What could possibly motivate such poor advice?

The medicine we need to take in the United States is harsh and unpleasant in the short run. Shutting down non-essential economic activity is extremely painful for small businesses and individuals who have little margin of safety in their finances. Large companies like Apple can close all of their retail stores and continue to pay hourly employees without much of a blip to the health of the balance sheet. The local restaurant with slim profit margins has no similar luxury even if the owner wants to help workers. Even worse, those who are in the “gig economy” – individuals such as Uber drivers, dog walkers, musicians, food delivery workers, among many others, will see their incomes evaporate overnight with a shut down.

The House of Representatives passed Coronavirus legislation early Saturday morning to alleviate some of the economic hardship that is sure to unfold over the coming days. With provisions such as increased access to sick leave and free availability of testing, the legislation is likely to pass the Senate and be signed by President Trump within the next few days. Other proposals have been made including a temporary payroll tax cut advocated by the President and a trial run of the “Universal Basic Income” proposed by former Democratic Presidential Candidate Andrew Yang.

Some combination of these proposals could alleviate the short term temptation to continue economic activity that risks spreading contagion throughout the country. As I wrote two weeks ago in Thoughts on the Coronavirus Correction, a one-time shock to an individual company does not necessarily imply that the intrinsic value of the company has fallen by very much provided that the long term trajectory of earnings is not somehow diminished permanently.

What is true at the micro level for individual companies is also true for the macroeconomy as a whole. Economists are just now coming to the realization that the United States economy is likely in recession. It seems like a foregone conclusion that real GDP in the first quarter will be below last year’s level. How could it be otherwise with the level of economic interruptions we have seen to date, to say nothing of what the next two weeks might have in store? With a recession defined as two consecutive quarters of GDP decline, it seems very likely that the downturn will extend into the second quarter and trigger an “official” recession.

Whether the recession extends beyond the first half of 2020 is impossible to predict at this point, but the chances of a second half recovery will be greater if we are able to successfully halt the spread of Coronavirus over the coming weeks. This will require tough medicine of a type that few Americans have ever experienced, and leaders willing to put short term considerations aside, up to and including the risk of losing elections in November.

In the long run, the United States economy will come back, as it has from countless panics and stresses in the past. Individual companies, however, may perish during this period if they are not robust enough to withstand a period of stress. In some cases, over-leveraged businesses will be reorganized in bankruptcy with creditors becoming the new equity owners. In other cases, liquidations will occur.

From an investment standpoint, it is important to review holdings with a fresh pair of eyes, but to avoid panic. Market quotes from three weeks ago are not relevant to today, nor are estimates of intrinsic value that were made prior to the crisis. Investors should update their assessments of intrinsic value and evaluate holdings in the context of current quotes. Being a long term investor does not mean one should not constantly update and reassess when significant events occur.

Coronavirus and the economic dislocations to come will certainly be one of the most significant financial events of our lifetimes. But more important than financial difficulties, it could very well become a tragic health episode for many of us in the coming weeks. Hopefully citizens and the politicians who represent us will rise to the occasion.

Coping With Market Meltdowns II

“The market is like a large movie theater with a small door.”

— Nassim Nicholas Taleb, Skin in the Game

There is an old saying that experiencing a bull market is similar to riding up an escalator while living through a bear market is more like riding down in an elevator. At times, the elevator may appear to be in a free-fall. Bull markets, born in an environment of maximum pessimism, are initially met with skepticism and build in strength as confidence grows over time. Howard Marks compared the market cycle to the movement of a pendulum in Mastering the Market Cycle. At the inflection points, when the pendulum reaches maximum optimism or maximum pessimism, it momentarily stalls out and then reverses course. When markets expect perfection, one chink in the armor can be the catalyst causing the reversal. When multiple hits occur nearly simultaneously, the reversal can be shockingly rapid.

At the time of this writing, on the morning of Monday, March 9, 2020, the Standard & Poor’s 500 is not yet in “bear market” territory, as defined as 20 percent drop from its record high, but conditions do resemble a free-falling elevator. Exchange “circuit breakers” were triggered almost immediately when trading began due to the S&P 500 falling 7 percent. The fifteen minute halt in trading was followed by a modest rally and the index now trades at 2,785, about 17.8 percent below its February 19, 2020 record high of 3,386.15.

