In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Christopher Bloomstran discuss:
- China’s Demographic Timebomb
- Market Frothiness: A 2021-Like Bubble
- Low-Debt, High-Yield Strategy: Beating the S&P 500 with Selective Investing
- The Hidden Cost of Share Repurchases: Are Investors Getting a Raw Deal?
- Buffett’s Cash Reserves: Buffer Against BNSF Weakness and Retail Slump
- Costco: A Great Business, But Overvalued at 50 Times Earnings
- Can Profit Margins Recover?: Potential for 7.5% Annual Returns
- Beyond the “Mag 7”: Limited Upside Potential
- Buyback Blitz: Is Apple Following the Right Playbook?
- The Munger Effect: How One Man Shaped a Business Empire
- Utilities, Regulations, and Renewables: The Tricky Triangle for Berkshire
- What to Expect at Berkshire’s 2024 Meeting
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias Carlisle: This meeting is being livestreamed. This is Value: After Hours. I’m Tobias Carlisle, joined as always by my cohost, Jake Taylor. Very special guest today, the inestimable, Christopher Bloomstran. How are you, sir?
Christopher: [chuckles] I’m doing okay. You always crack me up at the outset.
Jake: [laughs]
Christopher: I’m good. How are you, fellows?
Tobias: I’m doing well.
Jake: Better.
Tobias: I went out to Indian Wells. Saw the tennis. It was great.
Jake: Oh yeah.
Tobias: Fan.
Christopher: Two of my favorite Left Coast guys.
Tobias: There you go. [crosstalk]
Jake: How was Indian Wells? Did you have a good time at that, Toby? It’s kind of on my bucket list.
Tobias: It’s so good. It’s a great festival, and you can just walk between the courts. So, I went and saw the Aussie, Alex de Minaur. He won. And then we saw some of the girls because my daughter is a tennis player, and then went and saw Sinner and a few other guys. It was great. It was excellent.
Jake: Nice.
Tobias: That professional tennis up close is just crazy. They’re so good.
Jake: Was your daughter inspired?
Tobias: Yeah, she loves it. Yeah, she’s pumped right up.
Jake: Nice.
Tobias: Eager to go.
Jake: Well, Chris, so you’re back and you’ve surfaced from writing the annual letter and you’re still alive. That’s good news. [laughs]
Christopher: Yeah, I made it. I got to the finish line. I don’t know how many more years I can do it [Jake laughs] at the cadence I do. [Tobias laughs] Ha-Ha. This one was particularly rough. And I got myself behind, as I mentioned, kind of preshow. I’ve stuck to this walking program. I had the hip replaced in December, which turned out to be a really good time to do it. But I’ve been out walking at least a couple of hours a day listening to you guys on podcasts and [Tobias laughs] earnings calls. In fact, I’m listening to way more podcasts, because you got to kill time and be productive at the same time.
And so, the hip recovery, given that I lost about 60 pounds, was really easy with the exception of sitting at length. If you write 150-page letter, you sit at length. And I write all night. So, I got myself behind, because I was killing two to two and a half, three hours every day. I had to ditch the walking in the last week. The roosters welcomed [chuckles] the end of the night for me. I took a picture outside. The sun was up pretty much the last seven days in a row.
Jake: Just to get over the finish line?
Christopher: Yeah, I got it done and it was great. Then decamped immediately to South Florida. It turns out I’ve got a lot of clients and friends that for whatever reason, don’t retire to South Dakota. [Jake laughs] So, I hung out with your man, Brewster, and saw his new digs and his old digs,-
Jake: Oh, nice.
Tobias: Oh, nice.
Christopher: -his grandmother’s digs, and had a couple of good meals. It was great.
Jake: That’s good. I think I’ve teased you before Chris that we can basically do away with the CFA program as long as you just take a test on understanding Chris’s letter and what’s in it. I figured I might be getting up over the 50% mark at this point. I don’t know if that puts me at like CFA level 0.5 at this point or what, but–
[laughter]Christopher: Oh, that’s nonsense.
Tobias: I think we should start with– And the thing that I noted when I shot back my response to Chris from his letter, 25 years in business. That’s amazing.
Jake: Congrats.
Christopher: Yeah, 25 years as Semper, it’s big milestone. I was talking to Jim Grant last week. He just had his 40th anniversary. So,-
Tobias: Wow.
Christopher: -back in the days of fractional trading, five [unintelligible 00:03:39] or 62.5% of grants. But yeah, 25 years is a big deal, and it flies and it goes fast. And 33 years doing this thing professionally, or 34 years may be now. It’s blur. When I think about when we first bought Berkshire and how old I thought Warren and Charlie were at that time, but [Jake laughs] that was early—It was February of 2000, and they’ve had a pretty good run. Charlie almost to a 100. Pretty remarkable.
Jake: It is pretty funny to listen to the old AGMs from back then. And even mid 90s, people are asking about succession, what’s going to happen when you guys get hit by a bus or get too old? It was 30 years worth of it.
Christopher: I hope I’m around to celebrate Semper’s 70th anniversary. I’m not sure can I get much more than that. And we’ll see. May be losing 60 pounds will help in that effort. I’m drinking my kombucha now, which I never even heard of. [Jake laughs] My daughter laughs at me. I figure 55 years of—God, you think about all the rib-eyes and the T-bones and the fillets and the cheeseburgers. [crosstalk]
And then later on bourbon and beer back in the college days, and a little Bordeaux and burgundy. [Jake laughs] There’s something like 9 billion living probiotics, whatever that means, in the– How do you fit 9 billion of these things in this little 16 or something 473 milliliter bottle? But they must be doing something– It can’t be bad. I don’t envision my stacks of rib-eyes and fillets stopping anytime soon. So, we need to do something for the gut.
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Market Frothiness: A 2021-Like Bubble
Tobias: No, they’re good for you. Chris, this market was pretty loopy through 2021. Feels pretty loopy again to me now. Given that you actually have been doing this professionally through the fall period, what do you think, are we at 99 levels of loopiness now, or are we still sort of–? We’re 2021 levels of loopiness. Where are we? How do you feel about the market right now?
Jake: What inning is it? Is that–?
