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Will Berkshire Go Bust?

Posted On August 13, 2015 7:36 am
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A couple of recent moves highlight the differences between Google and Berkshire Hathaway and suggest Age may finally be catching to Warren Buffet as the bulk of his investments are mired on no growth industries.

In the wake of Google’s (GOOGL) move to make Alphabet soup of their company much has been made of the fact they are adhering to Buffet’s noting in a letter to potential shareholders in 2004 ahead of Google’s initial public offering. Page and co-founder Sergey Brin quoted Buffett when outlining the company’s long-term focus.

“Much of this was inspired by Warren Buffett’s essays in his annual reports and his ‘An Owner’s Manual’ to Berkshire Hathaway shareholders,” the letter said, in the lone footnote at the bottom of the statement…

But the similarities are only skin deep; that is Google is adopting the holding company structure but none of Buffet’s investment style.  And that probably speaks to why I think Google has a bright future while Buffet’s Berkshire Hathaway (BRKB) seems doomed to continue its recent under-performance.

Since the 2009 lows shares of BRKB have gained 100%.  That may seem pretty darn good.  Accept when you realize less than half the 205% the S&P 500 has gained in that time. This year has been no better as shares of BRKB have been in decided downtrend channel losing some 7% thus far in 2015.

BRKB chart 8.12.15

Despite its latest, and one its largest acquisitions, of Precision Castparts (PCP), for $37 billion in cash I think the future prospects for Buffet’s holding company looks bleak.

In fact that acquisition highlights some of its problems, challenges and differences from Google. The fact it takes huge acquisitions to move the needle, and note the large cash outlay may result in a rating agencies downgrade of Berkshire Hathaway two notches as it will be forced to draw down some $12 billion from its insurance units’ reserves to finance the purchase.

Buffet is notorious for investing in basic brick and mortar business such as railroads, consumer staple foods such as Heinz and McDondalds, which itself is falling out of favor with younger generation, and building materials.  His one foray into technology has been IBM, which has been losing market share for five straight years.  The only thing holding up IBM stock, barely, has been its massive share buyback program.

Compare this to the way Google grows its business; it uses free cash flow from its highly profitable search advertising business make many relatively low cost acquisitions.  It focuses on emerging technologies that offer high growth.  Some examples are self-driving cars, genetics and space exploration.

Berkshire is built on lumbering earthbound businesses with limit growth opportunities.  It needs all the separate businesses to carry their own weight otherwise the company as a whole gets dragged down.  Google invests in so called “moonshots” in which one big transformative “winner” will more than offset the flubs that don’t take-off.

One big evolutionary business venture could completely transform Google to the point where its current search business is a relatively small subsidiary. I think it’s that type of vision that’s behind its corporate restructuring.  Allow individual business to run somewhat autonomously and flourish under the protective umbrella of the parent holding company.  They are desirous of change to drive growth. This is the antithesis of Buffet’s investment style which is to basically find stable businesses with “moat” and maintain the status quo.

But Buffet’s moats my slowly be disappearing.  As mentioned above McDonalds and Coke may never regain its place as the iconic burger joint  and soda combo tastes are changing.  The the landscape is filled with Shake Shacks (SHAK), Red Robin Gourmet Burgers (RRGB) and Sonics (SONC) just to name a few. And the beverage industry has moved towards teas, energy drinks, and flavored waters.

Or think about how technology might undermine some of Buffet’s other core holdings.  For example the car insurance business in which Geico is Berkshire’s crown jewel, is likely to face a upheaval of a whole new pricing structure once self-driving cars become a reality.

Or the financial industry in which Berkshire is a big holder of Goldman Sachs and JPM Morgan.  The traditional brokerage business is already under assault from so called robo-advisors such as Wealthfront and the basic loan and capital raising industries are also moving to technology based and social platforms such as Quicken and Kickstarter millennials are more comfortable using.

Berkshire Hathaway, like Russia will be around for quite a long time. But the aversion to innovation, and embrace of stagnation and sameness as antidote to risk, could become huge liabilities in the not too distant future.

Buffet says he likes to invest in companies “forever.”  But Berkshire is one I’d avoid. It has no future.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.