To add further gloom to market sentiment, a price war in crude oil broke out over the weekend between Russia and Saudi Arabia sending the oil price down to the low $30 range this morning. Concerns regarding an impending recession have sent the ten year treasury note to a record low yield below 0.5 percent. Of course, all of these numbers are sure to be obsolete by the time you read this article. All of these developments are being attributed to stress related to the Coronavirus pandemic which has only become more severe since I posted some thoughts about it last week.

Same Movie, Different Circumstances

Almost exactly eleven years ago, on March 6, 2009, I published Coping with Market Meltdowns which proved to coincide almost exactly with the end of the financial crisis bear market and the start of the bull market that still lives today, albeit ailing in the intensive care unit on life-support.1 Of course, the big story at that time was an a “pandemic” of a different sort, one that shook confidence in the underlying pillars of the worldwide financial system. By the time the financial crisis bear market was over, stocks had fallen well in excess of fifty percent. We are nowhere near such a decline today but some of the lessons from that bear market still apply today.

Let’s take a brief look at the five principles outlined in Coping With Market Meltdowns to see if they still apply today.

  • Know Your Temperament. “Successful investors need to have a temperament that permits independent thinking and analysis and does not allow the opinions or actions of others to dictate their own actions.” Having a calm and rational temperament is a perennial requirement for operating successfully in financial markets. There is no doubt that arming yourself with the right principles helps. Having a strong sense of what Warren Buffett calls an “inner scorecard” is necessary — a bear market is no time to seek external validation. You need to have confidence in your positions and the temperament to avoid rash actions when under stress.
  • Know Your Investments. “Successful investors know their investments.  They do not make investments based on talking heads on television, by reading newsletters, or by taking “hot tips” from their neighbor.  The problem is that knowing your investments takes significant time and effort.” There’s a significant learning curve when it comes to understanding a business well enough to make a meaningful financial commitment but maintaining the knowledge does not necessarily require a massive amount of time. For example, it might take months of effort to understand Berkshire Hathaway well enough to invest in it but maintaining that investment might require only a few days per year.2 If you cannot invest the time needed to understand a company, you are better off buying an index fund.
  • The Market Is Your Servant, NOT Your Boss. “Mr. Market is a manic-depressive who serves up all kinds of quotations for what you own on different days.  On some days, he is giddy with optimism and offers you a high price and you can choose to buy or sell.  On other days, he is depressed and marks everything down.” This always has been true and always will be true … not allowing Mr. Market’s emotions to influence your own behavior is absolutely required.
  • Understand Intrinsic Value. “What keeps me out of trouble is that I never listen to Mr. Market’s opinion on the value of my holdings.  I really don’t care what the market thinks.  Instead, I keep a spreadsheet of the intrinsic value of my holdings based on my estimates.” This advice still holds true today. Having an independent assessment of intrinsic value allows us to anchor our sense of value to a number that is independent of market quotes. One very important caveat is that intrinsic value estimates can and will change over time. If you owned a cruise ship operator and made an estimate of its intrinsic value as of January 1, you would be delusional to not update your intrinsic value assessment in light of the severe business impacts that have accompanied the coronavirus situation. One should never be emotional but should strive to be realistic at all times and to then anchor to realistic assessments of intrinsic value, not market quotes.
  • Don’t Invest the Rent Check! “No one can make intelligent decisions if they do not know where their next rent or mortgage payment is coming from.  The stress would make it impossible.  It makes no sense to put yourself in a situation where you must liquidate long term holdings for short term consumption needs.” Stocks represent pieces of real businesses and are inherently long term investments. Stocks are no place to put any money that is needed in the near term.

Then and Now

The market crash of 2008-09 represented extremely trying times. As I wrote in a brief personal history a couple of years ago, the crash of 2008-09 vaporized a significant percentage of my net worth at a time when I least expected it and I had a limited margin of safety. Although I had lived through the dot com crash of the early 2000s as an investor with skin in the game, a combination of luck and skill (but mostly luck) spared me from any significant harm during that debacle. So, the 2008-09 crash represented my first real “trial by fire” in which I lost a significant amount of money.

The nature of an eleven year bull market means that millions of individual investors and thousands of professional investors have never lived through a period in which 20 percent or more of their net worth is vaporized. These individuals are untested and cannot completely know how they will react until the losses appear on paper. No amount of “paper trading” or simulations can prepare an investor for losing a big chunk of their net worth for real. Even reading every word that Benjamin Graham and Warren Buffett ever wrote cannot provide full immunity from acting foolishly during bear markets.

