The Contra Guys see Berkshire’s ventures into airlines and tech as confusing and out of character.Rick Wilking/Reuters
Over the 40 years or so that we have been investing, our system has evolved. We learned from what worked – and even more so from the errors that were made. Unfortunately, there were more than we care to remember. But evoking some of those painful memories has been critical to advancing our methodology, which though different than the early days, has remained rooted in our contrarian and value bent.
So, we were taken aback when looking at the recent investments of Warren Buffett and his sidekick Charlie Munger. Let us preface by stressing that we have tremendous admiration for these two gentlemen, both for their investing skill and the honourable ways that they appear to lead their lives.
Our impressions were deepened further a number of years ago when attending the Berkshire Hathaway Inc. annual general meeting in Omaha, Neb. Listening to those gentlemen rhapsodize was a wonderful experience for us and one that is high on our recommendation list to investors. For us to attend this gathering, we had to buy into the company. By no means is this a Contra enterprise, so this purchase was meant more as an investment in knowledge and a fun trip. It was on both counts. Buying technology corporations was anathema for Mr. Buffett at one point in time. That has changed over the years as his foray into International Business Machines Corp. demonstrates. The original bite into Apple Inc. was downright confounding and bolstering the position recently only added to our confusion. When the second acquisition was made, the stock traded near historical highs at more than $100 (U.S.), with the book value less than one-quarter of that. Risk has increased by our reckoning, as Apple had nil debt in 2012 and today it stands at about $88-billion. Investors should also consider that while Apple has had a tremendous run, people's love for technology can be extraordinarily fickle and there is a necessity to keep fans alight with continual product improvements. The technology graveyard is littered with enterprises that could not keep up. Mr. Buffett is famous for his quotes on why not to invest in the airline sector. One of our favourites is when he said, "I have an 800 [free call] number now that I call if I get the urge to buy an airline stock." Evidently that line was disconnected, as he added to his positions in four corporations in the industry.
One of them, Southwest Airlines Co., has one of our favourite ticker symbols, "LUV." It does not get much cuter than that. But as a financial outlay, loving it is not something that it appears Berkshire would normally do. This is another stock that is trading near historical highs at around $58, while having a relatively miserly book value of less than $14. Not so attractive by those metrics.
His other purchases in this field include American Airlines Group Inc., Delta Airlines and United Continental Holdings Inc. Again, all trade at huge multiples to the book value and near historical highs. All could have been purchased at about one-quarter of their current prices four years ago. That would have been a heck of a lot prettier. One could argue that Mr. Buffett is buying these enterprises for future cash flows, one of his hallmarks. While right now in all cases those numbers are pretty sexy, if there is a major global problem that restricts travel, all of these ventures in flying could nosedive. The price-to-eanings ratios are also reasonable. In addition, since these four are North America's largest airlines by far, having all of them under Berkshire's influence should diminish competition and allow for more pricing power.
Are Mr. Buffett and Mr. Munger passing the baton with a new generation making more decisions at Berkshire? That seems like a pretty realistic conclusion.
Given that the stocks purchased all seem top heavy in price, it seems quite possible that the worth of the companies might topple when the markets take their inevitable beating. If that happens, for people who like playing the shorting game, Berkshire could prove a good play. And since the company does not pay a dividend, the risk is somewhat diminished. However, with the 180-degree shift in the investments being made, it would not surprise going forward to see a dividend implemented, especially with the huge cash hoard held by this corporation. If that happens, it could propel the stock price up further, ceteris paribus (all other things being equal).
At our end, we do not play with shorting, having been burned in the past both with paper trades and real money. Quite simply, that is not part of the way we do business. Ultimately when investing, to achieve success it is critical to have a disciplined methodology. Looking at Berkshire's recent stock plays, it appears the modus operandi has shifted dramatically. This is giving us pause and making us strongly consider selling our position.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter.