- Berkshire Hathaway stock massively underperformed the market in 2015.
- Berkshire Hathaway stock has also underperformed the S&P 500 Growth Index over the last 5-year period.
- Is Berkshire Hathaway still a worthwhile investment?
2015 has proved to be one of those rare years that Warren Buffett’s BRK.B (NYSE:BRK.B) has badly lagged the market. The Sage of Omaha’s holding company finished the year 12% down. In contrast, the S&P 500 (INDEX:SPAL) finished the year with a return of -0.73%, which rises to 1.19% when you include dividend reinvestments (Berkshire does not pay any dividend). In other words, Berkshire stock underperformed the market by more than 13 percentage points, a really bad performance.
So what has been eating the Berkshire stock? All its top four core holdings comprising of Wells Fargo (NYSE:WFC), American Express (NYSE:AXP), Coca Cola (NYSE:KO) and IBM (NYSE:IBM) performed poorly during the year losing a combined $5B+ in 2015. American Express fared the worst losing $3.4B while IBM was down $1.75B. Berkshire Hathaway’s other equity securities (42% of its portfolio) combined for a total loss of another $1.6B. Not even Berkshire Hathaway’s portfolio of preferred stock was spared the capitulation, losing a combined $1.8B.
By all counts that was a horrible performance by Berkshire Hathaway. So what’s going on here? Is Warren Buffett and, by extension, Berkshire Hathaway, losing his mojo?
Efficient Market Hypothesis
Warren Buffett’s investment style has mainly focused on value picks of companies with sizable moats that makes it difficult for them to succumb to competition. But it appears as if the moats surrounding some of his companies are drying up and the walls being breached. A good case in point is IBM, whose once dominant position in the server business has been brought to its knees by cheaper and often more efficient products from rivals. Another erstwhile winner that is slowly losing its formidable brand power is Coca-Cola. More than 70% of the company’s revenue comes from sugary carbonated drinks which are being shunned by an increasingly health-conscious consumer.
There is another theory that can be advanced to explain why Berkshire Hathaway’s legendary run could finally be coming to an end: the Efficient Market Hypothesis, or EMH, advanced by none other than Warren Buffett’s most prominent intellectual rival, Eugene Fama. Mr. Fama won the Nobel Peace Prize in Economics in 2013 by advancing the theory that explains why trying to beat the market on a consistent basis really is a mug’s game. Fama, together with his assistant Kenneth French, used data from 1982- 2010 that showed that returns from actively managed funds such as Berkshire Hathaway had a huge 99% correlation to the market. In effect, the data suggests that active investing really is a zero-sum game where a gain somewhere is offset by an almost equal loss elsewhere before accounting for fees and expenses.
Berkshire Hathaway’s poor performance in 2015 is noticeable due to the huge underperformance relative to the market. But a closer look at the performance of the company over the past three years suggests that this is something that has been going on for some time. Berkshire Hathaway has actually significantly underperformed the market over the past five years, with a return of 61.4% vs. 71.4% for the S&P 500 Growth Index (the index tracks the performance of large-cap U.S. securities with growth characteristics).
Berkshire Stock Price vs. S&P 500 Growth Index 5-Year Share Returns
Source: CNN Money
Fama also found that after factoring in the fees charged by actively managed funds, only 3% outperformed their passively managed peers.
When viewed over its entire lifetime, Berkshire Hathaway falls squarely in that exceptional 3% of actively managed funds that outperform the market. But over the past five years or so, the performance of the company has only been average, suggesting that it’s not entirely immune to EMH.
Now the million dollar question is whether Berkshire Hathaway is really worth an investment at this point. That depends on your investment horizon. Warren Buffett's investment style involves holding on to stocks for what seems like an eternity. With duds such as IBM not expected to recover any time soon, chances are that Berkshire Hathaway stock will continue yielding average returns over the next 3-5 year period. In the 1998-2000 period, Berkshire Hathaway lost a staggering 44% of its value compared to a gain of 32% by the market yet Warren Buffett still hang on to his core stocks. To understand Warren Buffett’s thinking about falling stock prices, read this excerpt from his 2011 investor letter where he discussed IBM.
Has Warren Buffett and Berkshire Hathaway lost its mojo? Maybe not but as he recently observed, the days of beating the market by 15%-20% over long stretches are over. Warren Buffett’s record post financial crisis is mixed at best. Two of his notable homeruns include the $750 Goldman Sach’s position that is now worth about $2.5B while his Bank of America Corp position has expanded from $5B to $11.2B. But then again his $13.2B IBM position remains firmly underwater.
Warren Buffett considers Berkshire stock as cheap enough to buy when they hit a multiple of 1.2x book value or less. The current reading of 1.3x book value still has some room to run before Warren Buffett can consider buying back Berkshire stock which should add considerable shareholder value. Maybe long-term investors will be well-served if they wait for the Berkshire stock to drop to something like 1.23 x book value before considering opening long-term positions.