In truth, even experience in prior bear markets provides no immunity from foolishness, although knowing how you reacted in the past can provide a decent indicator of how you might react today. Of the factors discussed eleven years ago, perhaps the most important one is to not have funds invested in stocks that will be needed in the near term. There is no way to act with equanimity when you are under financial duress. When your baseline financial safety is threatened, you fall all the way down to the bottom of Maslow’s hierarchy of needs which is a recipe for panic. As Charlie Munger says, in a reference to the Monopoly board game, no one wants to “go back to go”, meaning having to start over from scratch. The prospect of such a disaster is not conducive to rational thought.

Buying (Partial) Immunity

Making yourself financially bullet proof is the only way to buy partial immunity from panic during market crashes. The problem is that buying this immunity comes at a high cost during bull markets. It starts with avoiding leverage that can be called in response to a decline in security prices – in other words, avoiding direct leverage on your positions via margin. Avoiding personal leverage of other types provides further mental peace of mind. For investors relying on their portfolio for cash flow needs, maintaining either cash or a bond ladder representing several years of cash adds more peace of mind, but at the cost of abysmal negative real returns on that cash.

Investors who are regularly accumulating financial assets through savings from employment or a business face different challenges. These investors need to focus on the fact that market declines present opportunities to purchase assets at lower prices which should enhance their long term returns. The main concern for investors in the accumulation phase should be to maintain their earnings power through their employment.

What if an investor is relying on his or her portfolio for current cash flow but has invested everything in stocks or other risky assets? Such an investor will end up being a forced seller, but must still avoid panic! Here the key factor is to have a low withdrawal rate as a percentage of the portfolio. By limiting withdrawals to a modest level, ideally below 3 percent, the damage can be contained by only liquidating a small amount of the portfolio at depressed prices. Too many investors in this situation will instead panic and liquidate everything — this is a mistake in all scenarios other than a multi-year bear market followed by stagnation, in other words another Great Depression scenario.

More Things Can Happen Than Will Happen

It is tempting at the moment to fall victim to hindsight bias — wasn’t it “obvious” that the market would trade sharply lower due to coronavirus? It is true that the prospect of a pandemic occurring at some point is always a risk, but this is a risk that is impossible to time or predict.

Consider the headlines over the past weekend that led to today’s sharp decline. Coronavirus cases have increased and many dire predictions have been made regarding potential spread and economic impact. Then, the news regarding oil prices added to the gloom and markets went into a freefall.

Returning to Howard Marks, consider this tweet from 2018:

What would the markets be doing this morning if the Israeli researchers who have been searching for a Coronavirus vaccine had announced a breakthrough over the weekend? Or if researchers at the Galveston National Laboratory had announced a breakthrough?

These alternate histories did not occur last weekend, but if they had, what we would be experiencing today would probably be the opposite of what is actually taking place. Extrapolating the current state of affairs into the future is fraught with risk.

Many of the pundits who now claim credit for predicting the current decline are “perma-bears” who have been predicting doom and gloom for years. Even broken (analog) clocks are correct twice a day. The world does not stand still and humanity’s quest for answers is constant.

The fact is that no one knows whether the stock market will soon enter a bear market, how long that bear market will last, and the catalyst that will eventually cause the pendulum to reach its nadir and reverse course. Coping with market meltdowns successfully requires a calm temperament, confidence, knowledge, and financial resources built up during calmer times.


  1. Readers may also find Using Checklists to Control Emotions During Market Meltdowns, published in 2010, to be useful in the current market environment. []
  2. I spend a couple of days analyzing Berkshire’s annual report (some thoughts on the 2019 report were sent to newsletter subscribers last month) and around half a day analyzing each quarterly report. []

Thoughts on the Coronavirus Correction

Financial markets have finally come to the realization that Coronavirus is a story that is not going away anytime soon. As long as the virus was confined mostly to China and other cases could be readily explained, markets in the United States appeared complacent. However, reports of an increasing number of cases in Europe over the past week, including some that appeared to be spreading within local communities, caused Wall Street to react sharply in recent days.