[laughter]Christopher: No, it’s late. It’s late, and we are in extra innings. I thought 2021, the end of 2021 was a secular peak, and I’ve got a section in the letter on it. You look at what stocks had done in the decade leading up to that, 16.6% a year. Profit margins were at all time high, 13.3%. You were 22.9%, I think, as a multiple on earnings. And so, when you’re capitalizing a record profit margin at a historically very high multiple, it doesn’t leave a lot of margin for air. And then things blew up in 2022, and you had the big recovery last year. And essentially, the S&P was up 1.7%, the Mag 7 now that you’ve added Nvidia and Tesla to the mix, they were up something like 2.7% for the two years.
Here up this year, S&P is up, whatever it is, 8% or 9%, and the Mag 7 is up 15% or 16%. You’re back to those 2021 levels. Whether you call 2021 or secular peak or this moment a secular peak, getting much more out of the market– We can get into this, but the factors that make up how you generate returns are pretty much stacked against the aggregate investor. So, I think things are pretty frothy in a lot of parallels. This Nvidia, my God, Thursday, had something like a $270 billion swing in market cap, intraday. My God, the whole market cap of the company was less than that in October of 2022, a year and a half ago.
Jake: Yeah, that’s wild.
Tobias: Back in the old days.
Jake: Yeah. [chuckles]
Christopher: Back in the old days. Yeah. But in fairness, I’ve never seen a large company mature. They’ve been public for a long time. What’s going to be two consecutive years earn more than their prior year’s revenues. Think about that.
Jake: Yeah, it’s wild.
Christopher: Now, I don’t think a 55% margin is sustainable, and you happen to have a shortage right now of what they sell to their handful of big customers. But the big customers not going to allow a 55% margin. They’re going to manufacture some of their own stuff. You’ve got some competition. And so, you’ll have misses. And at 2$.4 trillion that thing was kind of ridiculous. I thought it was ridiculous at $1.2 trillion. I think in retrospect, when you look at this thing 10 years out, whatever, you’ll have miss, miss, miss somewhere between here and there, and the thing will be more rational.
But it’s as frothy as anything in the late 90s. Now, great business growing. But Microsoft was ridiculously expensive in the end of 1999. As I wrote in my January 2000 letter, I said shareholders will lose money for 15 years. And indeed, they did. Because you couldn’t do $620 billion market cap on 20 billion in sales, albeit at a 37% or 38% margin. It was that far ahead of itself. And at $2.4 trillion on $60 billion in revenues, what’s going to wind up being 110 this year. If they do a 55% margin, whatever, they make $30 billion net. Using today’s level of revenues and profits, it’s way, way, way ahead of itself.
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Costco: A Great Business, But Overvalued at 50 Times Earnings
Chris: I think even beyond the Mag 7, the market is so bifurcated at the top end of maybe 40 or 50 or 60 companies. Even Costco, which we still own in some of our older accounts, which we’ve owned since 2004, we paid $29 for it. It’s going to earn that in a couple of three years. But it traded at a $350 billion cap on $250 billion in revenues and a 2.7% margin. It was trading at 50 times earnings, a week and a half ago. And lo and behold, with the four letters in the ticker, back in the old days, really back in the old days, your three letter tickers were all New York Stock exchange companies. NASDAQ. Costco has always been a NASDAQ company. And it’s in the NASDAQ 100.
And so, I don’t think anybody in the right mind would buy Costco at 50 times earnings. The company doesn’t buy shares back with the exception of maybe diluting a little bit of what they do give away to shareholders. But 50 times is ridiculous. It’s a great business. They’ll continue to open stores at the cadence of 20 or 25 a year. But you can’t pay 50 times for a business that’s going to grow way less for the next 20 years, and it’s grown for the last 20 years. And so, it’s not just the 7, but there are still– [crosstalk]
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Can Profit Margins Recover?: Potential for 7.5% Annual Returns
Tobias: I don’t even know if it’s the 7 this year. It’s only Nvidia, Meta. I think the others are Apple. I don’t think it’s even half of the 7. I think it’s only two or three of the 7 at this point are doing– [crosstalk]
Christopher: Yeah, couple, three of them are down. Apple’s down, Tesla’s down. And Nvidia is just driving the bus here.
Tobias: We just switched Netflix for Nvidia. The end just got switched out and nobody said anything.
Christopher: Well, they did. Yeah, it was a letter swap.
Jake: So, Chris, let’s play the red team. In this case, the angels argument, because I think you’re pretty convincing in your letter about the different levers that can be pulled to create returns, sales growth, margin, expansion or contraction, share count, dividend, multiple. When you look at where all those are, they’re all bumped up against the most optimistic versions of themselves, historically. But let’s take the angels version, and where might we be surprised to the upside one of those five that all of a sudden maybe makes the returns for the next 10 years, not quite as dire as we might otherwise believe?
Christopher: Interesting. So, as you guys know, I put these five factors together. The first four, multiplicative, dollar change in sales, change in the share count, change in the margin, change in the multiple. And then the last being dividend yield being additive. I’ve got a handful of scenarios looking out 10 years playing with different iterations. So, without doing it off the top of my head, I pulled this out. So, I’ve essentially got four cases. And the most bullish of cases would assume that you wind up back at what I think. Again, we were 2021 secular peaks. And so, your profit margin which has declined for the S&P 500 by 190 basis points over the last two years, you’d run it back up from 11.4 to 13.3. You’d take the multiple back up to where it was.
We compressed it down to the low 22s from 22.9. Frankly, with S&P being up 8% this year, you’re back to that level already. And if you get there, you get a little bit of expansion. You get maybe one and a half points per year out of expansion in the margin, and then you get whatever sales do on a per share basis, and the dividend yield, which is given high prices, the dividend yield is near record lows today. In that scenario, you make about 7.5% a year from the beginning of this year, and you just juiced a point of that in this last two and a half months.
You tell me, I mean of those five factors, where are you going to get more out of that? Most likely would come from a profit margin north of 13.3. I think Warren Buffett was wrong in his 1999 Fortune article when he talked about the mean reversion and the bracketed range of profit margins. He missed a lot. You wouldn’t have known that we’d get to zero interest rate policy for a bunch of the last 20 years. And so, all this corporate debt, which is mammoth in size, but was bearing very low interest cost. And that very low interest burden added about three points to the profit margin.
