Motley Fool Hidden Gems Investing - Berkshire After Charlie

Episode Date: February 26, 2024

Warren Buffett’s annual letter points to a steady path ahead. (00:21) Jason Moser and Deidre Woollard discuss: - Why Berkshire Hathaway doesn’t pay a dividend. - If utility businesses are in trouble. - What a mountain of cash means for the insurance business. (17:53) Ken Costa, author of The $100 Trillion Dollar Wealth Transfer, explains how a sea change in wealth could impact the world’s financial future. Companies discussed: BRK.A, BRK.B, DPZ, LULU Claim your Epic discount: www.fool.com/epic Host: Deidre Woollard Guests: Jason Moser, Ken Costa Producer: Ricky Mulvey Engineers: Dan Boyd, Chace Przylepa Learn more about your ad choices. Visit megaphone.fm/adchoices

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all ready to go from day one so you can hit the ground running. Bring it with SAP Grow. AI Cloud ERP for any size business. Settle in, friends. It's Uncle Warren's story time. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Jason Moser. Jason, how's your Monday going so far? Hey, Deidre, going really well. It's beautiful weather here northern Virginia. So, you know, I feel like I feel like maybe spring is just around the corner.

Yeah, I hope so. Well, over the weekend, Berkshire Hathaway's annual report dropped. So we've got the task of looking at it. Interesting report. You know, even if you're not a Berkshire Hathaway investor, take a look at it. You don't have to read the whole 152 pages. The first 16 will do you. You know, it was first one without Charlie Munger. Beautiful to hear him call charlie the architect of berkshire but uh he also went back on one of the things he loves to talk about operating earnings versus net earnings so he calls it net income worse than useless so he says doesn't reflect a company's true status he shows the you know the operating earnings versus the net earnings i don't know jay said he taught he's talked about it for years he's right but it's

not like anybody else uh is is doing the same thing and reporting both or at least not a lot lot of companies. No, it definitely feels like it's kind of hit or miss as to how companies will view this. I understand that to a degree. Not all companies are the same. There are certain metrics, I think, with certain businesses that can start to make a little bit more sense. In the case of Berkshire Hathaway specifically, I do understand his gripes with net income, particularly when you consider the accounting updates that were changed in 2018, I think it was, which ultimately, and he pointed this out in the letter, it can ultimately change the capital gains or losses that Berkshire

can realize to the excess of $5 billion on any given day. And a lot of that is because Berkshire Hathaway, we know, it's a business that does a lot of things. But one of the things it does, and does very well, is invests, right? I mean, they invest a lot of their capital into businesses. And the value of those businesses, right, that changes day to day, just like we witness in the stock market. And so, his gripe with net income is that it's not really reflective of the actual business of Berkshire Hathaway, right? the operating earnings give you a better window into how the actual business itself really is doing. And so, I do understand that perspective. I mean, you can argue he's much more focused on

the long-term shareholder. And I think that's what so many of us like about Berkshire, about Buffett, and about the late Charlie Munger. But it is one of those things that it doesn't, It's not one of those things that applies the same to every business. But I absolutely understand why he feels so strongly about it in regard to Berkshire Hathaway. Well, you mentioned the long-term investor. And in this letter, he takes the framework of talking to his sister, Bertie, and talking about the reasons why people buy Berkshire. They don't buy Berkshire to cash in on a hot stock. They buy it the same way you described it as the same way you might buy a farm or rental property.

The thing I'm wondering here is, Berkshire, it's sitting on this mountain of cash. Like, how big is this mountain of cash? So big that they could really buy most of the S&P 500, just about every company, not every company, but a lot of them. So big, it's kind of hard to get your brain around. But he's also said most of the companies that are worth investing in, they're too pricey. Outside the U.S., he's seeing no candidates for meaningful options for capital deployment. You know, I keep asking, should Berkshire just pay a dividend?

I know they're probably not going to in Warren's lifetime, but frame the argument for me there. Well, it certainly feels like he, I think you're probably right. It feels like at least we shouldn't expect that for the rest of his lifetime, which is funny because you know he loves owning all of these businesses that pay that company so much in dividends every year, right? From that perspective, there is a second-order dividend that we get from Berkshire that shareholders in Berkshire Hathaway get just by virtue of the fact that the company owns so many businesses that pay them dividends. But you're right, it's $167 billion-some-odd they have on the

balance sheet now at this point. The debt that they have on the balance sheet is just well-structured, staggered out. That's not a concern. Berkshire is just this amalgamation of these cash-producing businesses. It feels like a dividend would be in order, even maybe just a special dividend. Maybe there will be some sort of tax law or something that comes up that prompts them to initiate a special dividend. We've seen that happen before. Costco stands out as a company that did that not all that long ago. But yeah, I mean, he clearly loves the businesses that pay them dividends. We just haven't seen them want to take that next step with the direct shareholders. I mean, it's that age old argument, right? They do that because they

