A reminder: my blog serves as my own investment journal. Not as investment advise. You’re an adult. Dyodd.
If you follow me on twitter or Facebook, most of you will already know I’ve gone to cash, choosing to exit all trades. There are a few reasons why especially with the conviction that I had on the tanker trade.
Investing is About Probabilistic Wins
When I first invested in tankers, the thesis was simple. Underlying supply tightness would wind up ship charter rates, cash flows would grow, debt reduction would occur, multiple expansion might happen, and share prices would naturally follow.
All of the above happened with the exception of share prices. Shares appreciated materially for most tanker companies heading into December than dropped off a cliff as the consequences of covid attracted heavier shorting both via long tech / short commodites and from short traders who “foresaw” the coming rate plummets.
Of course, March Contango Madness (yet another symptom of underlying supply) tightness came around and promptly blasted tanker companies with cash. Just take a look at that cash generation.
And then the subsequent debt reduction.
This was generally the case across the board for most tanker companies in 2019 till 2020Q2. They had big earnings bonanzas, debt got reduced, companies got significantly derisked, intrinsic value should certainly have shot up as the useful lifespan of the company arguably increased when the risk of bankrupty correlatively decreased.
Yet share prices stayed muted. In fact, nothing much happened. Share prices bounced around a bunch and stayed below expectations. Here is where I thank my lucky stars. My early investment in tankers by portion of allocation was to severely overweight STNG at around $17-22 as I bought in batches. Later on, I added $TNK at close to $1.85-2 (pre-reverse split).
Then when I discovered Euronav, I made the simple decision to just lever up and buy a large amount. In fact, I was much more bullish on Euronav due to their VLCC heavy concentration, which was in fact the vessel class that was heavily in short supply. It was only my over weightage (with leverage) w Euronav that allowed me to stay above water in dividend gains. Shares appreciated about a dollar from where I bought in at $8.65 and bounced between there to $10.
All in, a year had passed since I started investing in Sept’19 to Sept’20 and as I looked at tankers, I felt disproportionately displeased.
Shorts had been wrong. Cashflow had been amazing. Debt had been reduced. Dividends had been paid and share prices kinda just languished. Euronav was the only one not down due to both yield and share buybacks.
Had any other company on the market announced heavy buybacks, great earnings recoveries, heavy yields, and a shareholder friendly management, we would have been seeing massive share price appreciations. In an era of companies like Nikola and Tesla, that’s not asking for a lot.
Yet nothing happened. I was both dismayed and irritated.
I could continue to hold, wait for the covid weight to be lifted off of oil’s back (which indirectly is a shipping problem) and therefore wait for share prices to appreciate, or I could get out whilst I was still up.
Invariably, this meant I had to take an educated guess on where covid would end up, how much that would affect oil demand, how badly shipping would be affected for the long term, and ultimately and most importantly, if the probability for shipping to still deliver outsized returns was still rather high.
My conclusion was “this is too difficult”. I could certainly stay vested, and watch it with an eagle eye, but with my upcoming planned surgeries, I think it’s best not to risk it.
There are just too many factors at play and anyone who had made predictions were laughing stocks. In fact, the only tanker company I am relatively certain will do well right NOW as of 2020 through 2021 was $DHT Holdings. Their long term charters reduced breakevens to $2800/day in 2020 and $11,400 / day in 2021.
None of the rest of the tanker management companies had the risk avoidance that DHT Holdings does and if I had to choose one company to put my money in still, I’d put it in DHT Holdings and just lever up for the dividend gains and call it a day.
But whining is for losers, and thankfully, I have no one to hold a gun to my head. So off we go.
Berkshire Hathaway B Shares Are Cheap
I’m a fan of developing new habits and routines. They compound your life’s expected value drastically over time.
Eg; I’ve lost approximately 6kg since I switched my routine to 4 eggs and hot cup of coffee in the mornings (milk, no sugar) over the past 3 months with little to extra exercise.
A simple but powerful habit when it comes to investing is to keep a checklist of high quality companies in a shortlist and revisit it whenever the VIX index (aka the fear index) spikes hard. Or whenever, you know, your phone starts ringing and people start saying the markets are “melting”.
Berkshire is one such company I’ve been very interested to buy into for quite some time. For reference, here is a quick article by Rod Maciver on passing Berkshire Hathaway at $97 per share in 1982 (the share today trades at $328, 804).
I’m not convinced me and Rod are standing at equivalent forks in paths but I am convinced right now that Berkshire as of today is rather cheap.
Here’s the quick but simple math as of the latest report: https://www.berkshirehathaway.com/qtrly/2ndqtr20.pdf
- Class A – 671,199 shares outstanding, current mkt price $328,804 ($220,692,915,996)
- Class B – 1,394,160,774 shares outstanding, current mkt price $218.94 ($305,237,559,859.56)
- Combined Class A&B Shares = $525.93B
- Current Equity Holdings: $207,454M
- Cash: $36,074M
- Short-term investments in U.S. Treasury Bills: $110,518M
- Sum of cash, short term investment in US treasury, equities: 354,046M, or about 354.046B
- Debt: 106,689M
- Minority interest: 3,758.0M
Numbers have quite closely matched Koyfin. Enterprise value from above is $486B. Operating cashflow was about $34B. Or about a 14x so-called “payback period”. It’s worth noting here enterprise value does not in fact account for the considerable amount of equities held on Berkshire’s balance sheet, which here totals $207B. If we strip that out from the enterprise value, we’re looking at $279.53B, which makes for about a 8x multiple.