Jake: Tax rate down.
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Beyond the “Mag 7”: Limited Upside Potential
Christopher: But you get these Mag 7s. The group of the 7 stocks has a margin of 20%. It was 22%. Microsoft is 36%, Nvidia is going to be 55%. The group gets pulled down by Amazon, and you tell me how their business shakes out between AWS and their retail businesses. Their [unintelligible [00:14:19] business is going to have lower margins than Costco’s 2.7%. The third party is going to probably have a little bit higher margin level, but they’re a five margin. I think they can be a 10 depending on what they do with their cloud business. But there’s 20. It’s double the–
So, if that group continues to gobble up the world, you can make a case for a profit margin north of 13.3%. But in the last 10 years, 12 years, the margin for that group was 22% and it’s back down to 20%. I’m a skeptic on getting much more than a mid-single digit return. And then I play with the number of scenarios that holds margins and multiples constant. Well, then you’re only going to get sales growth per share and the dividend yield. And the sales growth per share comes from dollar sales growth and any change in the share count, and then you run more bear scenarios. And you tell me what inflation does. That’s really going to dictate the return series, I think, at least the components of the return series.
So, if we’ve let the inflation genie out of the bottle, you’re going to run sales hotter than they’ve run over the last two decades. And in the last three years, sales have run at about 11% a year for the S&P. For the last two years, they’ve run at about 9%. But they were inflationary periods and that’s how you got the profit margin down by 190 basis points.
Jake: It wasn’t volume. Yeah.
Christopher: So, sales growth per share was about 3.4% for each of the last two decades. It was a different mix. In the first decade of the last two decades, you ran sales closer to six in dollars, but you had a growing share count. And then in reverse, you had a shrinking share count, but much lower, 3.5% dollar growth per sales. So, if you run sales at that level, you can play around with holding margin multiples constant. But if you run hotter, if you run more sales, and I’ve got several scenarios where you run sales at nominal sales at 6% a year, you’re not going to keep margins where they are today.
If inflation runs hotter, you’re going to cripple profit margins for a whole bunch of companies that can’t pass through costs. And so, you get shrinking margins, you’re going to also get shrinking multiples. So, you take the multiple back to its historic 15%, and then you run an extreme of taking it back to 10%, then you’re looking at low single digit returns to maybe as little as negative 3% a year. Reality is probably somewhere in between all these. And so, S&P wise, you do 3% or 4%.
The Mag 7 is what I used to call the Fab 5 before you included the other two. They were 12, 13, 14 times 10 years, 12 years ago, Apple traded net of cash for less than 10. Microsoft traded for less than 10. And those two were the big dogs of that group. Well, they went from low to mid-10s, even a single digit for a couple of them, to where they are today. As a group, they were 32 to earnings. At the end of the year, they’re back to 38 times earnings, which is where they were in 2021. You’re really only going to get sales growth and nominal dividends. Meta is going to start playing a dividend. But sales growth is half of what it was 10 years, 12 years ago.
They’re just bigger businesses and they can’t grow as fast. Their sales, in fact, didn’t grow much faster than the S&P 500 sales for the last couple of years, interestingly. I just think you start trading, pricing these things at mid-30s to earnings. There’s way more than go wrong that can go right. If you think otherwise, the math is just a math and plug in whatever assumptions you want to plug in. That’s why I put it in the letter. I think if you’re the CIO for university endowment or a big pension fund, or you’re a 401(k) investor, trying to figure out how to allocate your 401(k). You think passive is the solution. The math is pretty easy. It’s pretty straightforward. I think it’s understandable to those beyond your CFAs.
Jake: Yeah. And throwing a bunch of, seems like what used to be cap light businesses, the CapEx for those guys is really ballooned a lot too with AI. One thing I’ve tried to wrap my mind around also is, there’s some kind of double counting almost that’s happening where Nvidia’s revenue is Facebook’s CapEx. And there’s this circularity to everything there where, okay, they’re adding it and they get a 55% margin on it, which gives a big earnings number. And then Facebook’s taking that CapEx and chopping it up into pieces and spreading it out over, I don’t know, whatever the useful life of a server is, 10 years or something. So, we’re like, they look a little bit more profitable as well today relative to the actual cash going out the door. It feels like there’s something weird going on there. And these are really big numbers.
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Low-Debt, High-Yield Strategy: Beating the S&P 500 with Selective Investing
Christopher: Yeah. Well, the numbers are too fat for Facebook, and certainly for Microsoft’s Azure, AWS within Amazon. To let your chip supplier keep those margins, you’re going — At some level, do it yourself, you’re going to balloon your R&D, you’ll figure it out, whether AMD winds up being a competitor to the current iteration of chip. Who knows? But it’ll come. You’re not going to do 55% as a chip designer from here to eternity. There have been very few businesses that would run at a 50% margin. Visa, Mastercard would be a couple of them. But capitalism being what it is, you’re just in a period where there’s a shortage. And there’s a huge demand for processing. I’m not sure much of it’s new. You’re just processing way more data way more quickly.
But you look at the depreciable lives of the software and the hardware that goes into the data centers and equipment, they’ve doubled the depreciable lives of this stuff. Maybe that’s right, maybe it’s wrong. But I don’t think this is much different than the classical semiconductor cycle. You just happen to be in the sweet spot. There’s a retail craze now. A good friend of mine just lost a portion of a client’s asset, a doctor who wanted to put his entire million and a half dollar IRA. So, a fraction of his net worth, but put the whole thing into Nvidia, just a few days ago. A friend wouldn’t do it for him and said, “Well, you’re going to have to just eke it out and do it somewhere else, because I’m not going to do this for you or to you.”
Jake: Oh, man. Back to that again.
Christopher: Wow. That’s 1999, early 2000 behavior. You go to any cocktail party, talk to anybody, and everybody was loaded into the tech, and they did not want to hear how silly a lot of it was. Really good businesses. Some of those businesses were really good businesses, Sun Microsystems, Oracle, Microsoft. But they were priced beyond perfection. Some of these things are priced beyond perfection today. Competition will come. It’ll come from within. It’ll come among, to your point. They’re selling to the other big tech companies. Nobody’s going to keep a 55% margin albeit outsourcing Nvidia’s CapEx and heavy lifting to Taiwan Semites.
