The dialogue out of the annual Berkshire Hathaway (BRK.A, BRK.B) meeting will be beaten to death this morning, including the three hours of discussion on "Squawk on the Street" this morning, so I am not going to rehash the full five-hour meeting; I'll leave that to others. I want to drill down to one very insightful question, and answer, that deserves a second pass -- both for what it says about Berkshire, and about good investments in general.
One of the first questions started by positing that through most of the company's history, Warren Buffett sought high cash flow, low capex businesses. These wonderful businesses were self-funding and threw off significant cash that could be reinvested in other wonderful businesses, thus putting the magic of compounding to work in growing Berkshire. Now, Berkshire is mainly investing in businesses that are attractive-- not necessarily wonderful -- and require substantial capital investment to maintain their moat. Why the change?
Buffett's answer was that with the size of capital Berkshire must move now, there simply are not enough large businesses that are capital light, so by necessity it is forced into the railroads and other industrial businesses.
The answer was succinct, but also telling as to how Berkshire is losing its edge, to some extent. In reality, there's no shortage of very large, very profitable, high-IP and capital-light businesses that Berkshire could buy, or more likely take a public market position.
Let's start with technology. We can respect Buffett's position that he does not want to invest in businesses he does not understand, but his position in IBM (IBM) is a self-refutation of that long-standing position. Furthermore, he has sufficient expertise he can tap right on his board: Bill Gates has been there since 2004. Microsoft (MSFT) has now been publicly traded for 30 years, and it still kicks off billions and billions in free cash flow -- far more than they possibly know what to do with. For most of Gates' tenure on the Berkshire board, the stock was fairly cheap, so even the valuation argument falls short.
Microsoft is but one example. All of the mature technology companies have decades of history, are still high-IP, high-value-added companies whose mid-term future (the next 10 to 20 years) is predictable. How about Oracle (ORCL) or Cisco (CSCO)? Is a new competitor going to take over the relational database market any time soon? What about Google (GOOGL), with 87% global market share in search? The need for search is undeniable, so it is a market that will be here for the rest of our lifetimes, and the ability for anyone to dislodge Google diminishes every day. Even Gates can attest to that, with the failed efforts to develop Bing.
A large public market position in any of these names would fit Buffett's criteria on nearly every dimension.
Instead, he owns IBM -- a dying relic with no future beyond servicing its legacy installed base. In IBM Buffett has gone back to cigar butt investing, trying to get the last puffs out of business that has played out. It has been said that services are where tech companies go to die. Buffett was asked at the meeting about IBM's moat, and he could not answer the question. It was by far the weakest answer of the whole afternoon, and the lack of conviction was telling. Maybe he can see IBM might be his next USAir.
This brings up a larger issue. As smart and disciplined as Buffett and Berkshire Vice Chairman Charlie Munger are, at some point does it become too difficult to grasp the direction the world is going, and to differentiate the winners from losers? This is a problem for all of us as we move through life. The issue was glaring and obvious that afternoon. For instance, after 20 years, Buffett has immense respect for Amazon (AMZN) -- he was a walking advertisement for the stock the whole afternoon and this morning -- so why does the obvious recognition not translate into action? If Buffett were 22 years old and visiting Amazon on a Saturday afternoon, like he did at GEICO all those years ago, what would his assessment be? Now is the time where Ted Weschler and Todd Combs need to assert themselves, to the extent possible. Those two should be more in touch with opportunities among modern, mature, predictable, high cash flow businesses that are Buffett's forte, but he seems to struggle to find.
I am only touching on one industry. What about big pharma? Large companies with high margins and high value-added products. For the last 50 or more years, investors have regularly fretted about patent cliffs, and wondered what will the new drugs be. After 50 years, perhaps the industry knows how to manage those issues. The industry is utterly unpredictable in what breakthroughs will happen, but utterly predictable in that breakthroughs will occur.
This question, more than any other, revealed insight to Berkshire's stock; it is now a wealth-preservation vehicle. You can own it and feel comfortable that you will not lose money in any meaningful way. But it is no longer even close to being the wealth-accumulation vehicle it was when Buffett was young. Retired readers should feel comfortable parking their wealth in Berkshire. Younger readers should look elsewhere to build their own fortunes.