Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) 2017 fourth-quarter earnings report showed that the company had $116 billion in cash and equivalents on its balance sheet at the end of the year -- an enormous sum of money and well beyond the $20 billion CEO Warren Buffett likes to keep handy.
There are four main ways Berkshire can use its cash. It could acquire a large company (or several), purchase common stocks of other companies, buy back its own shares, or pay a dividend to shareholders.
Why hasn't Buffett pulled the trigger on any big acquisitions?
Buffett's preferred use for Berkshire's cash is to make large acquisitions. While he also loves creating value by adding to Berkshire's stock portfolio, growing Berkshire's portfolio of companies is the priority. Wholly owned subsidiaries generate cash that can then be used to acquire more businesses and/or stocks, creating a sort of "cycle" of growth.
However, Berkshire hasn't made any big acquisitions recently. Aside from buying a minority stake in Pilot Flying J last year, a relatively small purchase for Berkshire, the company hasn't made a big acquisition since it bought Precision Castparts in 2015, which is the main reason so much cash has built up.
The short answer to why Berkshire hasn't acquired anything recently is that everything it would buy is too expensive.
In his letter, Buffett discussed the five qualities he looks for:
- Durable competitive strengths.
- Able and high-grade management.
- Good returns on the assets required to operate the business.
- Opportunities for internal growth at attractive returns.
- A sensible purchase price.
Apparently, Berkshire found candidates that met some of these requirements, but the last one was the deal-breaker. "That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high," Buffett said.
Just to put Berkshire's massive cash hoard into perspective, Nike, Texas Instruments, Adobe, and Lockheed Martin are each worth less than Berkshire's cash on hand. However, Buffett is a very picky buyer, especially when it comes to getting his money's worth.
Is a buyback or dividend in Berkshire's near future?
Despite widespread speculation after Buffett himself said the "D-word" at last year's annual meeting, I don't think Berkshire will pay a dividend anytime soon. Buffett has directly addressed the question of why Berkshire doesn't pay a dividend, and his suggestion is essentially that if a Berkshire shareholder wants a dividend, that person should simply sell, say, 3% of his or her position every year. And the notion of paying a dividend has been largely absent from any recent Buffett comments.
A buyback may be more likely. Berkshire's board is willing to buy back shares at a valuation of 1.2 times book value or lower, a value that Buffett has said would be a significant discount to the intrinsic value of the stock. The stock trades for just under 1.5 times book value as I write this, but if 1.2 times book is a big discount, it's conceivable that Buffett and Berkshire's board could raise the buyback threshold to a level Buffett feels is a "mild" discount.
Having said that, I wouldn't hold my breath for either option. In his letter, Buffett said that "despite our recent drought of acquisitions, Charlie [Munger] and I believe that from time to time Berkshire will have opportunities to make very large purchases." In other words, Buffett doesn't sound like he's given up on his preferred use for Berkshire's cash.
How big will Berkshire's cash problem get?
Berkshire's $116 billion cash hoard certainly is a lot of money, but it's not unheard of in the corporate world. Apple, for example, has more than double this amount of cash -- although to be fair, before tax reform, it wasn't cost-effective for Apple to use most of it.
If valuations of public and private companies remain high and Berkshire's stock remains too highly valued for Buffett to feel comfortable with a buyback, I wouldn't be surprised if Buffett allowed the cash stockpile to get significantly larger before he seriously considers a dividend. Until some interesting opportunities present themselves, Berkshire will probably continue to have a cash problem.