Jake: So, given maybe not the most bullish, call it, general S&P 500 for the next 10 years, your portfolio at Simper right now, I think, seems like you’re very excited about it. And just the metrics on how does that compare– And maybe this speaks to some of the bifurcation that’s happening in the market right now.
Christopher: So, if you run that two years, everything was flat. S&P and the Mag 7’s and all that were up just a little bit. We managed to make money. In 2021, we were up about a percent. We were up-
Jake: It’s 2022.
Christopher: We were up like 10. 2022. Sorry. We were up 10-ish last year. We were up something like eight or nine this year. But for that two years, we were up, call it, 10. So, we were ahead of all that. As recently as well year end and even before the world decided that Jay Powell was going to ease the Fed funds rate three or four or five times this year and implicitly, they’d stop shrinking the balance sheet below some number, call it, $7 trillion, that you lit the torch underneath the market and ballooned everything up. We were down for the year in mid-October, and went up quite a bit for the year.
And so, things were really cheap. But a year end, we were a little over 10 to earnings, with a 10% earnings yield with multiples to book and sales and cash flow at a third to a half of the S&Ps. So, we have twice as much earnings yield. Where I think we have a very long-term advantage is, if you look at our businesses, we don’t employ debt generally in the capital structure. We’re very debt averse. And so, our businesses are largely unlevered, which means they earn about as much on capital as they earn on equity. And so, our companies earn about 16 on equity, about 15 on capital. Well, the S&P earns 20 on equity.
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The Hidden Cost of Share Repurchases: Are Investors Getting a Raw Deal?
Christopher: When you had Brewster on a couple of weeks ago, you guys were talking about a little bit of this, book values are very understated relative to replacement costs. That has a lot to do with amount of share repurchases that take place at premiums to book. Company like Starbucks doesn’t have any equity, because they bought back so much of the stock we own it. So, we have no book value in that one. But you couldn’t rebuild Starbucks today without a lot of capital and a lot of money. And then you’ve got some historical assets as well.
But still, so if you’ve got book value for the S&P at a little over 1,000 on a per share basis, that gets you to $9 trillion, let’s call it, market cap of a little over $40 trillion. Sales are more like 1,850 or 1,900, so almost twice book. But point being, a 20 ROE is not right, but it is what it is. But there’s so much leverage sitting next to the equity that does exist. They’re almost like amounts that the return on capital for the S&P is 12 and ours is 15, where if you own the S&P 500 for the last 20 years, you get about a third of your profits distributed to you as dividends. And all of the balance, more than all of the balance because it got augmented with debt, has gone to share repurchases. You’ve only shrunk the share count by seven-tenths of 1% each year for the last 20 years. But they’re giving away almost 3% to themselves on the front end. So, it’s not anti-dilutive.
If you go back 25 years, 25 years, we’ve done this experiment of share repurchases consuming two-thirds of profits. The share count for the S&P 500 is unchanged. [Jake laughs] Two-thirds of all the money earned by all shareholders in aggregate went to repurchasing shares, and there’s no change in the share count.
Jake: Where’d all the money go? [laughs]
Christopher: Where’d all the money go? Now part of it gets recapitalized when the banks blow up in every financial crisis.
Jake: Right.
Christopher: And so, you get a ballooning share count oddly in the last two quarters, the share count is up despite repurchases at still very high levels, although below the cadence of a year ago. And so, we largely own businesses that we get way less in dividends. Berkshire skews this, because they don’t pay a dividend. But we only get about 17% of our aggregate profits coming to us as dividends. So, the balance, which is the preponderance. We own businesses, and part of our mission is to find companies that actually have places to reinvest money at the returns on equity and capital. Some of our companies, like an Olin, don’t. But largely they do.
And so, the Semper portfolio is not being reinvested just in share repurchases to offset dilution, giving money to executives. We own companies where you have more of a founder mentality, where these folks really are trying to find places to reinvest in their businesses or bolt on acquisitions that make sense and are done at economically logical level. I think that’s what drives our return over time. That’s what’s driven our return over the last 25 years. It’s the preponderance of our profits actually being reinvested in companies that do invest in those returns, and not at 20 times earnings with two-thirds of your profits, which is a 5% earnings yield. That’s how your S&P for the last 25 years, which was expensive during the tech bubble, but the S&P has done 7% a year. That’s it. You make 5x your money. You make [unintelligible 00:27:39] 10.5%, you make twice that. And you’re sitting here today at those similar valuations and corporate behavior that’s doing exactly what it’s done for the last 25 years. And that’s burning up a whole bunch of corporate profit.
Jake: And maybe it has to almost be this way because of the pro cyclicality of share buybacks and pushing prices up. But I’m going to guess like on a dollar weighted basis, what do you think that over the last 25 years, the purchase price on a PE basis has been of these buybacks?
Christopher: Well, it’s your multiple of the market. You haven’t been far off of 20x to earnings. We’ve been very few times in the last–
Jake: And nobody was buying back when it was cheap. That’s my point. 2008, people were initiating equity and not doing buy backs.
Christopher: No, the share count went way up 2008 and 2009. Again, that was the financials in the bank. So, when things get really cheap, even early in the pandemic, everybody suspends their share repurchases because you worry about needing the capital in case things get really bad when you’re in a financial crisis like 2008, 2009. Beyond the banks, repurchases slow, which tells me there’s something perhaps going on in the economy today. And it’s not just all of a sudden, a rationality by your CFOs and your CEOs. Something has slowed the share repurchase cadence in the last half year. And I think it’s business conditions that were probably weaker for a lot of businesses and a lot of industries. And it’s all the inflation as well.
If you’re having to give money to labor, which has suffered for the last two or three decades, if you can’t pass through price and you’re eating it on margin, well, that’s less operating income that can go to share repurchases. If you’re a dollar general that we own, they’ve got some blocking and tackling issues, which made the stock really cheap, which we took it up from 2% of capital a year ago to 10. Bought our last block when we took it from 4% to 10% at 113 a share. It’s 160 today. But they cut their share repurchase. The stock was trading at a [chuckles] massive discount, but they put some debt on the books to buy shares back when the thing traded at 22 times earnings, and you’d rather have them buying it today.