For the week ending on February 28, 2020, the S&P 500 was down 11.5 percent. This leaves the index 12.8 percent below its recent record high close on February 19, 2020 well within the “correction” range that is typically defined as a decline of ten percent of more. Of course, the history of the S&P 500 shows that there have been many other precipitous declines including its largest ever one-day drop of 20.5 percent on October 19, 1987, an event also known as “Black Monday”.

Black Monday might be beyond the personal recollection of many investors but the fourth quarter of 2018 should still be fresh in everyone’s memory. From September 20 to December 24, 2018, the S&P 500 declined by 19.8 percent, just under the twenty percent threshold that would have marked the start of a bear market. At Friday’s close of 2,954.22, the S&P 500 is less than one percent above where it stood on September 20, 2018.

While stock markets appeared to be in a near free fall at times, the bond market rallied strongly as worried investors sought the perceived safety of United States government securities. The ten year treasury note started the week at 1.46 percent and fell to 1.13 percent by Friday, February 28 which is an all-time record low yield.1 Since bond prices move in the opposite direction of yields, this means that investors in the ten year treasury saw the value of their bonds rise last week while stock investors suffered losses. Whether “safety” can be attained by purchasing securities at slightly more than a one percent yield issued by a government that has pledged to inflate the currency by two percent per year is a significant long term concern but beyond the reckoning of market participants in the midst of a panic.

This article provides some thoughts regarding how one might keep the situation in the proper perspective, how to think about changes in the valuation of business in response to a pandemic, and finally how the events of the past week might influence Berkshire Hathaway’s repurchase policy.

Keeping Things in Perspective

The Coronavirus situation is a serious public health emergency and people are correct to be concerned that it could turn into a much wider pandemic if steps are not taken to reduce the spread of the virus.2 Personally, I am much more worried about the spread of the virus within my local community in general as well as the risk to friends and family members who might be especially vulnerable.

The effects of the virus on business activity and security prices may well be significant, but in the long run, even the worst pandemics will run their course and conditions will improve. Personal and community preparedness is far more important at this stage than worrying about the prices of financial assets. Money is important but can be replaced whereas lives lost are lost forever. Trite, perhaps, but still very true.

In terms of business activity, a few thoughts on the subject might be helpful when thinking about the potential impact of the virus. It is useless to think in terms of the impact to stocks without considering the impact to the underlying businesses represented by stock prices. The following points might not be particularly insightful but still seem relevant enough to outline briefly:

  • Not all businesses are equally exposed. It is obvious that a cruise ship operator, an airline, or an operator of a high end hotel or restaurant in Venice will suffer greater harm from Coronavirus compared to an operator of gasoline stations or grocery stores providing essential products and services needed for daily life. For the most part, financial markets understand this type of “first level thinking” fairly well so we see stocks of airlines, for example, reacting very negatively to the prospect of travel disruptions.
  • Some business will be lost forever while other business will be deferred. Tourism seems like a prime example of lost business. Even though some travel will be deferred rather than cancelled, a lost season of spring tourism will never be fully recovered. However, if one considers a case where a manufacturer has suffered supply chain disruptions due to the impact of Coronavirus in China, much of this business might simply be deferred rather than lost forever. However, consumer confidence could come into play and prevent pent-up demand from materializing.
  • Leverage can kill. If a business is especially vulnerable to short term impacts of the virus and is also highly leveraged, Coronavirus could literally kill the business. At times like this, financial conservatism is paramount. During good times, leverage accentuates financial results but there is no free lunch available. The same leverage dampens results when times get tough and can be deadly. If you operate a fleet of cruise ships that are temporarily sitting idle at port, you still have to maintain the fleet and pay interest on your debt while your revenue slows to a trickle. How long can you survive?
  • Some businesses will benefit. The obvious examples here include companies that are selling equipment or services needed to combat the virus itself. There is currently a major shortage of N95 masks that are said to be partially effective in terms of slowing the spread of the virus. 3M will be able to sell as many of these masks as they can produce for the foreseeable future. Another obvious example includes companies manufacturing drugs or supplies needed in hospitals and other clinical settings. Finally, any company that comes up with a treatment or vaccine will clearly benefit, albeit with political limitations so as not to be seen as pricing treatment at levels perceived to be unfair.

