What is Warren Thinking?

Many times in the past, detractors have accused Warren Buffett of “losing his midas touch” especially during periods when his holding company, Berkshire Hathaway, underperformed the market. But whenever those embers of poor performance burned long enough, the Oracle of Omaha somehow managed to make a move that generated alpha, such as his purchase of Apple back in 2016. Indeed since his first disclosure of that position, Apple shares soared by 800%.

Fast forward to the present day and those same assertions are being made following the surprising disclosure that Berkshire Hathaway now sits on an enormous cash pile of $325 billion.  For example, Bitcoin proponent Max Keiser did not hold back. He declared Buffett’s decision to hold such a large cash pile as “a serious dereliction of duty… losing 15% - 50% a year in purchasing power.”

Those are strong words indeed, and Max may in fact be right but Warren may have less focus on the upside opportunity being missed as he does on the downside risk being avoided.

No doubt, Buffett’s cash hoard now is enormous in absolute terms, but it’s also large proportionate to Berkshire Hathaway’s market capitalization that is just shy of $1 trillion. Rarely does Buffett hold such a large percentage of cash, but when he has in the past it often has preceded market meltdowns, such as the 2008-09 Great Recession.

So, while Buffett may have the canons of negative opinion pointed in his direction once more, he is acting as rationally as ever, and choosing to sleep well at night with a mountain of cash that provides optionality versus staying invested in equities, let alone considering something more volatile, such as cryptocurrency.

Should Buffett be peering over the horizon and seeing that economic headwinds and choppy waters lie ahead for markets generally, and raising cash in advance of such peril, his genius will, if history is a guide, be lauded in retrospect versus ex-ante.

While many view the Berkshire Hathaway cash hoard as evidence that Buffett sees problems ahead and is building a reserve to go “elephant hunting” as he likes to call it by purchasing a massive company when the rest of the market enters a drawdown period, the Oracle of Omaha has in fact cited another reason for selling equities in droves. He sees risk that taxes will rise and clearly has concluded that capturing gains now at lower tax rates is a more prudent financial decision than sitting on existing gains, hoping for higher returns, and possibly selling later when Uncle Sam will take a larger share.

Regardless of whether tumbling markets or future tax rates are the reason for the cash haul on the fortress balance sheet, Berkshire Hathaway shareholders can take solace knowing Warren is at the helm and has clearly built ample reserves to ride out either scenario.

Another point of solace is that Berkshire Hathaway is trading just shy of 15x earnings, a threshold that Buffett is widely believed to use as a cut-off to make purchase decisions. It also means that Buffett is unlikely to authorize further Berkshire Hathaway share buybacks in the near-term because the margin of safety has diminished.

So, what does it all boil down to for those trying to gauge what to do based on the actions of the Sage of Omaha?

If the market does falter, expect Berkshire Hathaway to stumble too, but likely to a lesser degree than the market given the enormous liquidity reserves. In short, Berkshire is likely to deliver alpha if the market runs into a period of weakness. However, in the near-term as Max points out, shareholders may be missing out on greater returns had Warren chosen to embrace a little more risk-taking. For those who lean towards more conservative capital allocation, Berkshire is an attractive play now while risk-seekers should probably consider other alternatives.