BRK vs S&P?

[laksox]

Hi - I'm a newbie who's debating between putting new money into BRK vs SPY, and was just hoping to get big picture thoughts on a basic question.

 

Obviously, Buffett's track record is legendary and BRK has been an amazing investment for many decades.  At this point, though, given how large it is, is it meaningfully different than the S&P 500?

 

BRK's drawdown from peak-to-trough in the GFC and from peak-to-trough in the coronavirus pandemic is a percentage point or two less than the S&P 500's, but their performance since the GFC has been remarkably similar (and that excludes dividends).  And the risk of Buffett stepping down some point soon would seem to pose an additional risk.

 

I know a lot of people here have been longtime-holders of BRK, but do you see it as a superior investment to SPY for new money going forward?

 

Thank you! 

[Dynamic]

I think Berkshire's advantage over the S&P500 Total Return Index has diminished gradually over time as it has grown to be one of the top ten companies by market cap and now, if it has any advantage it's probably in the 2% cagr or less region, most likely less, if any.

 

There may be tax advantages for some, me included, by having no dividends distributed and income tax or withholding tax for non-resident aliens like me to pay on those.

 

It very much depends on your approach to investment. If, like me, you'd rather not hold cash predicting "9 of the last 2 bear markets" and instead keep compounding and accept drawdowns, Berkshire Hathaway or S&P500 both make reasonable investments most of the time and a few years of not missing out on compounding at high single digit to 10% rates will make up for a 20, 30 or 40% bear market plunge in the long run.

 

It's also likely that Berkshire is almost permanently priced a little below Intrinsic Value but usually not deeply undervalued, whereas the S&P500 is, to me, much harder to read. Also, I can get a pretty good feel for the 'normal times' downside potential price of Berkshire. Currently we are not in 'normal times' so it has fallen well below the soft floor of around 1.2x last reported Book Value as the market value and expected near term profits of almost all its investees have plunged sharply. But if the market dives much further, I'd expect Berkshire's outperformance (in falling less than the market) to widen slightly.

 

On the basis of Look-Through earnings yield (or its inverse, the P/E ratio) Berkshire Hathaway has for the last few years looked more attractive than the S&P500, and frankly I trust Berkshire's numbers not to be inflated more than I trust those of many of the companies in the S&P500, and generally, Berkshire has conservatism and financial resilience built into its culture. Debt is used very sparingly, and is placed only where it's appropriate and safe, such as the railroad and utilities, where customer demand is sufficiently stable to support debts at rates low enough to reflect the earnings safety. And because those subsidiaries that need the debt are themselves such secure credits, Berkshire ensures that their debts are not secured at the parent company level, so that in times of stress, Berkshire's creditworthiness cannot be affected. So, Berkshire is a financial fortress that retains its 'Rock of Gilbraltar' like balance sheet strength even in times of unusual exogenous stress, such as the GFC and the current pandemic, allowing it to take advantage of the prices and opportunities for excess returns produced by such crises. Berkshire employs some leverage, but it's very safe and it remains un-callable in almost any conceivable circumstances. Prior to this crisis, Berkshire's float - a form of uncallable leverage - was almost a perfect offset to the cash & equivalents - wiping out any cash drag but not applying any additional leverage. If they spend some of the cash, the effectively add modest leverage to the company at a time when it's able to make investments with a higher rate of return than normal. When buying BNSF a decade ago they even added a small amount of debt to ensure they retained $20bn cash to pay any potential reinsurance or insurance claims from a megacatastrophe, which they paid down within a short period.

 

And that's really where slight annualized excess returns above the S&P500 are likely to come from. Berkshire can tread water and approximately keep pace with the S&P500 during calm waters, but in rough seas (and I mean when prices haven't gone from expensive to average, but from average to positively-mouthwatering and where others sources of capital have dried up), Berkshire can make meaningfully large capital allocations and increase its leverage (at sufficient margin of safety to generate excess returns and increase its Intrinsic Value (although this may not be evident for some years) far more than the index can during the same periods. If Berkshire is able to increase IV by 10%, 20% or 30% during times of stress (depending on the opportunities available), that might translate into a long term excess cagr of 1-3% compared to the index, which still means you have 10%, 20% or 30% more capital than if you'd invested in the index.