There are certainly other considerations and we should all strive to go beyond first level thinking. One rarely gets paid in financial markets for thinking about the same things that everyone else is thinking about. Since the macroeconomic impacts are being discussed by nearly everyone, chances are that deployment of second level thinking is most likely to be fruitful at the micro level, that is at the level of individual companies.

Intrinsic Value Impact of Disruption in 2020

Unless you are looking at a business that clearly stands to benefit from the Coronavirus, which would be quite rare, it is nearly certain that the businesses you own will suffer some level of harm from this situation, either due to direct impact on business or through macroeconomic effects that could accompany a recession. No one knows the scope of the harm at this point because we do not have any understanding of how widespread the contagion will be. Nevertheless, we should bear several things in mind when we try to evaluate how a business slowdown will affect a particular business.

First of all, as noted above, think about leverage. Can the business survive short term vicissitudes and come out on the other side at all? Intelligent investors will never own companies that do not offer any margin of safety so, hopefully, the question of excessive leverage is one that filtered out such companies from consideration well before this crisis.

Assuming that Coronavirus does not kill the business, the rational way to frame your thinking about intrinsic value is to think about how free cash flow is likely to be impacted over time. And this assessment is going to depend on your judgment regarding how business conditions will develop over time for the company.

The intrinsic value of a business is the discounted value of the free cash flow (FCF) it will generate over the rest of its life. Necessarily subjective and impossible to predict with accuracy, this theoretical construct is still a useful way to think about the impact of any short term shock. Let us take an admittedly simplistic example to illustrate this point. In this example, assume that the business is not leveraged to the point where near term survival is in question.

Assume that you have a business that is expected to generate $10 million of FCF in 2020 and is likely to grow FCF at a 3 percent annual rate over the next thirty years. If you use a rate of 8 percent to discount the thirty years of future cash flow into present value terms and add the $10 million of un-discounted current year cash flow, you would arrive at an intrinsic value estimate of a little over $166 million, ignoring any cash flow that might be generated after this thirty year period. Of this $166 million estimate, over half is attributed to cash flow expected from years ten through thirty.

The exhibit below shows each year of expected cash flow discounted to present value terms:

You made these estimates a month ago before the Coronavirus news and now you need to adjust your assumptions based on your assessment of how a pandemic might impact near term and long term free cash flow. The difficulty is in making the assumptions, but it is easy to test your assumptions and see the impact on intrinsic value.

For example, let’s say that you believe that the business will suffer significant harm in 2020 that will never be recovered, but the trajectory of free cash flow starting in 2021 will return to the trend level of the exhibit above. Under this scenario, your intrinsic value estimate would decline by the un-discounted $10 million of lost free cash flow for 2020 and the value of the enterprise would decline by about 6 percent to $156.3 million.

Adding a little complexity, let’s say that you believe that the $10 million of lost free cash flow in 2020 will be partially offset by a $5 million of additional free cash flow in 2021 due to pent up demand, followed by a return to the prior trend level. In this case, intrinsic value drops by only 3.2 percent to $160.9 million as shown in the exhibit below:

But let’s say that the scenario is going to get much worse before it gets better. You expect negative FCF of $5 million in 2020, no free cash flow in 2021, and then a return to the prior trend level of free cash flow thereafter. Under this scenario, intrinsic value falls 14.7 percent to $141.8 million as seen in the exhibit below:

There are an endless number of permutations that are possible and the examples above are simplistic, but should serve to make two very important points:

  • Focus on business impact first, valuation later. The real question facing investors is accurately assessing the near and long term impact of a pandemic-related business slowdown and correctly ascertaining whether the business has enough of a margin of safety to weather the short term and survive to see the long term.
  • Focus on long term impact, not short term pain. The vast majority of the intrinsic value of a business is typically attributed to expected cash flows in the intermediate and distant future. While the short run impact can be painful, so long as a business can both survive in the short run and not suffer any long term impairment to its cash generating capabilities, the decline in intrinsic value is not likely to be calamitous.

Markets are emotional and capricious because human beings are emotional and capricious. Intelligent investors will have prepared for temporary disruptions in business activity by avoiding excessively leveraged businesses lacking a margin of safety and will attempt to make intelligent assessments of the long term prospects for the business. Then, if markets insist on marking down a business by fifty percent when a rational assessment indicates only a minor reduction in value, the intelligent investor can be poised to act by accumulating more shares with cash available as the fruit of prior sound long term decisions.