believe that they can put that money to better use. So far, it's worked out pretty well for shareholders, right? It's difficult to argue against that. But by the same token, we see this this quote, this passage in the letter this year, and I'll go ahead and read this because I think it's important. It says, quote, with our present mix of businesses, Berkshire should do a bit better than the average American corporation, and more important, should also operate with materially less risk of permanent loss of capital. Anything beyond slightly better, though, is wishful thinking, end quote. And so he's starting to acknowledge that Berkshire is really big, deploying that capital and finding acceptable and outperforming rates of return is

becoming more and more difficult. So it feels to me like we're closer to Berkshire offering up a dividend at some point, but when they do that is still anyone's guess. Yeah, yeah, absolutely. And I think it's important that, you know, he's not promising as eye-popping results, but he is looking to a market beating around a 15% return. So it's not exactly like the company's not going to grow at all. It's just not going to do these massive numbers. The other thing I find interesting is that they do do buyback. So I was talking to Jim Gillies, our friend and analyst, and he was pointing out that they've bought back around, I think it was 12% over the last, I think it's about five years. So there is that happening. And you know, with Berkshire, it's not one of those things

where you have to worry if a company is buying back at the wrong time. It's Berkshire. They always pick the right time. But do you think maybe, I like to believe so, but do you think maybe we'll see more of the buybacks instead of the dividend? I really just, I think that really depends on how much longer Buffett is actually in there calling the shots. I really do believe that Berkshire, I think, is always going to be Berkshire, and that culture is going to remain consistent for the most part. But at some point, this is going to be a company under new management and under new guidance. And there will likely be some differing perspectives in regard to that. I mean, it's nice to see, obviously, with share repurchases, a continued

spring share countdown. They did for a long time. I think they held that 1.2 times standard as far as buying back shares, 1.2X book or lower. It was that valuation perspective where they felt like it represented an opportunity. And then they changed that and said, hey, listen, we're just going to use our own guidance. We know it when we see it, so therefore, we'll do it. And we feel like shareholders will benefit from this. It's really difficult to say. They will continue, I think, to focus on surefire ways to return capital, like share repurchases. And as long as those share repurchases are bringing that share account down and then, you know, shareholders can feel really good about that. But dividends, I mean, that's cash in the pocket.

And, you know, when you hear talk of dividend kings and dividend aristocrats, I mean, Berkshire Hathaway is a business that could put itself in that position. Granted, to achieve that status, it would take a lot of time because that's what is required. But it certainly has the business that is capable of achieving that over time. Yeah, yeah, absolutely. Well, one of the things I found really interesting was his talk about utilities, pretty negative about future of utilities as investments, saying the final result for the utility industry may be ominous. Certain utilities might not no longer attract this attract the savings of American citizens. And so it sounds to me like he's really seeing a dramatic shift there in, you know, utilities tend to be those steady investments over time. But he's saying based on what, you know, what we've seen in California, what we're seeing in Hawaii, utilities become increasingly dangerous, it sounds like. It seems that way, you know, and you sort of have this different sort of way of looking at utilities between the public model and sort of the co-op or private model. I mean, I think about the utility company that I use here, that we use here in Northern Virginia, it's Novec, right?

It's a not-for-profit corporation. It's owned and controlled by the members, a.k.a. the customers like us, who actually purchase our energy from Novec. He absolutely has seen and expressed some concerns in regard to the space. You mentioned the states there. Things that continue to change in the utility space, right? I mean, environmental concerns, regulatory concerns, the amount of capital that these utilities are going to require in the coming years. And so we're seeing this sort of tradeoff right between sort of that private model versus the public model. And one one may not necessarily be better than the other.

But when you look at sort of this public model that he's pointing to, seeing more and more states kind of going this direction, it becomes really more about figuring out how to access that capital and less about profitability, right? I mean, we do see utilities becoming really truly a utility. It's becoming more and more difficult for these companies to pass pricing along, right? I mean, increasing prices for the users doesn't necessarily result in a more profitable business in this case. And given how we are seeing things play out going forward, obviously, a lot of concerns regarding climate change and the way these utilities operate, it does feel like these utilities are set up for a much more challenging stretch going forward, so I think he's right to note that.