 

Right now we've gone from a fairly pricey market to a moderately attractive market with a few areas potentially deeply undervalued, but a lot of stuff still far from cheap and quite a few long term compounders still looking fairly pricey compared to times like the month or two after 2001/09/11 and times in 2003, or the GFC in 2008-9. So Berkshire has a wider opportunity set, to invest more, but it's hardly like shooting fish in a barrel.

 

But overall, to me, I sleep better with Berkshire, and I suspect it will do well for me from here, and that prices around $170 for BRK.B are probably a once-a-decade opportunity for something with great certainty of producing a decent long term return. But one can take more risk, for example with banks and airlines and conservatively run oil and gas majors, to probably achieve a better return.

 

Berkshire remains the bedrock of my portfolio, which I'm happy to hold to 100% weighting. And if I do find high-conviction opportunities, I'd need to have a good expectation of them outperforming Berkshire to switch into those, and I'd base my weighting on their risk of failing to do so. In the past I've done it with a 25% position in Apple at $95, which doubled in a couple of years before I reverted to Berkshire, for example. And in effect my holding of Berkshire stock increased in proportion to the outperformance of that round-trip. In fact, I monitor my portfolio's value versus the equivalent number of BRK.B shares as a reasonable guide to whether I'm beating my Berkshire benchmark, as well as a more conventional comparison to SP500TR.

[vinod1]

Terrific response Dynamic. Wish there is a way to pin the thread so everyone who is starts out researching Berkshire reads this first.

 

Perhaps the only thing I would change is not to go 100% on any one investment. Two reasons (1) many of us mortals cannot think of all the possible risks that are likely to come up. I think Buffett said something to the effect that even BRK would have failed or at least severely impacted if the Govt did not intervene in 2008/9. (2) one investment can remain out of favor for a while. So if you have all your money in one investment and you need it for some reason, you might be forced to sell it at an inopportune moment. Whereas if you have say even 4-5, potentially one or two might be closer to fair value and you can monetize that.

 

Vinod

[Dynamic]

Very fair response, vinod1.

[clutch]

I don't think BRK will be superior to S&P. However, I still own BRK -- because it is easier to know when to buy and sell depending on its PV. For a beginner, having S&P ETF as your core holding and trading in/out of something like BRK with a small portion of your money might be a good idea, to get a taste of both passive and active investing.

[Xerxes]

It may be obvious, but I would also add that do you want to have 500 CEOs reporting to you as a S&P500 owner, or just 1.

Do you want 500 CEO zigging while the market is zigging also, … or do you want 1 CEO zagging while the market zigs.

 

Think of BRK management as a "allocation valve" ensuring a contrarian zig-zag.

 

[jeffsreng]

I value brk.b at $275

[laksox]

Thank you guys for the awesome responses (esp Dynamic!). 

[Viking]

Dynamic, great post. Over the past 10 years i have held BRK in my portfolio more as a bond substitute than an S&P 500 substitute. Sleep well at night holding.

 

$440 billion market cap.

1.) $120 billion in cash. Once in 10 year opportunity to deploy at very attractive rate of return.

2.) Bonds are very short duration; perhaps opportunity to redeploy some during current bond market dislocation at higher yield (i.e. munis)

3.) insurance pricing is in hard market

4.) utility portfolio should chug along

 

Stock portfolio is getting whacked big time; this will be ok for long term shareholders as it is providing Buffett lots of great opportunities to deploy $100 billion

[Guest longinvestor]

I wouldn’t rule out them pruning the portfolio right now. The cash position goes up. Waiting for Elephant walk in?

[Dynamic]

I wouldn’t rule out them pruning the portfolio right now. The cash position goes up. Waiting for Elephant walk in?

 

As I mentioned in a different thread here, I agree that Berkshire may have made net sales (continued WFC sell off) or only modest net purchases and buybacks in the first quarter given the relatively high prices in the first 8 weeks and the relatively brief period when more stocks they could buy are attractive enough, but by no means all)

[CorpRaider]

I like BRK better.