Berkshire’s Repurchase Prospects

It seems like much more than one week has passed since Berkshire Hathaway investors were immersed in reviewing the company’s 2019 annual report and Warren Buffett’s annual letter to shareholders. The content and context of the letter seemed to reinforce the idea that Berkshire is likely to repurchase shares in the future.

Much information regarding Berkshire’s past repurchase history can be found in this article published on The Rational Walk last week and readers are encouraged to review that information before considering this brief update.

One of the problems with static thinking when it comes to prospects for repurchases is that it does not reflect how Warren Buffett thinks about his opportunities to deploy Berkshire’s cash. Buffett does not fixate on book value at the end of 2019 when it comes to deciding whether to repurchase shares today and has de-emphasized book value as a relevant metric in general. Furthermore, it is likely that his thoughts regarding capital allocation have changed over the past week due to the decline in stock prices in general and Berkshire’s stock price in particular.

Although book value has been de-emphasized, it is still a relatively useful yardstick since it governed Berkshire’s repurchase policy until mid-2018. Since the policy was changed, Berkshire’s repurchases have fallen within a range of 1.25-1.43x the last reported book value, as discussed in last week’s article.

As of Friday, February 28, Berkshire’s Class A shares closed at $309,096 which is down 10 percent for the week, compared to the 11.5 percent decline for the S&P 500 index. Berkshire trades at a price-to-book ratio of just 1.18x based on December 31, 2019 book value which is far below the level at which recent repurchases took place.

This might seem to make repurchases a no-brainer, but of course Berkshire’s book value as of today is almost certainly lower than it was at December 31, 2019 due to declines in its large portfolio of common stocks. Based on my calculations, the stock positions reported on Form 13-F have declined by 12.1 percent year-to-date, assuming that the positions remain unchanged so far this year. This amounts to a decline of 12.1 percent, or $29.3 billion! Even accounting for a reduction in deferred tax liability, this hit to book value is probably in the neighborhood of $23 billion.

As an offset to this decline, Berkshire has almost certainly posted very significant net operating income year-to-date. If the run-rate over the past couple of years held constant for January and February, Berkshire likely posted about $4 billion of net operating income.

If the assumptions above are in the ballpark, Berkshire’s book value probably declined by around $19 billion year-to-date which would reduce book value per share from $261,417 at December 31, 2019 to around $250,000 per share today. That would put the current price-to-book ratio at around 1.24x which is still on the very low end of where Berkshire has repurchased in the past.

With $125 billion of cash on the balance sheet, Warren Buffett could have deployed a billion dollars or more to repurchase stock during the market decline of the past week, and that is only considering the volume on the public markets. He also opened up the possibility of private repurchases in his annual letter in amounts of $20 million or more. According to Yahoo! Finance, Class A volume was 2,900 shares and Class B volume was 49,481,700 from February 24 to 28 which is meaningfully higher than normal. I have not attempted to calculate the dollar volume with precision but it seems to have been in excess of $11 billion for the week.

Of course, whether any shares were repurchased also depends on the alternatives that became available during the week. Many of Berkshire’s top holdings, especially in banks and airlines, suffered declines last week far greater than Berkshire’s decline. Additionally, it is possible that other opportunities have come up since Buffett’s willingness to make big bets during a crisis is now well known. His phone might have been ringing quite a bit last week.

Further discussion regarding repurchases can only delve into speculation at this point. We will know how many shares, if any, were repurchased during last week’s tumultuous markets when Berkshire reports first quarter results in early May.

Concluding Thoughts

Markets can do anything in the short run and investors should never forget this fact. Long periods of quiet in financial markets lull investors into a false sense of security and long periods of steady gains feed complacency. When markets tumble, coping with meltdowns in ways other than panic selling becomes imperative.

Timeframe arbitrage is perhaps the only enduring advantage that most individual investors have left. It isn’t impossible to have differentiated insights ignored by professionals, and many individuals outperform on that basis. But for the rest of us, knowing when to focus on the long term when everyone else is focusing on next quarter becomes a huge advantage. At the same time, we should not deceive ourselves into thinking that we have not personally taken some sort of hit when an unexpected event like Coronavirus disrupts business activity. Almost all of us are somewhat poorer as a result.

