About 16 years ago, Barron's ran cover story on Warren Buffett questioning whether the billionaire investor had lost his touch. The issue came at the height of the Internet stock boom. Since Buffett has been averse to investing in tech stocks, Buffett and his investment vehicle, Berkshire Hathaway (BRK.A, BRK.B), appeared to be relics of an older investing era.
Fast forward to today and we all know how things turned out. From the beginning of 2000 to now, Berkshire's class A shares have quadrupled while the S&P 500 is up about 40%.
The secret sauce at Berkshire is not simply that Warren Buffett is a great capital allocator; he is a great capital allocator that gets better over time because he knows how to change. In the beginning, Buffett was buying statistically cheap stocks with low price-to-earnings and price-to-book ratios. Then Buffett meets Charlie Munger and starts buying quality business like See's Candies. See's teaches Buffett the enormous value of buying quality, capital-light businesses even if the multiple is on the high side. That lesson enabled Buffett to buy assets such as newspapers and make investments in companies that include Coca-Cola (KO) and American Express (AXP).
Then, as Berkshire's capital continued to swell, Buffett began investing in very capital-intensive businesses like utilities, railroads and airplane engines. The return was not as high but very acceptable given Berkshire's billions.
The learning is not over. It began with a $10 billion investment in IBM (IBM) -- a big bet on technology, which is a sector Buffett has avoided for nearly 50 years. The appointment of Todd Combs and Ted Weschler as investment managers also illustrated the evolution of Berkshire with news Tuesday that the company recently bought $1 billion worth of Apple (AAPL) stock.
Investors should see the light; Berkshire is a breathtaking company -- truly a one-stock portfolio, as evidenced by the numerous shareholders who count it as their sole equity investment. Start putting all these wonderful pieces together and there is a very strong case that Berkshire's Class A shares can deliver a long-term annualized return of 10% or more if bought at a good price. What is that good price? Well, Buffett has said Berkshire would buy back stock at 110% of book value or less. Later, the yardstick was moved to 120% of book value or less. Right now, Berkshire trades at 135% of book value, so watch it closely.