This is a pretty astounding number considering the widespread overvaluations we’re seeing all around.
This is a list of companies termed “high quality” and it’s recent valuation ratios leaving out banks (companies were lifted from Base Hit Investing aka Saber Capital Database and augmented with some of my own additions, please note the quality of some of these companies are debatable and not set in stone). None of these trade at an implied discount as wide as Berkshire’s does right now.
Even with book value approximation, BRK trades at about 1.4x book value.
Is this reasonable when almost everything else trades at 2-50x multiples? I’d say the answer is generally a big fat no. If intrinsic value is an approximation, than I’d say right now BRK is severely undervalued.
For a company that’s virtually indestructible except by way of nuclear war and violent, ongoing, widespread political upheaval, fueled by negative cost of capital from insurance float and cheap debt, allocated by some of the top investing minds of the world, it seems ludicrous to me that it trades at such a steep discount even comparing it’s official 14 year payback period versus some other storied stocks currently selling on the market.
In other words, while I wouldn’t call Berkshire “dirt cheap”, I’d say it’s probably between “cheap to slightly under fair value”.
I’m not normally a “quality compounder” bro. That’s because most “quality” companies trade at higher multiples which demand intense execution perfection failing which it’s stock price takes a beating. Alteryx is but one example of what happens when performance is underwhelming. Given the significantly resistant nature of BRK’s businesses (which emphasize predictability), I would say that 90% of the volatility you can expect in their stock price will be caused by the fluctuations of the equities held on their balance sheet which will swing with the tides of the markets. This is acceptable to me.
Some other advantages as a retail investor:
- Berkshire’s reputation and cash pile gives it’s managers access to deals street investors do not. Dominion Energy pipeline deal was a good example. Buying into Berkshire here gives you indirect access to deals otherwise unavailable on the open market.
- It’s cashpile, access to negative cost capital (refer to 2002 letter for an explanation on float), is another compounding factor. It will be able to take significant action through upcoming down markets either rebuying its stock as Buffett has done or making other acquisitions. In this manner, the inverse is true. If you are a shareholder of Berkshire, you should actively wish and pray for a horrible down market.
Of course, some investors will also say that Buffett’s recent purchase of Barrick Gold and Japanese trading houses are a warning signal. I think this is perhaps, foolish in the extreme.
When you’re building a Death Star, it’s probably wise to not allow such a thing as a thermal exhaust port be your undoing. Given Berkshire’s immense equity holdings and large cash pile, acknowledging the risk of inflation or hyperinflation in the years to come and crushing the probability of tail events is the only sensible move – it’s the only thing that kills Berkshire other than widespread calamity and economic collapse. And even the latter is not so certain to kill Berkshire.
Imo, Berkshire is cheap, well run, has an inflection point at any dip in the markets, enjoy access to negative cost of capital or is able to lower its cost of capital, and is also run by the top investment managers the world has seen. I’d be insane to not be buying into $brk.a or $brk.b at current prices.
Managerial Risks – Present But Not Lethal
Yes. I know. I just waxed lyrical and here I am talking risks. The risks are real. Buffett is old. So is Charlie Munger. Managers and successors can and probably will at some point screw this show up – because at some point, every business will be run by an idiot and we can expect this to be the case for Berkshire if we extend probabilities out to an infinite time line.
What is the risk of this? I’ve debated and struggled with the concept of this as I tried to understand the eccentricities and personalities via interviews, news coverage, and market moves implied (Amazon and Snowflake purchase for example).
In the end, my thinking is to not imagine if Berkshire will succeed in the hands of the 4 managers (Ajit Jain, Todd Combs, Ted Weschler, Greg Abel), but rather if Berkshire will really be heavily impacted by one or even two failing managers.
The risk in my mind, is not an approximation, but I judge it to be small – present and dangerous, but unlikely to present catastrophic destruction of value.
A decentralized leadership makes it so that a critical failure at the top does not reverberate down to each corner of Berkshire. In this manner, and highlighted by the extreme out-performance of the Outsiders, who nearly all favored a decentralized approach, Berkshire seems to be in capable hands and a sound investment at this point in time.
Growth Risks – Acquisitions will determine future pacing
Small company, big moves. Big company, small moves. Out-performance of smaller market capitalized companies is a well-covered phenomenon.
Berkshire is not an exception to the rule.
Growth in earnings will depend on out performance in subsidiary businesses and equities it holds as well as acquisitions of other companies at sensible prices. If markets continue to be exceptionally expensive, we must depend on the management’s abilities to source deals that are sensible. This may not be possible upon the passing of Berkshire’s front line pair.
It’s main insurance businesses are also susceptible over time to changing industry dynamics. Against this, investors have no defense but a management team that has foresight, agility, and ability to act in time to turn the tides.
Further, upon the passing of Buffett and Munger, we have no defense against repeated poor acquisitions. We must therefore rely on managerial quality, and discipline.
If concepts such as network effects, switching costs, and pricing power are moats in a business, I would reason that exceptional managerial quality that can earn the praise and trust of Buffett is another. Unlike the past however, we must expect to keep a closer on Berkshire for managerial deterioration.
If I had to consider between a cheap shipping stock, and a cheap-fairly priced Berkshire, I’d call Berkshire any day.
Disclaimer: I am long Berkshire Hathaway B shares.