Money is no object for Berkshire Hathaway (NYSE:BRKA); it’s several billion objects that have multiplication down to a science. Warren Buffett, chief executive officer and largest shareholder, has guided the company to unprecedented levels of profitability. However, speculation is growing over Berkshire’s record cash position.
According to the latest quarterly report, Berkshire is holding about $55.5 billion in cash and cash equivalents, representing an all-time for the American conglomerate that typically makes headlines for taking multi-billion-dollar positions in other companies. In comparison, Berkshire held $47 billion in cash during the second quarter of 2007, just months before the market peaked. Berkshire currently has more cash located in the Untied States than any other domestic corporation, including Apple.
Why is Buffett sitting on a record cash cushion? In the 2013 annual shareholder letter, Buffett explained that Berkshire “will always maintain supreme financial strength, operating with at least $20 billion of cash equivalents and never incurring material amounts of short-term obligations.” Despite that statement, it still doesn’t fully explain the current cash pile. Let’s dive into three possible reasons why Buffett has accumulated a record amount of cash.
1. Cash has value
Idled cash has a terrible return over the long-term, but it’s not exactly trash if you know how and when to put it to work. As the chart above from BlackRock shows, cash has an average annual return of only 0.5 percent after inflation, between the period of 1926 and 2012. When taxes are factored, cash has a negative return of 0.8 percent, compared to stocks which have an average return of 4.5 percent after taxes and inflation. However, Buffett holds cash for liquidity reasons.
Holding cash allows Buffett to shop for bargains, no matter when the sale occurs. “He thinks of cash differently than conventional investors,” explained Alice Schroeder, Buffett’s biographer in a report by the Globe and Mail. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price…the key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”
2. Similarities to Yoda
“Patience you must have, my young padawan.” Buffett and Yoda are both legends in their own right, and they both understand the importance of patience. While the Oracle of Omaha is quite vocal about his optimism for America, he is not willing to chase performance at any price, and he has no problem waiting on the sidelines until Mr. Market offers him an attractive deal.
Buffett refers to the stock market as a no-called-strike game. “You don’t have to swing at everything — you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, swing, you bum!” As the chart above shows, Buffett has been playing the game longer than anyone else by ignoring the noise of the crowd. For further proof of his patience, consider this: Almost all of Buffett’s wealth came after the age of 60.
While waiting for the perfect pitch can be a flawed strategy, Buffett is well in control of his emotions and has access to deals that retail investors can only dream about. He buys in the face of panic and side steps euphoria until reasonability returns. Following the financial crisis, Buffett made billion-dollar deals with Goldman Sachs and Bank of America that were only possible because of his investing acumen and iron-clad balance sheet.
3. More money, more problems
Berkshire is not your average business. The company’s insurance segment provides large sums of money from premiums that can be invested, known as the “float.” Over the past eleven years, Berkshire has grown its float from $41 billion to $78 billion. In 1970, the float was only $39 million. This impressive growth has allowed Berkshire to generate cash faster than it can reinvest it.
Through the first six months of 2014, Berkshire posted $11.8 billion in net cash flow from operating activities. In 2013, Berkshire received $1.4 billion in dividends just from its top four equity stakes in Wells Fargo, Coca-Cola, American Express, and International Business Machines. Considering that Berkshire hasn’t paid a dividend since 1967, and has a repurchase program that may never see action due to Berkshire’s impressive stock rally, Buffett is likely to use the cash pile at some point to buy stakes in companies. Unfortunately, deals are becoming harder to find.
Since Berkshire is one of the world’s largest companies by market value, it takes an elephant gun to make meaningful acquisitions, and targets are dwindling in the current bull market. Buffett’s favorite valuation metric, the market value of outstanding securities in relation to the nation’s output, is raising eyebrows. As the chart above shows, this metric is already above the previous market peak made during the housing bubble. This doesn’t necessarily mean the market is getting ready to collapse, but it may be giving Buffett enough reason not to pull the trigger on a major purchase.
Follow Eric on Twitter @Mr_Eric_WSCS
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