Most professional investors managing capital for others lack the luxury of thinking about the next three years because they are obsessed with what they will report to investors over the next three months. That’s just the inherent bias of most people moving large amounts of money in the markets and isn’t likely to change. As an individual investor accountable to no one but myself, I don’t intend to needlessly adopt this dysfunctional mentality.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.


  1. The daily Treasury yield curve database is a useful way to track government bond yields. []
  2. There are many sources of information on Coronavirus in the mainstream media, and many others, including Bill Gates, have sounded alarms regarding the situation. I have no expertise in the science behind the virus and no special insights beyond what has been widely published. Therefore, this article is mostly about how I would think about the impact of a pandemic on the value of financial assets, an area where I (hopefully) have some insights to share. []

Buffett Loosens the Purse Strings for Repurchases

Berkshire Hathaway has released its 2019 annual report along with Warren Buffett’s annual letter to shareholders. In the letter, Mr. Buffett spends some time discussing the power of retained earnings as well as general capital allocation strategies. Given Berkshire’s policy of retaining almost all earnings over the years, these topics are of utmost importance when it comes to understanding the company’s prospects for delivering adequate returns to shareholders in the coming years.

One important lever for Berkshire to add value for continuing shareholders is through repurchases of stock at prices below intrinsic value. In 2019, Berkshire deployed $5 billion of cash to repurchase approximately one percent of the company’s common stock. Since 2011, when Berkshire first announced a formal repurchase program, the company has allocated $8.1 billion to repurchase 33,139 Class A equivalents at an average cost of $245,177 per share.

Berkshire’s repurchase program was initially very restrictive and, as a result, few shares were repurchased. However, in July 2018, Buffett changed Berkshire’s policy which removed previous limitations that constrained repurchase activity. After July 2018, Buffett was permitted to repurchase shares at any time that he and Vice Chairman Charlie Munger considered the shares to trade at a discount to intrinsic value, provided that Berkshire’s cash balance remains at or above $20 billion.

This article presents a comprehensive overview of Berkshire’s repurchase activity since 2011. With Berkshire’s cash balance of $125 billion as of December 31, 2019 and continuing free cash flow arriving every quarter, the possibility of significant repurchases definitely exists if shares continue to trade at or below current levels.

Note: For additional commentary regarding the annual report, please read the special issue of the Rational Reflections newsletter which was sent to subscribers on Saturday afternoon.

Repurchase History: 2011-2019

Berkshire reports the specific number of shares the company has repurchased in each 10-Q quarterly report and in the 10-K annual report each year. The reporting is done by date range rather than on a day-to-day basis but still provides granularity that can be insightful. The exhibit below shows all of Berkshire’s reported repurchase activity since the formal repurchase policy was introduced in 2011:

Sources: Berkshire 10-Q and 10-K Reports

On September 26, 2011, Berkshire announced a formal repurchase program with the main stipulation being that management would not repurchase shares at a premium of more than 10 percent above book value. The market quickly took this as a signal that Berkshire’s shares were undervalued so only $67 million of stock was repurchased in 2011 before the stock price rose beyond a 10 percent premium. Shares never traded at a low enough valuation to trigger the repurchase policy in 2012 but when a block of shares from the estate of a longtime shareholder became available in December 2012, Berkshire changed the repurchase restriction to authorize purchases at a premium of no more than 20 percent above book value. This allowed Berkshire to allocate $1.3 billion to repurchases during 2012.

After 2012, Berkshire did not allocate any cash toward repurchases until August 2018 following an amendment to the share repurchase program that removed specific limitations regarding the premium to book value that could be paid. However, in 2014, Berkshire exchanged 1.62 million shares of Graham Holding Company for WPLG, a Miami television broadcaster, and this company came with $400 million in Berkshire stock which was effectively retired. This essentially resembles a repurchase – let’s call it the 2014 “quasi-repurchase”.

Since August 2018, Berkshire has spent $6.4 billion on repurchases which represents the bulk of activity since 2011 and most of the entries in the exhibit. Although the shares have not been repurchased constantly, some shares have been acquired in most of the months since the policy change.

Valuation of Acquired Shares

Let’s now take a look at a rough indicator of value for each of the reported repurchases since 2011. The exhibit below shows each of the date ranges along with the number of Class A equivalents that were repurchased and the average cost paid per Class A equivalent.1 The table also shows the “trailing book value” per share which is the book value per share reported at the last balance sheet date. For example, “trailing book value” for the last entry of 12/2/19 to 12/31/19 was the book value figure reported as of 9/30/19. Finally, the price/book ratio paid is presented.