Yeah, and it's interesting, speaking a little bit about climate change and events, so I want to pivot and talk a little bit about the insurance industry, because Berkshire so many things, right? It's everything from candy to rugs, you know, big investments in Occidental Petroleum, American Express, Apple, of course. But, you know, the driving engine of the company is insurance. And he said that he believes the insurance industry is going to experience what he called a mega catastrophe. And so thinking about that mountain of cash again that Berkshire is sitting on, you know, he says, you know, the insurance industry will have this gigantic moment, doesn't know when it's going to happen, but he says Berkshire will survive. They'll be open the

next day. So it's an interesting situation to think about insurance. Fine for Berkshire, but does it make you worry a little bit about insurance as a sector in general? As a sector, maybe. I mean, I think insurance is really hard, right? I mean, I think just the business of insurance is really hard. Figuring out, quantifying that risk, and then projecting it, forecasting it, and writing these profitable books of business. I mean, it's just really difficult to do really well over long stretches of time. And so, you know, there are a couple of quotes that come from the letter here that I think just really give us a good view into his mindset, right? He said at one point here in the letter, I quote, extreme fiscal conservatism

is a corporate pledge we make to those who have joined us in ownership of Berkshire, end quote. And that actually could kind of go back to that dividend talk we were having a little bit ago, too, right? I mean, he's just not so willing to go ahead and give up that cash out of pocket, necessarily, if he doesn't feel like he has to. And right now, shareholders still haven't really demanded it of him. And a lot of that just kind of really, I think, is due to the performance of the business over long periods of time. They just did a very good job of managing risk year in and year out with Berkshire. But when you look at insurance itself, I mean, Insurance is interesting. The quality of companies really does run the gamut.

Having worked in the insurance industry before, I worked for one of the large reputable companies out there with a big red umbrella. I'll leave it to you to guess which company I'm talking about there, Deidre. But the bottom line was, my experience with a lot of those businesses, you would see your reputable players, the big, well-capitalized companies that were thinking longer-term. There were a lot of companies that just didn't belong in that industry. And you could tell their lives were going to be very short because they just weren't writing good books of business. The service wasn't good. The coverage wasn't good. And so I think with insurance, you have to be very picky, right?

You do have to look for those companies that just have long demonstrated track records of performance. And when you look at Berkshire Hathaway, I mean, again, he pointed this out in the letter. I mean, the property and casualty insurance side of the business, I mean, this has just been something they have done so well for so long. They've been in the business for 57 years and talked about a 5,000-fold increase in volume from $17 million to $83 billion. And they still believe they have a lot of room to grow. And I think that confidence stems from the fact that they've been so cautious, so particular about the books of business they've written all along the way, right? So when you have that level of expertise, I mean, 57 years, that really does go a long way in this line of work. Yeah, good underwriting goes a long way.

Well, I want to finish up with talking about another company that seems to have no trouble paying a dividend. Domino's Pizza reported today, solid results, nice increase in same-store sales, 25% increase in the quarterly dividend to $1.51 a share. also a billion-dollar share repurchase program. Interesting, because there's a concerning amount of debt with this company, but they're really making this move. And I'm seeing this shift toward dividends in general, but what do you think of this one? Well, I do think, I mean, when you look at Domino's, they're in a good market, right? Pizza is pretty darn reliable. And no, I mean, they don't make the best pizza in the world. But you

know what? They make good food, right? And they make good food that a lot of people want to buy, and the numbers bear that out. So, I think when you look at Domino's, most of the debt that they have, it's in the form of low-rate notes that are staggered out very well over the course of time, all the way up to 2031. So, the debt, while it may look like a large amount, it really isn't when you actually look at how it's staggered out, right? The coverage ratio, which looks at operating income over net interest expense. It's right there at four and a half times, which is a very acceptable level for a company like this. The payout ratios consistently in that 25%, 35% range. So, they aren't really overstepping their bounds on the dividends that they're paying, right? The

net income that the company generates can really fund that dividend okay. And then the repurchases, I mean, the share count is continuing to come down. When you look at how the business is performing. The total return for this business has outperformed the market over the last five and 10-year horizons. And so, I think in the case of Domino's, they've done a very good job of managing their capital position and balance sheet very well, making sure to return value to shareholders with both repurchases and dividends. It's nice to see them raise that dividend because I suspect that'll keep a lot of people on board. Yeah, I think that's true. Well, thanks for your time today, Jason.

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We talk about a lot of stocks on the show, but it's just a peek at the Motley Fool's investing universe. This year, we're rolling out a new offering. It's called Epic Bundle. service includes seven stock recommendations every month model portfolios and stock rankings all based on your investor type we're offering epic bundle to motley fool money listeners at a reduced rate as a thanks for listening to the show so for more information head to fool.com slash epic we'll also include a link in the show notes for you over the next decade it's estimated that trillions of dollars will pass from baby boomers to millennials what does this type of generational shift mean for the future of investing? Ken Costa, author of the $100 trillion