So, Apple, when it was cheap– Part of the beauty of why Apple was so good is they started paying a little dividend quarter of their profits. But then they really ramped up their share repurchases. And only in the last three or four years did the stock go from a low 10s multiple to earnings. Well, they haven’t slowed the share purchase. But because you’re trading it 30 times, you’re retiring a far smaller proportion of the company. So, there’s no price. It doesn’t seem like there’s a price sensitivity with a company like Apple. I’d put most companies in that camp where there’s no price sensitivity. They’re simply trying to offset dilution by making themselves all fatter and happier.
Tobias: That’s one thing that Jake and I have talked about offline, possibly, that Buffett praises Apple for a lot of those buybacks that seem to me that they happen at prices that, are as you say, they’re just price insensitive, where he’s anything but– He’d just rather that they spend it on Apple stock than go and buy something silly?
Jake: Get an Apple car.
Tobias: Like, Go and buy GM or something. Yeah.
Jake: [chuckles]
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Buyback Blitz: Is Apple Following the Right Playbook?
Christopher: Well, there’s not a lot you can do with– Apple doesn’t have a lot of capital needs. So, what are you going to do with the money? I’d rather have a company do what a Costco does. The stock has rarely been cheap. They know how much money they need to open 25 stores a year. They’ve never changed the cadence. And so, they started paying a dividend in 2004, and then they’ve paid a series of special dividends that are– If you add them up, the four or five special dividends, it exceeds our cost basis in the stock. They give it back instead of overspending. And that’s probably for having Charlie on the board for all those years. I think there’s a rationality to when it makes sense to retire a share and when it does not make sense to retire a share. Anyway, Warren’s not going to blast Apple on their capital allocation in a public setting.
Tobias: But you can also not pat him on the back for it in your letter.
Christopher: No, I agree. I think he really does think just– You’re proportionally increasing your ownership, and I think that’s his point. But it only makes sense if you’re doing it when the stock is cheap. I think they’ve proven here in the last couple of three years that they’re not doing it the way Berkshire has done it when they retired a whole bunch of stock in the 1960s and 1970s. They issued it like it was going out of style in the 1990s when Berkshire traded at three to book. They’ve been buying it back for the last six years. But it’s the model of how this should be done. They’re very price sensitive. He talks about the need for it being price sensitive, and companies shouldn’t have a need for capital otherwise. I’m bewildered. Then you publicly tolerate it and endorse it in a public setting with an Apple. Who knows?
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The Munger Effect: How One Man Shaped a Business Empire
Tobias: Let’s just change gears a little bit. Charlie Munger, as everybody knows, passed away at the end of last year.
Jake: What? You didn’t tell me.
Tobias: [laughs] You missed that.
[laughter]Tobias: It wasn’t well noted in the media but do you have any reflections on Munger, and what do you think the impact will be on Berkshire?
Christopher: Well, he, like you guys, he became a hero to so many of us in the investing world. I think Warren’s tribute in this year’s letter– Couple things jumped out of me, called Charlie, the architect of the firm, and Warren was the general contractor, and explained why that was the case. I think that was the case. He also, even though they were, what, seven years apart, called him an older brother figure, and even a father figure at some level. It brought a lot of wisdom. I think my take is he really was the DNA of Berkshire and a lot of the culture and the things that are so important at the board level, the share repurchases at Costco, for example, or the paying special dividends instead of simply just trying to shrink the share count massively.
I think what he gave to Berkshire will persist for a long time. I also thought the choice of black. I didn’t see anybody note this. But generally, the Berkshire annual report has a different color to it each year, and black was only fitting in the year you lose Charlie. They used black two years ago in the 2021 annual report. So, you would not have had a repeat had it not been for the loss of Charlie. And Warren would have said, “We’re going with black this year.” But he didn’t say anything about it. I thought that was a very small, unnoticed touch as well.
I tried to pay tribute what little I could in this year’s letter by interspersing a bunch of Charlieisms and some of his quotes in the lead off to each section. And then, instead of book recommendations and music– For those that aren’t as familiar with Charlie, and one of the great things he said was, “You can be a lot wiser by learning from the eminent dead.” Well, he’s now our eminent dead, right?
Jake: Yeah.
Christopher: Yeah. He made a whole series of book recommendations over the years. I think anybody that is not familiar can go to the CNBC archive, and just listen to all these old Berkshire meetings back to 1994 and get Peter Kaufman’s poor Charlie’s almanac and read his series of speeches that he’s given at Stanford and USC’s business school and all the various places. There’s an awful lot of common sense and wisdom and humor to the guy. He’ll be greatly missed. He was the reason you’d go to the Berkshire meeting so many years. The rapport between Warren and Charlie was just a thing of beauty. So, we’ll miss him badly, and you guys– Will all miss him badly. Berkshire will miss him, but his spirit will be with Berkshire for an awfully long time, I think, and that’s the greatest tribute.
Tobias: Buffett used to describe him as The Abominable No-Man, because he used to say no to so much. Given that he bought things like Alibaba, how do you square the–? He seems to be willing to buy things and BYD and so on. He seems to be willing to buy things that Buffett does not, and yet he’s The Abominable No-Man to Buffett. How do you square those two?
Christopher: He’s human. [Jake chuckles] He believed in the China’s growth miracle. It was so correct for so many years. He was a big fan of Lee Kuan Yew. China modeled their rise to capitalism on what Singapore and some of the other Asian tigers had done, a command control economy. Li Lu is obviously a good friend. He had money invested with him. I couldn’t have invested in Alibaba. We just don’t do that. We’re not going to invest in a communist regime.
Yeah. I put it in this year’s letter. When Warren did The Superinvestors of Graham & Doddsville, and it’s now in the appendix to the intelligent investor. But he gave a speech at Columbia commemorating the 50th anniversary of the book. At Columbia, he put Charlie’s track record in with seven or eight other managers that were great. But you can see Charlie swung for the fences a lot more than Warren would.