As we can see, the first two entries were both done at or below 1.1x book value given the restriction imposed at the time of not paying more than a 10 percent premium to book. The 2012 purchase was executed at 1.17x book value, below the 20 percent premium to book dictated by the December 2012 amendment to the repurchase program. The 2014 “quasi-repurchase” is interesting because the effective price was 1.33x book value even though the limitation for actual deployment of cash remained at 1.2x book value.

Once the self-imposed handcuffs specifying a maximum book value were removed, we can see that Buffett had no qualms about repurchasing shares at price-to-book ratios up to 1.43. Indeed, the initial repurchase range from 8/17 to 8/24/18 was executed at 1.43x 6/30/18 book value. The range for repurchases in 2019 was from 1.25 to 1.42x book value.

Does Book Value Still Matter?

At this point, we should note that Warren Buffett’s 2018 letter to shareholders de-emphasized book value as an appropriate (albeit understated) gauge of intrinsic value.2 This appeared to change the goalposts when it comes to thinking about repurchase activity. From a mathematical perspective, any shares that Berkshire repurchases above book value will have the effect of reducing book value per share even though management believes that it is increasing intrinsic value per share by buying back shares.

Over time, the gap between book value and intrinsic value will grow due to repurchase activity and, hopefully, the ongoing generation of economic goodwill within operating subsidiaries. So, looking at the price-to-book value that Berkshire pays to repurchase shares might not be meaningful from a comparative basis over time. Nevertheless, given that the policy was only changed recently, many shareholders continue to follow book value and find it useful to think about the price-to-book ratio that Buffett feels comfortable with when it comes to repurchases.

Prospects for Future Repurchases

Four years ago, I wrote an article considering what Berkshire Hathaway might look like ten years in the future. Here is a short excerpt from that article on the topic of repurchases:

Mr. Buffett has indicated that Berkshire’s board of directors will consider repurchases as a means of returning cash to shareholders.  Repurchases, if made at levels at or below intrinsic value, can be more efficient than dividends because only shareholders who are voluntarily departing will face tax consequences.  If repurchases cannot be made at prices that make sense, cash dividends will have to be initiated and all shareholders would face the tax consequences.

Berkshire’s current repurchase limit of 120 percent of book value would have to be increased substantially in order to make repurchases of any significant size possible.  Since 120 percent of book value is far below any reasonable assessment of Berkshire’s intrinsic value, it follows that Mr. Buffett and the board of directors would have to agree to increase the repurchase limit in order to return material amounts of cash to shareholders.

Berkshire Hathaway in 2026, published on April 26, 2016

The removal of the 120 percent limit in 2018 dramatically increases the ability of Berkshire to use repurchases to return cash to shareholders in the coming years. With $125 billion of cash on the balance sheet, Berkshire is carrying excess cash earning very modest returns. That cash is earning negative yields on an inflation adjusted basis and it is certain that Warren Buffett and Charlie Munger take no joy in having it on the balance sheet and would much prefer to deploy it to purchase great businesses at attractive prices.

Cash represents optionality and, at age 89, Warren Buffett is still going strong as CEO of Berkshire Hathaway and shows no signs of slowing down anytime soon.3 It is certainly possible that he will have another opportunity to deploy many tens of billions of dollars in a market crisis, either in marketable securities or outright acquisitions. However, Berkshire’s $125 cash pile will continue to grow in the near term and modest repurchases of 1-2 percent of shares outstanding annually seems more likely than not.

With Berkshire A shares trading around $335,000, which is a modest 1.28x book value as of 12/31/19, it would not be surprising to see significant repurchases this quarter. Buffett’s unusual offer in his annual letter to repurchase blocks of shares of $20 million or more is a signal that, at the right price, he is willing to loosen Berkshire’s purse strings.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

  1. Each Class A share is equivalent to 1,500 Class B shares in terms of economic interest although Class B shares have only 1/10,000 the voting rights of Class A shares. []
  2. I have long been skeptical of the utility of book value when it comes to thinking about Berkshire. []
  3. Buffett looked and sounded great in his appearance on CNBC this morning. In this clip, he discusses the difficulty of buying back Berkshire shares relative to the stock of other large companies. []
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