Q&A: MU professor on teaching about Buffett, Berkshire Hathaway’s annual letter, succession

Andrew Kern | Via Trulaske College of Business

Berkshire Hathaway will hold its annual shareholders meeting this weekend in Omaha, Nebraska. On Saturday, Warren Buffet and Charlie Munger, Berkshire Hathaway’s chairman and vice chairman, will revive their annual tradition of conducting an hours-long question-and-answer session with an arena full of shareholders, analysts and reporters. The event sheds light on the famed financiers’ investment decisions and a range of other topics.

One person who’s especially familiar with those investment philosophies is Andrew Kern, a University of Missouri finance professor and the director of MU’s Jeffrey E. Smith Institute of Real Estate and Capital Markets. For more than a decade, Kern has taught a class about Buffett’s investment strategies. In the course, he covers topics including Buffett’s views on management, investing and valuations.

After Buffett released Berkshire Hathaway’s annual shareholders letter in late February, Missouri Business Alert caught up with Kern to learn more about his class and break down the annual letter.

This interview has been edited for length and clarity.

Missouri Business Alert: Can you tell me a little bit about the Warren Buffet investing class, what you do in there and how you became interested in teaching it?

Andrew Kern: I was a Warren Buffett fan before teaching that class. The class was originally conceived by a guy named Harvey Eisen, who is an alum of Mizzou and has a connection to Warren Buffet and thought the school would benefit in having that approach to business taught. We cover case studies on businesses he’s bought over the years, and we also talk more generally about his attitude towards management and investment and valuation. So we use a lot of examples, naturally, from Berkshire Hathaway.

MBA: Dissecting this year’s shareholder letter, what were the big takeaways from it?

AK: He talks about the five groves in his forest. That means there’s a variety of different ways he can invest now. He can invest in entire businesses, he can buy a large stake in a public company by buying a lot of stock, and he can have partners that he works with. I guess the takeaway from all of it is he will be investing more and more in entire stocks rather than entire companies because there simply aren’t enough private companies or public companies that will make a large enough impact on his portfolio now that it’s so incredibly huge. So, he will be buying more stocks but that is not a call on the market. He’s not buying stocks because stocks are cheap, but really because that’s his only option. It’s either that or accumulate more and more cash, which he doesn’t want to do. When I say he, I mean Berkshire Hathaway.

MBA: How did this year’s letter differ from previous years?

AK: There’s one big difference. He no longer wants to use the change in book value as the main measure of the success of Berkshire Hathaway. And the reason for that is a lot of what Berkshire can do is not reflected by book value anymore, whereas that was not always the case. Now … it makes more sense to look at the change in market value, rather than the change in book value.

MBA: Do you believe that’s an effective way to go about benchmarking performance?

AK: Yeah. A few years back I was at the annual meeting, and someone asked him, why do you compare the change in book value to the change in the S&P 500?” He said, there’s no real reason for it. We just do it. We’ve always done it that way, so we’re going to continue.

MBA: Was there anything in the letter that shocked you or came as a surprise?

AK: Well, he made an announcement that we already knew, which was Greg Abel and Ajit Jane will jointly take the reins as operational managers of the company. That wasn’t a shock at this point in time, but it was kind of surprising when it was announced last year. Honestly, nothing shocked me. The company has $122 billion in insurance float, which means that the company is actually highly leveraged even though it doesn’t necessarily borrow. It has a lot of liabilities it has to pay, whereas it hasn’t really issued a lot of debt for the purposes of expansion. It all comes from his insurance operations.

MBA: My next question was actually about the succession plans that you mentioned.

AK: Well, there’s more to it because there’s also his two investment guys. Ted Weschler and Todd Combs are jointly handling increasingly large portions of Berkshire’s marketable securities portfolio from what I understand. That portfolio itself is growing, so they’re going to have more and more money under their control as time goes on. Especially once Buffett is gone, I expect that they’ll probably make investments similar to what Buffett has over the years because there’s already a lot of overlap between what they’ve decided to invest in and what Buffett has decided to invest in.

MBA: One thing that Buffett points out is to not be so stuck in the “trees” of the businesses that Berkshire is investing in. What are your thoughts on that statement?

AK: I think it gives a great guide for how people should be analyzing the company. Because if you think about it, in terms of the groves that he mentions, you can value those groves a lot more easily than you can the component companies, which are so varied and so different that it would be an overwhelming task to look at all the subsidiaries the company has. So instead, he says, look at our non-insurance portfolio companies, look at our insurance operations, look at our marketable securities portfolio, and look at our joint partnerships.

MBA: What direction do you see Berkshire Hathaway going in the future?

AK: Berkshire will do fine in the long run. The biggest change is going to come when Buffett dies, or Charlie, which, given their age, will be pretty soon, unfortunately. And when that happens, I think that the market will temporarily get scared as it adjusts to the new leadership. But, having the collection of companies that it already does, it would take a lot to harm Berkshire Hathaway because the companies they have are already operationally independent. I think that it will continue to outperform the market in general because it has component companies or investments that are poised to do better than the market in general. I think that we’ll probably see more and more large investments in economically significant businesses like Apple. I mean, he has $50 billion of Apple in his portfolio, of all things. So I think we’ll see larger and larger stakes in big public companies like that and fewer what he calls “elephants,” which are the Berkshire Hathaway Energies, the Burlington Northern Santa Fes, the Geicos, or companies like that — big companies that he can wholly invest in.

MBA: Are there any points that you think people will bring up at the shareholders meeting?

AK: He spends a considerable amount of time talking about Tony Nicely, who is the CEO of Geico. And I think there might be concern there that now that Geico is as big as it is, maybe there’s room for the company to fall behind because, as he mentioned, they’re the No. 2 car insurer in the world. If I were at the meeting now, I would probably ask him about the management of what he calls “elephants.” And his answer is going to be, I “trust them all.”

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