Jake: Yeah. It was wild to see– I’ve looked at it before, but it really stood out to me this last time, that 1973, 1974, he wiped out all the way back to 1967. Like, seven years’ worth of progress were gone in a year and a half, basically.
Christopher: The S&P was down in those two years, 50%, kind of 24, 26, whatever it was. He was down over 30 in each of those two years. And that scarred him. If you go back, read the biographies and you listen to some of the comments he made, I think he concluded, “Wow, maybe I shouldn’t be swinging for the fences the same way.” Really pained him to lose money for shareholders and the management fees, which weren’t clawed back. That bear market did a lot of damage. He recovered the next year, but then he hung it up. He doubled or whatever. In 1975, had a big return and then hung it up. And then a couple of years later, officially joined Berkshire as vice chairman. But had done some investing with him side by side in diversified retailing, which then bought Blue Chip Stamps, and they collaborated on several deals. We were very good friends and we’re talking a lot.
Jake: It’s interesting for 20 years though, they were not under a single really unifying umbrella yet, that they’d still been working together but not actually as officially like Berkshire chairman, vice chairman.
Christopher: I just think he’s human and I think he was wrong on China.
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China’s Demographic Timebomb
Tobias: But you’re pretty bearish on China. What do you think about China? I know you just mentioned Alibaba. But generally, just don’t invest in communist regime. It’s not the VIE or whatever they call it, that structure where– I don’t know what the rights are. It’s [crosstalk] equity.
Christopher: It’s a VIE. Alibaba, if you own Alibaba, you don’t own equity in a business. You own a certificate in the Cayman Islands. And communists at a point tend to just take all the money away and you’ll never get it out. I’m fairly confident that most of these Western businesses are stuck in China. And at a point, who knows whether it’s when China actually does wade across and try to take over Taiwan. Who knows what the end game is? I’ve got a section in the letter on China. I always try touch on two or three themes beyond Berkshire and beyond the Semper portfolio.
I’ve got a section on China. I am very bearish. You’ve got a country that in the last 40 years, but really in the last 20 years, grew to the second largest economy in the world, $18 trillion. They brought half their population off the farms into the cities. There was a growth miracle component. They never did it with a profit motive. The Shanghai Exchange is negative for the last couple of decades. The businesses don’t earn a return on capital, but that’s not been the mission. The mission from a party standpoint was we’re going to grow and we’re going to bring people off the farms, and they did that. And really, the one child policy was disaster. But anytime a nation industrializes, families stop having as many kids, because you don’t need a lot of bodies on the farm, free labor. So, you go from seven to five to four kids. China’s now got a birth rate of 1.2. You need 2.1 to sustain a population.
The other thing that happens though, as the birth rate declines, when a nation industrializes, is the current population lives longer, access to medicine and healthier living. City living is not as hard on the body as living in farms. And so, you get this big expansion of the older portion of the population. So, China is so top heavy now with 1.4 billion people that there’s no way to reverse that gruesome one child policy, which you’ve now got so far fewer women, because families would abort the girls because you wanted the son as the heir. There’s no way to undo decades of a failed policy. And so, the Chinese population is going to shrink by half over some period of the next 30 years to 70 years. You look at what they’ve done to grow and the leverage that they’ve used in the last two decades.
We have a huge debt problem in the West and in all of industrial world. We’re 350% credit market debt to GDP in the United States, and the same holds for Europe. China is way above that. They’re an $18 trillion economy with something like $55 trillion or $60 trillion in debt. You’ve got Evergrande that’s blown up and Country Garden. Evergrande had over $300 billion in liabilities, and they liquidated a couple of weeks ago, and there’s nothing. There’s nothing. Every property developer is done, you’ve got something like $13 billion of hidden off balance sheet debt that exists at the province and the municipality level that is not counted in the official Chinese debt numbers, all of that money got lent to property developers. And then in turn, the wealthy Chinese who got rich as the early age of industrialization, they’ve invested in that stuff. And so, there’s no capital left.
You combine these huge overbuilding of infrastructure with a population that’s now been shrinking since 2021, and as I said, is going to get cut in half. It’s a really bad way to grow your GDP per capita by cutting your population in half. But that’s [Jake laughs] essentially what’s going to wind up happening over the next few decades. Overlay that demographic problem with no need to build more buildings, and they’re going to complain. What’s really odd is they will finish all the projects under construction. Even though every single property developer in the country is bankrupt, they’ll finish that stuff and then they’ll blow it up. But you’re not going to put more people into the cities. In fact, people in the cities are probably going back to the farms as the population shrinks. There’s no more opportunity.
So, the largest importer of every base commodity in the world, Toby, the iron ore from Australia and Brazil, it’ll still come in, and it’s coming in now, but less and less of it will get used domestically. Right now, they’re dumping everything on the world, Olin, in the case of the caustic and chlorine world, they’re dumping epoxy resin on the world at prices that make no sense at whatever point the West sanctions that. But there’s no economic use to it. They’re losing– China has among the highest electricity costs in the world. It makes no sense to do it. But that will all come in reverse. And that’ll bear on global growth, which is already slower for the last two decades because we’ve put too much debt into the system. So, I’m very bearish on China. No, I would never invest in a place where you don’t have rule of law.
I think Starbucks at some level with their 7,000 stores out of a 38,000 or 39,000 base. China is a big component of the growth curve for Starbucks. They’re company owned stores like they are in Japan, not in Korea. They intend to open a lot of stores. If China really gets sideways with the West– And again, Taiwan will have a lot to do with it. But international trade will have a lot to do with it. Their debt problems will have a lot to do with it.
There’s a not insignificant chance that Starbucks is just a single example loses their assets in China and they’re commandeered by the state. That enters our thinking and observing this for a number of years. I had a series of predictions in my 2000 letter and then the follow up, my 2014 letter, said, China’s GDP would not pass that of the US in 15 years. Now, they won’t do it in the next 70 years, because you’re not going to do it with a population that gets cut in half. We have net growth in population of the US. And a lot of embedded advantages to how we’re situated with agriculture and friendly neighbors to our north and south, and two big oceans on the left and right side of the country. Most powerful military in the world.
Jake: That big of a waterways?
