Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), the conglomerate led by Warren Buffett, had a strong year in 2017, with many of its subsidiary businesses and stock positions performing quite well. A few days before the end of the year, Berkshire's stock price had risen by 22% in 2017 -- undoubtedly considered a win by investors.
However, 2017 was a rather uneventful year for Berkshire in terms of acquisitions and stock purchases. Berkshire's only significant acquisition was a stake in Pilot Flying J, a relatively small purchase for the company. While Buffett and his team made a few stock purchases, the unloading of much of the IBM stake meant that the portfolio's contents didn't grow very much, aside from generally higher stock prices.
With an ever-growing cash stockpile, new business-friendly tax laws, and shareholders anxiously waiting for the company to make some moves, I'd be surprised if 2018 isn't a more exciting year for Berkshire.
Berkshire's cash "problem"
At the end of the third quarter, Berkshire Hathaway had more than $109 billion of cash and equivalents on its balance sheet. And it was recently announced that Berkshire was receiving a $3 billion cash windfall from the redemption of its Restaurant Brands International preferred shares.
Along with the cash flowing in from Berkshire's other businesses and the lack of major acquisition activity during the fourth quarter (the Pilot Flying J deal should roughly balance out the Restaurant Brands inflow), this should result in Berkshire's cash hoard having grown significantly larger by the time you're reading this.
While having so much cash is a good problem to have, it's still a problem. This is a 12-figure sum of money that's earning little or no returns for investors, and represents roughly one-fourth of Berkshire's entire market cap. To be fair, Buffett has said that he prefers to keep at least $20 billion on hand, but this still leaves about $90 billion in excess cash just sitting around.
And the potential solutions...
There are five ways that Berkshire could ultimately deal with its cash problem:
- Do nothing. Berkshire could allow its cash hoard to continue to grow. I view this as the least likely option on the list, as Buffett has expressed his desire to do something to prevent the cash stockpile from growing indefinitely.
- Make a major acquisition (or several). Acquiring entire businesses is Berkshire's preferred way to grow, but with equity valuations climbing higher and higher, it has become more difficult to find attractive opportunities. Plus, as big as Berkshire is, and as big as its cash stockpile has become, any acquisition would need to be pretty big -- say, $10 billion or more -- to really make an impact.
- Aggressively add to the company's stock portfolio. The same problem exists here. Stocks have gotten expensive. Sure, there have been a few each quarter that Buffett and his team have bought, but does the Oracle of Omaha really like any stocks enough right now to put billions and billions of dollars into the market?
- Buy back shares. Berkshire's board has authorized buybacks if shares fall below 120% of book value. Well, as of this writing, Berkshire trades for nearly 160% of book. However, Buffett has said that this policy could potentially be adjusted if the cash continues to pile up.
- Pay a dividend. Berkshire hasn't paid a dividend in 50 years, and this notion would have been laughable just a few years ago. Much to investors' surprise, Buffett mentioned the possibility of a dividend at Berkshire's latest shareholder meeting, so this option is on the table, as well.
The exact option, or combination of options, that Berkshire ultimately chooses is anyone's guess at this point. However, I think 2018 will be an active year for Berkshire's capital deployment, in whatever form it may take.
Business-friendly tax laws could motivate Berkshire even more
Obviously, the new 21% corporate tax rate will likely boost Berkshire's profits, just like it will for many other companies. (Berkshire's current effective tax rate is about 27%.) This could increase the company's cash flow and cause the stockpile of cash to grow even faster. Berkshire would also get a reduction on the deferred tax liability that comes from gains on its massive stock portfolio, which would boost the company's book value, and make a buyback more likely.
In addition, the provision in the new tax bill that allows full and immediate expensing of acquired assets could give Berkshire even more incentive to put its cash to work, investing in its subsidiary businesses.
The bottom line is that Berkshire is heading into 2018 with tons of unwanted cash in the bank, lower taxes, and lots of possible ways to put its money to work. I'd be willing to bet that Berkshire's 2018 will be much more exciting than 2017.