wealth transfer, explains what this could look like. Let's start with the title of the book. I've been calling it The Great Wealth Transfer, but you put a dollar figure on it, a big dollar figure with $100 trillion. Why that number and how is the wealth transferring? So it's $100 trillion, 64 trillion of it in the U.S. and the rest in Europe and the rest of the world. And the way in which it's transferring is people think, oh, well, maybe that's just in a very long time in the distant future. No, it's happening now because the bank of mom and dad and the bank of grandpa and grandma are already helping the next generation, putting down deposits for homes, being able to help with escalating rent everywhere in the world's cities, and also helping on the

college account. So, we're already seeing that happening. In addition to that, it continues to grow as this whole period of the disposable income has increased in an era of low interest rates. assets have gone up. And so, people are making gifts of shares and bonds to that next generation. So, it's growing. And it's just going to continue until we see this huge amount transfer. Well, it's fascinating because we have people living longer. And I think younger people feel like they have more time to sort of ease into their financial life. They're staying at home longer. It's an interesting time period that seems a little different than other wealth transfers. Well, it's interesting, firstly, because a generation is living longer,

healthcare is better, but equally, a next generation are becoming very much more savvy than a previous one because they have access to a large number of tools that give them an understanding of investment and how to invest. However, a taboo subject still exists, between discussing succession openly and discussing money openly. But what is important is that the two generations are able to talk together, because if they don't, we will have a conflict of generations rather than the cooperation of generations, which is what I am most concerned about. Yeah, I'm a little concerned about that, too. Also, the other criticism I've heard of the wealth transfer is that it's going to accelerate the current

financial inequalities of the world because it's going to concentrate wealth. Wealth goes to wealth. Is that something you're also looking at? Well, the worldwide, there will be an increase in the wealth that a generation has achieved and its assets, but it is transferring. Yes, it will transfer to the next generation, which may be thought to be in that wealthy bracket. However, the fact of the matter is, this next generation has got some very clear ideas as to how it wishes to see that wealth spread in terms of having the financial capacity and the power to influence climate change, environment, justice, inequality, which are very important values to the generation. And I'll just add this, that one of the important things to look at, a generation

dies and then the money goes to the next generation. That happens normally. But there are three very important distinctions. At the same time, not only is finance moving, but power is moving as well and the next generation are empowered by technology um as never before and the speed of change of technology which they've embraced and which is going to enable them to change uh the very ways in which we are living together whether it's artificial intelligence or or uh quantum computing and they are the power going to them in terms of social media, where not only the social media at their fingertips, but able to influence even major corporations in the directions in which they want to go. And when you add that to the agenda that

they have, you see a situation that could easily become explosive. Well, one of the things you say in the book that I think contributes to that is, so by 2030, all baby boomers will be at least 65 years old. At the same time, millennials are going to make up 75% of the workforce. So you've got these two massive populations going through this big life transition, and you've got those millennials taking power. What does that set us up for? Well, that sets us up for either the clash of a generation or for the cooperation. And the way I put it is this. We need the hindsight of the boomer generation. We need the insight of the next generation who are seeing the shape of the world very differently from a previous

generation, which would create a foresight to be able to anticipate the social, political, and financial changes that are coming. Now, either we pull it together, and in the book, I speak about co being the answer to this divide. You know, we know about co-investing, co-living, but the big philosophical change is co-destiny as the two the working two generations working together to be able to to to know that we all have to live well on this planet but equally that millennial or as i call them the zenials the millennials and the gen z's um they will be in positions of very real influence. And I would add this. It is interesting that the view always was and was attributed to Churchill. I'm not sure that it was accurately attributed, that if you're not

a socialist when you're 20, you have no heart. And if you are a socialist when you're 40, you have no head. But I think that what is changing is that this Xenial generation led by the millennials have maintained their concern for society, for prosperity, yes, but also for purpose. They want to do good and do well at the same time. So I think that there is a major shift that they have maintained, rather than, as a previous generation would have looked at, you know, for sort of financial reward as being the most important test. As an investor, I'm always trying to figure out where the money is going, where consumers are spending. Given this wealth transfer,

what are you looking at in terms of how people spend? Are the same luxury brands still in play? What is the younger generation value in terms of how they spend? I think they look to authentic branding, where they can trust the brand. An example would be Lululemon in its athletic wear, if one can mention a company. They've built up a reputation that the generation has trusted, that they think the values are good, and they think that whether that's true or not, I can't comment. But that's one of the growths. They know it's reliable and it's authentic. So, I think authenticity in the brand is going to be a significant development for the generation as well. And we will see increasingly that sort of

coexistence with where, you know, I want to know the provenance of where something has come from. And, you know, there's a slightly change to that, which is how can you support the communities in which or from which you have got your latest whatever luxury brand it might be. So, yes, in a curious way, it's still brand conscious, but more discriminating about the brand and its problems. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear.

I'm Deidre Willard. Thanks for listening. We'll see you tomorrow.