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Standing on the Shoulders of Giants

Standing on the Shoulders of Giants

Standing on the Shoulders of Giants

Charlie Munger, Berskhire's Growing Cash Pile, Valuations, and Opportunities in Fixed Income

On Saturday, May 4, 2024, Berkshire Hathaway released its first quarter earnings, and on that day, thousands made their annual pilgrimage to Omaha, Nebraska, to listen to the investment gospel of Warren Buffett at Berkshire’s annual meeting. It was the first annual meeting since the November passing of 99-year-old Charlie Munger, Vice Chairman of Berkshire. Like Warren, Charlie grew up in Omaha, Nebraska, and as a teenager, worked at Buffett & Son, a grocery store owned by Warren’s grandfather. The two first met in 1959 and instantly became friends, but it took 19 years for Warren to convince Charlie to join Berkshire Hathaway as Vice Chairman in 1978.

Buffett opened this year’s annual letter to shareholders with a special tribute to his dear friend and credited Charlie with being the architect of today’s Berkshire Hathaway. In 1965, Charlie gave Warren the following advice:

“Warren, forget about buying another company like Berkshire. But now that you control Berkshire, add to it wonderful businesses purchased at fair prices and give up buying fair businesses at wonderful prices. In other words, abandon everything you learned from your hero, Ben Graham. It works but only when practiced at small scale.”

Benjamin Graham, author of, “The Intelligent Investor: The Definitive Book on Value Investing,” became Buffett’s mentor after he took a class from him at Columbia Business School in 1951. Charlie’s advice to Warren was to abandon the deep-value strategy he learned from Graham and instead focus on investing in great businesses at reasonable prices – simple advice that has stood the test of time.

Warren eventually followed Charlie’s advice, and today, Berkshire Hathaway is valued at $890 billion.

So, what can we take away from this year’s annual meeting? Long term, Buffett is very bullish on the U.S. economic outlook; however, for the past few years, he has been accumulating cash much faster than he is finding new businesses to invest in or buy outright. On March 31, 2024, cash, cash equivalents, and short-term U.S. Treasuries on Berkshire’s balance sheet totaled $189 billion, the largest amount on record for the company. Buffett declared: “It’s a fair assumption that they’ll probably be at $200 billion at the end of this quarter.” Assuming he needs to maintain $60 billion in reserves inside of Berkshire to operate the conglomerate, that means he will have around $140 billion at the end of the second quarter that he is waiting to invest. At 93 years old, he is exercising patience, with the expectation that he (or his successor) will take advantage of a future market pullback or correction to deploy Berkshire’s excess cash.

Warren’s belief that U.S. equities are currently selling at premium levels is based on what is known as the Buffett Indicator, his favorite gauge to measure valuations. During an interview with Fortune magazine in 2001, Buffett asserted that the indicator, “is probably the best single measure of where valuations stand at any given moment.” It takes the total value of all publicly traded companies – using the Wilshire 5000 index – and divides that by the latest reading of GDP (gross domestic product) in the U.S. While this indicator is signaling the U.S. markets are richly valued, the critics point out that the formula ignores the money U.S. companies make operating outside of the U.S. (think Microsoft, Apple, Google, Amazon, Coca-Cola, Proctor & Gamble, Walmart, etc.) and does not take into consideration how interest rates affect valuations.

What implications does this indicator have for the average investor? Given the high valuations in the U.S. equity markets, our preferred approach is to incrementally deploy cash via dollar-cost averaging, meaning investing smaller amounts of cash regularly as opposed to all at once. It is crucial to recognize that Berkshire’s size and massive capital reserves limit its focus to substantial, well-established corporations (large caps) that are trading at premium valuations – hence, Buffett sitting on the cash.

What looks attractive in today’s markets? We are finding opportunities in other asset classes. Currently, small caps and international equities are signaling attractive entry levels, both selling at discounts to their historical valuations. In the Q & A session of Berkshire’s annual meeting, Buffett was asked about investing overseas, and he responded that he is more comfortable with the rules, regulations, and reporting standards in the U.S. and thus has historically focused on investing in and buying domestic companies. As to small caps, Berkshire has previously commented that it is too big of a company to invest in the small-cap sector – it would be disruptive for the sector and not move the needle for Berkshire due to its size. However, for the common investor, we believe these two asset classes are appealing right now.

What about fixed income? The Federal Reserve’s ongoing higher-for-longer monetary policy stance offers conservative investors, retirees, and those nearing retirement an opportunity to lock in attractive bond yields and other fixed-income returns for the coming five to ten years. This is a tremendous improvement over the yields available two years ago, creating a silver lining to this extended period of elevated rates, especially if inflation remains manageable, which we expect it to do.

With these insights in mind, it is prudent to routinely review your asset allocation to confirm that it aligns with your risk profile, time horizon, and financial objectives. As always, we are monitoring the market trends and industry news and will continue to provide timely updates.