Summary
- Berkshire Hathaway has accumulated over $125 billion in cash and T-bills.
- Using Berkshire's huge cash hoard for an acquisition vs. returning it to shareholders has been a hot topic of debate.
- I use a DCF model to show that a large share buyback today is preferable if the next big acquisition is more than 3 years away.
Letter Provides Few New Clues
Berkshire Hathaway (BRK.A) (BRK.B) issued its annual report this past weekend, prefaced by CEO Warren Buffett's letter to shareholders. Ahead of the release, investors were hopeful for some clarity on the disposition of Berkshire's $125 billion pile of cash and T-bills. Many shareholders are impatient for Berkshire to either make an "elephant-sized" acquisition or return some capital to shareholders through buybacks. As long-time Buffett watchers know, Warren is not one to tip his hand on potential deals, so it should come as no surprise that the letter did not provide any hints on that topic. Buffett did, however, make some comments on share buybacks. The two biggest takeaways on that subject are:
1. Buffett believes shares were only modestly undervalued at certain points during 2019, hence the modest buyback of about $5 billion or 1% of market cap.
2. Buffett would like to avoid paying up too much in the open market for shares, so he provided a contact for those interested in selling large blocks of $20 million or more.
So, the debate on what to do with the cash will rage on, at least outside of Berkshire HQ. Read the comment sections of other Berkshire articles here on Seeking Alpha and you can see views ranging from "I trust Warren to invest that cash at the right time and returns will be great!" to "Buffett has lost his touch, give shareholders some cash back so they can redeploy it themselves." (I'm paraphrasing here. Quotes do not exactly represent specific comments word-for-word.)
Even the biggest Buffett fan will have to admit that "forever" is not an optimal holding period for cash especially in the current low interest rate environment. I attempt to build a more quantitative framework to help understand how long it is worth waiting for the next big acquisition. I will use a discounted cash flow model to do this. While a lot of assumptions are involved, I will try to point them all out so that others can substitute their own assumptions and see if the conclusion changes.
In my base case, I show that waiting more than 3 years for the next big acquisition produces a lower present value than spending that amount on a buyback this year. This result depends on the expected ROI of the acquisition and its anticipated growth rate. At this point I am comfortable staying Bullish on Berkshire because I expect to see the cash used within or close to this 3-year time frame.
