In some ways it is hard to criticise Berkshire. Its shares have kept up with the stockmarket and its standing is exalted. It is the world’s seventh-most-valuable publicly traded firm (the other six are tech concerns). But Mr Buffett’s behemoth is a puzzle. Its recent deals have had drab results, suggesting a pivot to mediocrity.Get our daily newsletterUpgrade your inbox and get our Daily Dispatch and Editor's Picks.
Since 2007 Berkshire has spent $106bn on 158 firms. The share of its capital sunk into industry has risen from a third to over half. The largest deals include BNSF, a North American railway, Precision Castparts (PC), a manufacturer, various utilities, and Lubrizol, a chemicals business. Further transactions are likely. Berkshire has roughly $100bn of spare cash. In his latest letter, published on February 24th, Mr Buffett complains about high valuations but says there is a possibility of “very large purchases”. Berkshire thinks of itself as a friendly buyer to which families and entrepreneurs are happy to pass on their crown jewels. There is something comforting about its mission to be a home for old-school businesses run by all-American heroes.
Yet it is not an obvious formula for superior performance. Berkshire must pay takeover premiums and has $64bn of goodwill. It enjoys no synergies of the sort corporate buyers claim and unlike private-equity firms does not overhaul management at its targets. There is no clear reason why being owned by Berkshire improves performance. Mr Buffett has largely missed the past decade’s tech boom, the big force behind the stockmarket.
Can Berkshire turn water into wine? Schumpeter has attempted to answer this by crunching the numbers, using a certain amount of guesswork. There are two ways to capture how Berkshire creates value, both of which Mr Buffett has in the past endorsed. One is measuring Berkshire’s own book value and how this increases. The other is to examine its “look through” profits, which are made up of the earnings of its wholly-owned businesses as well as its share of the earnings from the firms in which it owns small stakes. Over the past five years its book value has grown by a compound annual rate of 11%. Berkshire’s look through return on equity (ROE) has usually been 8-9% (all further figures exclude the impact of a $29bn one-off gain booked in 2017 relating to America’s law slashing corporate tax).
Those results are worthy of Mr Buffett, but the next step is to split Berkshire into two areas and examine the larger part—its acquired industrial businesses, spanning its railway, energy, utility, manufacturing, services and retail units. These have a total book equity of $191bn, most of which was built up in the past decade. By this measure Berkshire is the second-largest industrial concern in America. The industrial arm’s operating performance is bog standard and, once you include the goodwill, its ROE is a weak 6%, down from 9% in 2007 before Berkshire shifted course (these sums exclude the amortisation of intangible assets, which is in accordance with how Mr Buffett assesses profits).
The industrial businesses’ lacklustre record mean they account for about 60% of Berkshire’s sunk capital but have generated only about half of its look through profits, and 40% of its growth in book value over the past five years. For the five big industrial companies where figures are consistently available, total profits have risen by 4% a year since 2012, which is no better than a basket of similar peers. Profits at BNSF, for example, have risen only just above inflation and in line with other railways. Speaking to CNBC on February 26th, Mr Buffett suggested that a sixth business, PC, had not met its own internal targets.
