Even value retailers are being hurt by inflation and the cost of living crisis
Investors should not be too critical of Warren Buffett after the chairman of Berkshire Hathaway (BRK.A:NYSE) moved the goal posts on measuring performance at the sprawling insurance and industrial conglomerate.
Buffett watcher Keith Ashworth-Lord, who runs the ConBrio Sanford Deland UK Buffettology Income (GB00B3QQFJ66) fund, says the changes make sense as Berkshire’s business model changes.
Return on book value at Berkshire, the performance measure historically used by Buffett, has averaged 19.2% since 1965 versus returns on the S&P 500 of 9.7%.
But the rate of growth has slowed in the last two years. In 2014, Berkshire failed to beat the S&P 500’s performance over five years for the first time since Buffett took control.
And in 2015, performance was again weaker, falling to 10.3% annually over five years versus 12.6% on the US stock market benchmark.
Changing the measure of Berkshire’s performance from book value to an ‘intrinsic value’ based around normalised earnings is an important step in the evolution of the company, says Ashworth-Lord.
‘The theme which carries on right the way through the annual letter is this argument around the intrinsic value of Berkshire and how that now significantly exceeds book value,’ says Ashworth-Lord.
‘One of the reasons for that is the accounting treatment of acquisitions, which Berkshire has clearly done a lot of in the past. If an acquisition does not work, you write off the goodwill associated with it.
‘But if the acquisition goes well, the goodwill remains on the balance sheet at the same amount you paid. That’s the case even if the current value of the business you bought is now worth far more than the amount paid for it.
‘That’s the argument Buffett is making when he says intrinsic value exceeds book value and why he says share buy-backs will kick in at 120% of book value.’
Insurance float is another key area of focus in Buffett’s 2015 shareholder letter (published 27 Feb 2016), says Ashworth-Lord, and yields further insights into how Berkshire makes its money. Float is basically free money provided to insurance companies because customers pay for premiums up front but typically tend to claim, if at all, at a later date.
‘Investors who diversify widely and simply sit tight with their holdings are certain to prosper: in America, gains from winning investments have always far more than offset the losses from clunkers.’ - Warren Buffett
All insurers benefit from this extreme negative working capital cycle which grows as the amount of premiums written increase. Berkshire’s float has grown from $27.9 billion (£20 billion) in the year 2000 to $87.7 billion in 2015.
Float is invested mainly in bonds and equities, providing the main avenue for Buffett’s stock-picking skills. This delivers substantial investment income to Berkshire which in 2015 totalled close to $15 billion including $5.2 billion in interest and dividends and $9.4 billion in investment gains and losses.
That compares to a $34.9 billion of pre-tax income from all Berkshire’s businesses.
Returns from Ashworth-Lord’s fund in 2015 were 27.2%, more than 20% better than Berkshire’s 6.4% increase in book value. Measured in sterling, Berkshire’s return was 12.3%.
Positions recently added to the ConBrio fund include chemicals manufacturers Victrex (VCT) and Croda International (CRDA), consumer lender International Personal Finance (IPF), oil and gas support services firm Rotork (ROR), retailer Dixons Carphone (DC.) and soft drinks supplier AG Barr (BAG).
ConBrio Sanford Deland UK Buffettology Income is a good way of playing Buffett’s approach.
