In recent years, it seemed like Warren Buffett was drifting from his roots. The legendary investor is the most famous disciple of Benjamin Graham, whose methodology focused on finding companies with clear tangible value, either in the form of a rock-solid balance sheet or under-appreciated equity in its brand.
[InvestingAnswers Feature: Benjamin Graham -- The Father of Value Investing]
But more recently, Buffett has started to look like a lot of other portfolio managers, shifting into high-growth stocks and what seemed like risky bets on the economy. He didn't necessarily seem inclined to hold stocks for the long haul, and he shuffled some positions with a relatively high degree of frequency. When he bought risky but potentially lucrative special investments from Goldman Sachs (NYSE: GS) at the height of the financial crisis, the Buffett we once knew seemed to have truly changed his stripes. (That Goldman stake is now worth more than $5 billion and will likely be bought out by Goldman in coming quarters.)
You can't blame him. Value investing hasn't been as profitable as in decades past and Buffett simply learned to 'beat the market at its own game.' Kudos to him for showing the flexibility to adapt to changing market conditions.
But what are we to make of his latest moves and the latest annual message? A close read shows an investor who, at 80 years old, is still shifting gears as necessary. But he also gave an indication that he may just be starting to ramp up his old value approach once again.
1. Bullish -- with Limits
Make no mistake, Buffett remains bullish on the U.S. economy. He sees the nascent economic expansion as just getting some momentum, and in his annual message to investors, he notes that 'money will always flow toward opportunity, and there is an abundance of that in America.' He's also less concerned than others that the persistent trade and budget deficits will have ruinous consequences.
But that's not the same thing as saying the market looks attractive. After all, stocks have doubled from their March 2009 lows, and anyone who has been in the market for decades must be thinking about booking profits when the market stages a furious rally in a short time.The clearest sign of any concern that the recent go-go phase in the market may be troubling him: Buffett has been selling stocks but declining to re-invest those profits elsewhere. His firm, Berkshire Hathaway (NYSE: BRK-A) now has a hefty $38 billion in cash sitting idle (as of the end of 2010).
But there's no indication Buffett has any desire to sell off any positions that still look like real value plays. And the companies that are 100% owned by Berkshire probably aren't going anywhere. Berkshire's ownership of GEICO, for example, is the investment that keeps on giving. Year after year, GEICO throws off massive cash flow, and it's hard to see that changing, since GEICO operates in an oligopolistic industry that has major barriers to entry. Berkshire's ownership of GEICO will likely outlast Buffett's time on earth.
So what will he do with the $38 billion in cash sitting idle on Berkshire's books? One option is to wait for a big market pullback so that value plays uncover themselves through sharply lower prices. But his bullishness on the U.S. economy seems to indicate that he's not expecting that to happen any time soon.
A second option is to look for opportunities to find solid companies that are mispriced in relation to long-term cash flow. That was the logic behind his massive $26 billion investment in Burlington Northern Santa Fe Railroad in November 2009. Berkshire's move to acquire Burlington was based on analysis of industrial and economic trends. Buffett thinks railroads have an inherent advantage over truckers, and he thinks they will have a wide moat well into the future.
Burlington is already sharply boosting Berkshire's total cash flow, and will likely keep doing so for years to come. To be sure, there are fewer big fish out there that are the size of Burlington Northern, but if anyone can find them, Buffett can. In his annual missive, Buffett coyly noted that Berkshire is on the prowl for another mega-deal. He said, 'Our elephant gun has been reloaded, and my trigger finger is itchy.'
2. A Massive Nest Egg and a 10,000-Foot View
If you want to invest like Buffett, you need to look at industries from a 10,000-foot view. Big long-term bets like Burlington Northern are the hallmark of Buffett's value-creating approach and Buffett may indeed be shifting back to his value roots. He noted in his annual report that he always looks for simple-to-understand businesses that are debt-free and throw off huge and consistent amounts of cash flow.
In a few months, it will be interesting to assess his first-quarter moves to see what he's doing with all that cash. Will he re-deploy funds back into traditional stock investments? Or will he patiently wait for several quarters -- or more -- to hunt the big game that he increasingly prefers?
One thing to note if you're a shareholder in Berkshire Hathaway: you may have noticed that the stock tends to lag robust market rallies. The asset base is ill-suited to compete with pure growth stocks. But you should be heartened by the fact that the company's portfolio consists of a healthy set of stable, cash-flow powerhouses. In light of ever-rising stock markets and still-uncertain economic prospects in the United States, that's a nice place to be.
3. Preparing for a Post-Buffett World
Buffett turned 80 years old last August, and readers of his annual message are always looking for insight as to who will replace him as the head of Berkshire Hathaway (he's already said that his role will be split among several executives -- to learn more, check out Happy Birthday, Warren Buffett…Will You Answer the One Question on Everyone's Mind?).
Some have speculated that when he steps aside, shares of Berkshire Hathaway will lose their luster. There may indeed be a knee-jerk reaction, but such a move would be short-lived. That's because whoever succeeds Buffett will simply replicate the approach that he laid down a half-century ago. At this point, the 'cult of Warren' has been institutionalized into the DNA of Berkshire Hathaway.