Christopher: All of it. China is not going to pass the US in terms of GDP, despite their having $1.4 billion, our $340 billion. It’s not going to happen. They’ve already done it. The miracle has run its course, and that’ll reverberate in a lot of places. And if you’re an investor, a PM or analyst, you better be thinking about how the rollover in China– Demographics take forever. This is not a quarterly or a yearly thing. It’s going to happen over a long period of time, but there will be second and third and fourth order effects that are going to bear on how capital is treated globally. I think China is as big of a risk as the debt bubble that we all sit underneath in the industrial world, and you better pay attention to it. At least that’s my take.
Jake: Scary. [laughs]
Christopher: It requires a little kombucha.
Jake: Yeah, it does.
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Utilities, Regulations, and Renewables: The Tricky Triangle for Berkshire
Tobias: I’m interested to get how you feel about– We’ve got about 13 minutes left. How you feel about Berkshire, where it is now and how it’s doing? This is a question from JT. What it says about the economy, how it’ll do?
Jake: Yeah. Berkshire is the keyhole into the US economy. If anything, you’re seeing, what are you seeing from that?
Christopher: They are a pretty good proxy for the US economy, for sure. It’s largely a domestic business. There are components of the conglomerate that have been pretty weak. Rail car loadings have been really weak for the last several years. They turned a little bit in the fourth quarter for all of the class one, the six class one rails, Berkshire included. But the BNSF is earning about $2 billion below what I would call normalized earning power. It’s been pretty weak. Warren had the letter–
Jake: That’s volumes mostly? Is that what volumes are down?
Christopher: Yeah, it’s volumes and it’s not just coal. In the last two years, last year especially, it’s everything except for new cars. Some of this is now a rollover in trade. I’ve got in my secular peaks and troughs graph, I included total dollar exports, total dollar imports and net trade as a percentage of GDP. We’ve rolled that over. And again, this is China now slowing in the last three or four years. I think global trade is going to come in a little bit. And to the extent, we’re an exporter and an importer, a lot of that Western rail that Union Pacific’s and BNSFs roll through the ports in the West Coast and volumes there come down. Coal is clearly in decline, and you’ve had a little bit of a resurgence. Certainly, in Europe, you had a big resurgence. But as we retire coal fired capacity and replace it with renewables, coal is going to remain weak, and that impacts Burlington.
The utilities were okay. Warren talked about the regulatory environment. I’m sure he’s pissed. PacifiCorp had the fires in 2020 in Oregon and northern California. I think they paid a little over $5 billion for PacifiCorp in 2006 or 2007. They’ve set aside $3 billion pretax so far to cover losses net of about $500 million in reinsurance. And you’ve got the regulatory body, the PUC, saying, maybe you ought to be burying all of your power network.
Jake: Yeah. Right.
Christopher: Well, that’s fine. If you’re going to make us bury it, but you better give us a regulated return. Utilities always come with the risk of stranded costs. Go back to when we closed a lot of nuclear capacity in the 1980s. You have these nuclear decommissioning trusts. You exist as a monopoly. You would never build a coal fired plant or a nuclear plant or a wind farm or a solar farm, unless you were going to get a return on it. And so, the regulators have to be fair with the utilities. You look at what happened with SCANA, and their stranded nuclear costs just a few years ago. Total disaster. We had big cost overruns and the regulator said, “That’s on you. That’s not on the rate base.” Well, you got to get a return. And what we’ve done, rightly or wrongly, by racing toward carbon neutral 2050, rightly or wrongly, the cost of it is not exclusively falling on the individual consumer of electricity. It’s not on the data center. It’s not on the household user of power.
Tobias: The bitcoin miner.
Christopher: The bitcoin miner. [Jake laughs] It’s on. A lot of it’s on the tax base. A lot of it’s on the Federal taxpayer. Berkshire’s got like a $1.9 billion tax credit last year. Their tax rate was incredibly negative. So, the taxpayer is burying the cost. And beyond PacifiCorp, when you close half of your nuclear capacity, Berkshire has closed something like 16 or 18 of their coal fired plants, and you’re putting in wind and solar. If you built a 60-year life coal plant, you better be allowed the entire return on it, either through a higher rate base on your current renewables. But if they say, “Sorry, that’s on you,” nobody in the right mind is going to build the next– You’re not even going to maintain your grid. You’ll just walk away from it.
PacifiCorp’s debt is trading at 97 cents on the dollar. It’s essentially 6% yield at par. You haven’t stressed it, but if the regulatory climate in one of their markets became so bad that they were going to kill the profit motive of a private monopoly, walk away from it. And here are the keys. We’ll bankrupt the equity piece. And then all the debt they put in it, which is, split 50/50 with the equity side. We just give it back to the regulator and say, “You guys run it. We’re not going to build the next plant for you, we’re not going to maintain it. If you’re not going to let us make money on it, here you go. It’s yours.”
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Buffett’s Cash Reserves: Buffer Against BNSF Weakness and Retail Slump
Christopher: But we are trending toward a more populist regime from a regulatory standpoint. Not just with utilities, but across the board, the way our political winds are blowing. And if we’re going populist, some of your regulated businesses may not be as good a businesses. I don’t think that’s where we’re headed. I think the message was a warning shot to regulators like, “This is insane.” And the conspiracy theorist in me will say, “If you look at where all those fires started, there were a whole big series of fires.” Don’t discount the fact that Arson might have had something to do with it, because it sure looked to me, when you look at the interstate and the highway map, that most of those fires started at trailheads just off the interstates. You do have climate kooks running around that will do anything to kill traditional power. And if it means setting a whole bunch of forests and homes on fire to achieve their end, they might do that. And so, Berkshire is going to take a $3 billion hit on $5 billion in equity capital. That is not insignificant. And so, then you get reinsurance and the insurance world.
GEICO is back to healthy. They’re still trailing progressive. But you had a period where you lost a whole bunch of money coming out of the pandemic. You made a whole bunch of money. You had to give money back to policyholders. Then you had all the inflation. It got really expensive to fix cars, and then you had to go get rate in places like California and New York. New Jersey gave you rate late. But the auto industry is very healthy again, because they got enough price. Now we don’t like it, because you’re paying a lot more for your auto insurance.
