What Does Buffett Know?
Berkshire Hathaway, Warren Buffett’s holding company, now holds $116 billion in cash. Cash that is not invested in the markets. It begs the question, what does he know?
Money managers are paid to invest in assets, not hold cash. When the best asset manager is not investing in the markets, its usually because he is worried about what is taking place.
Managing money is hard. Investors always expect a return. When you are in cash there is no return. Investors get mad, money gets withdrawn and asset managers lose their jobs. So when somebody like Warren Buffett holds cash and is not a buyer of assets, we should sit up and take notice.
All markets move in cycles. We’ve been in an uptrend for quite some time. What Buffet is doing is making sure he has lots of cash when the next downturn hits. In fact, in the last downturn, Buffet made out like a bandit making muti-billion dollar loans to blue chip financial companies at a 10% return which included buying shares at a discount.
Contrast what Buffett is doing with corporate America that is taking the opposite stance. Record-low interest rates have spurred companies to take on more debt to buy more assets. Sometimes this type of debt can make sense. Given that the rates are so low, many companies aren’t taking this debt on for good reason. They are taking it on because they can. They simply can’t resist.
In his recent letter to his shareholders, Buffet made the following statement regarding the trend of issuing debt and hoarding cash: “Both Charlie Munger and I believe it is insane to risk what you have and need in order to obtain what you don’t need.”
In prior posts, I’ve written on the ability of Amazon to grow like crazy because of its ability to borrow massive amounts of debt. Netflix is another company following this model, planning to spend $7.5 billion to $8 billion on content in 2018. That’s a lot of debt for a company that operates with a negative cash flow of over $3 billion even though it has over one hundred million subscribers!
Yet markets continue to reward companies like Amazon and Netflix. In times past, the markets would have punished a company that burns through billions of dollars. Today, not so much.
Just recently I did some work for an innovative startup in the parking space and the founder was criticized by an investor for not having a plan to launch nationwide within six months. Let’s be clear: the company has no revenues, no money, no proven track record and no proof that the business will work. Yet, here was an investor asking if they had the millions needed to launch a parking app even though nobody knew if the company would ever be profitable.
As the investor explained, the market wants to see global ideas and fast growth. Nobody cares about a slow model and organic growth with profits earned. The capital markets have the capital…and investors want to see innovators access that capital and launch products not only nationwide but, in many cases, globally.
For many companies that isn’t a winning formula for long term success. Its not how you create prosperity. Yet the market is rewarding these “debtor” companies while punishing those companies who take a more prudent approach with an eye to the longer term.
Buffett knows that human beings tend to make irrational decisions. In the late 90’s, when every stock with a dotcom attached to its name soared in value, Buffett stood on the sidelines. He knew that the key to success in the financial markets was by being a good steward of the capital entrusted to you. When the markets finally crashed in the early 2000’s, it was Buffett who began buying at prices he found attractive. He did so because he was the only one who had cash on hand.
When someone of Buffett’s stature elects to sit on over $100 billion in cash, it should cause all of us to pause and re-evaluate not only what is signals but also what we intend to do about it.
Steve