The Natural Limits of Profit Growth: Berkshire Hathaway Edition

A year back, I explained that profit growth are constrained by natural economic forces: in particular, the law of compounding, competition, changes in  the risk environment, changes in the production process (lengthening or shortening), boom bust cycles, and government interventions (e.g.taxation and deficit spending).

Warren Buffett's flagship Berkshire Hathaway should serve as a great example.

In terms of prices, while Berkshire Hathaway had, in the past, outclassed the S&P by a wide margin especially during its maiden years, that magic appears to be ebbing.

Since 1999, Berkshire returns appears to be growing at a rate similar to that of the S&P. In conventional perspective, this makes Mr. Buffett's company a seeming proxy for the S&P.

The crux is that natural economic barriers to profit growth has been eroding on the foundations of Berkshire’s profit growth rates as reflected by stock prices as shown by the chart above from Businessinsider

Now the growth aspect. Agora publishing’s Bill Bonner at the Daily Reckoning says that in realization of this phenomenon, Mr. Buffett seems to be moving his goal post to in order to embellish his social position : (bold mine, italics original)

This focus on quality over price is what turned Berkshire Hathaway into such a money machine for Buffett and his partner, Charlie Munger. For 36 years, the duo tossed their coins and got heads every year.

But in 2000, the tails began to appear. You may say that Buffett and Munger “changed their strategy.” Or they “made a mistake.” But if their success were based on skill, why would they suddenly forget how to make money?

“Berkshire’s investment portfolio performance has been extremely poor for at least the last 14 years,” writes colleague Porter Stansberry.

Between 1970 and 2000, the lowest 10-year annualized return on Berkshire’s investment portfolio was 20.5%.

Starting in 2000, however, the wheels come off. Between 2000 and 2010, the annualized return was 6.6%. And, after never recording an annual decrease in book value, Buffett lost money twice in the 10-year period (2001 and 2008).

note here of the effect of boom bust cycles on Berkshire's balance sheets…

Relative to the S&P 500, these numbers haven’t gotten better since 2010.

In 2011, Berkshire’s portfolio return was 4%. (The S&P 500 was up 2.1%.) In 2012, Berkshire’s portfolio return was 15.7%. (The S&P 500 was up 16%.) In 2013, Berkshire’s portfolio was up 13.6%. (The S&P 500 was up 32.4%.) In 2014, Berkshire’s portfolio was up 8.4%. (The S&P 500 was up 13.7%.)

Last week, Buffett moved the goalposts. Instead of reporting Berkshire’s results in terms of book value only, he showed how well the company did in terms of share price.

Why he did this is a matter of some controversy.

Did he do it, as he claimed, because book value no longer gives an accurate picture of the value of his “sprawling conglomerate”?

Or did he do it because the gods have turned against him; his book value increases have underperformed the S&P 500 for the last 14 years and it is becoming embarrassing?

Barron’s offers an opinion:

Buffett probably can be faulted for not being forthright in the letter about the disappointing performance of the Berkshire equity portfolio that he oversees.

Of the company’s big four holdings, American Express, IBM, Coca-Cola and Wells Fargo, only Wells Fargo has been a notable winner in recent years. […]

Buffett tends to manage the portfolio’s largest and longest-standing investments. Two managers who help run the rest, Todd Combs and Ted Weschler, have outperformed Buffett in the past few years.

If the law of economics has affected the world's greatest investor, why do you think others will be immune?  

In the Philippine context, those stratospheric valuations justified on supposedly perpetual headline G-R-O-W-T-H will be faced with reality soon.