And to the extent, you’ve got weakness. You’ve got retail weakness in places, and you’ve got the BNSF weak. The offset to that is you’ve got this $167 billion cash portfolio that today is earning 5.3%. You’re at $9 billion interest. That would have been earning nothing two years ago. That makes palatable weakness in various places. You’re one recession away.
Jake: That’s the mount Berkshire, as you called it.
Christopher: Yeah. [Jake laughs] I think I dreamt that up at 5 o’clock in the morning.
Jake: Yeah, it was in a haze. [laughs]
Christopher: Well, Berkshire gets criticized for having all this cash laying around. They shouldn’t. Since they did the Gen Re deal, when Berkshire traded at three to book and they bought insurance business to essentially diversify the stock portfolio, they’ve run the cash relative total firm assets at an average of about 12%. Well, if you’re $167 billion on a trillion, and $70 billion or a trillion and $80 billion, you’re a little higher. Now because you are not– [crosstalk]
Jake: A couple percent higher. Nothing that, but major.
Christopher: You’re in the range of where the cash has existed for the last quarter century. It’s just Berkshire has over a trillion dollars in assets. It’s the largest company in the world by tangible assets. But– [crosstalk]
Jake: And that doesn’t even count really the– Buffett said that, what BNS carried it like $30 billion of book value. He thought it was like $500 billion in replacement.
Christopher: That’s probably right. These rails were built 100 years ago. You’ve got assets that are fully depreciated. A part of them has to get maintained, but part of these are just carried it– I think it would cost $500 billion. I think he was probably right. I think it would cost $500 billion to replace the asset. Nobody’s going to do it, because the assets are already in place. I think they paid $35 billion for it and most of the profits, since they bought it of then upstream to the parent. And they had an opportunity to really improve the network by-
Jake: Yeah. Doubling hike.
Christopher: -intermodal and adding track in various corridors, and blowing out all the tunnels and improving the bridges to accommodate the double stacking. But that’s all run its course. And so, the railroad is a good business, risk to the downside from a regulatory standpoint. And as trade comes in, it’ll be okay. It’ll earn 12% or 13% on current carrying equity value. The equity of the firm is actually up to $50 billion. So, it’s grown since-
Jake: Of all the CapEx.
Christopher: -the purchase. There’s still goodwill that sits there. In fact, the railroad and the utility have both like $50 billion in equity capital today. I think the utility business, unless the regulators screw it up is still going to absorb a whole bunch of growth CapEx over time, because we are going to do more renewables. And if we’re going to do them and the taxpayer is going to subsidize them, it’s a really good use of capital.
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What to Expect at Berkshire’s 2024 Meeting
Tobias: Chris, we’ve got only a couple of minutes left. But what do you expect to see this year at the annual meeting?
Christopher: I’ll be disappointed if we don’t have a cardboard cut-out of Charlie. [Jake laughs] You’ll have a celebration of Charlie. It’s going to be emotional for Warren, for sure. I think you’ll probably have Greg and Ajith probably at the desk for the duration of the meeting now where in the last couple of years, they’ve had them in the morning session and it was just Warren and Charlie in the afternoon. My guess is you’ll have those three fielding questions throughout the day. I just hope Warren, 93 years. He’s living beyond the expiration date as well.
The culture of Berkshire will maintain and persist for a long time. The meeting’s so fun, because you guys go. We catch up with all of our friends. It’s more of a celebration than just simply the six and a half hours of listening to Warren and Charlie answer questions. You can go to the CNBC archive and I encourage everybody to go do that. Listen to those old meetings. There’s so much wisdom that has come out of this cumulative meetings over time. I hope to see you guys, 10 years and 20 years and 30 years in Omaha, because it’s a special thing. There’s no annual meeting, obviously, anything like it. Berkshire’s got a community of cultists that were developed because of Charlie’s care and touch and Warren’s care and touch, and hopefully, it lasts a long time. It’ll be a tribute year for the meeting and also a celebration of Charlie’s life.
Jake: Do you think record attendance this year?
Christopher: I don’t know. I think the attendance has fallen off in the last– [crosstalk]
Jake: It has a little bit. I think it peaked in– [crosstalk]
Christopher: -since they’ve been live streaming the meeting on whatever, Yahoo or whoever does it. It’s going to shrink over time, which frankly, it’s too many people in Omaha. The fact that [Jake laughs] I’m paying for four nights, I bring clients and friends that come in on Friday and go home on Sunday, we got to pay for four nights at the Embassy Suites. That’s a little stupid.
Jake: Yeah, they really got you over the barrel.
Tobias: It’s their entire year’s profit over those four days.
Christopher: Well, that in the College World Series. Yeah, so, they get you where they can. He tried to fix that problem. In fact, he had me talk to Steve Jordan at the Omaha World Herald a few years ago. I’d brought up the price and the minimum nights. He called all the hotel managers into his office and said, “Knock it off. I’ll move the meeting to Texas, if you don’t treat the shareholders a little more fairly.” Then you went to a two-night requirement versus a four. They never really lowered prices.
Jake: Doubled the price. Yeah.
[laughter]Christopher: But they were back at it within a couple of years. And so, he said, “Look, I don’t want to be the bad cop in my town.” He says, “Why don’t you tell the paper what’s going on, and then Steve can go run around and talk to all the different hotels?” And nothing came of it. [Jake laughs] I was the bad guy in the paper for a minute. I went incognito when I checked into the hotel that year.
Jake: Yeah, I bet.
Tobias: Chris, we’re coming up on time. Thanks so much for spending the time with us. And congrats again on 25 years. That’s an extraordinary achievement. That’s the true measure of success in this business, I always think.
Jake: Yeah.
Christopher: Well, it’s a blur. It seems like we started the thing yesterday. But again, I hope we’re doing this thing for a much longer period than another 25 years. But thanks, gents.
Tobias: Well, thanks for coming on again. Folks, we’ll be back here same bat time, same bat channel next week. Don’t know who the guest is yet. We’ll be figuring it out-
[laughter]Tobias: -over the course of the week. But thanks again. Christopher Bloomstran, Semper Augustus. We’ll see everybody next week.
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