On Saturday, August 4, Berkshire Hathaway released its second-quarter operating results, and as usual, the conglomerate dazzled. Operating earnings soared by 67% to almost $6.9 billion, while investment income leaped to $4.8 billion from $0.2 billion in the year-ago quarter. As a whole, Berkshire has generated $1.55 billion more in net earnings through the first half of 2018 than it did during the first half of last year.
But amid all of this good news looms an intriguing data point that I'd classify as somewhat worrisome: the company's cash position.
Is Berkshire Hathaway's growing cash pile a red flag?
According to its Securities and Exchange Commission filing, Berkshire Hathaway ended the quarter with $64.56 billion in cash and cash equivalents and $46.54 billion in short-term investment in U.S. Treasury bills. Combined, that's $111.1 billion, or an increase of more than $2 billion from the previous quarter.
As my colleague Matt Frankel noted earlier this week, the increase in cash value during the second quarter may be entirely attributed to Bayer's acquisition of Monsanto during the quarter. Monsanto was a holding in Berkshire's investment portfolio at the time the deal closed. This would imply that Berkshire Hathaway completely reinvested its operating earnings for the quarter back into stocks; otherwise we'd have seen a larger uptick in its cash position.
Nevertheless, over the past 20 quarters (that's five years), we've seen substantial growth in Berkshire Hathaway's total cash position. Since partnering with 3G Capital Management to buy Heinz (now part of Kraft Heinz), and announcing a $5.6 billion deal to acquire NV Energy, both in the first half of 2013, Berkshire's cash position has more than tripled.
This is a far cry from the norm, with Berkshire Hathaway and Warren Buffett consistently holding anywhere from $24.5 billion to $49.1 billion in combined cash and short-term investments between the first quarter of 2006 and the second quarter of 2013.
Even Buffett sounded off about the company's cash position in an interview with CNBC following the company's first-quarter operating results:
[Cash is] just about the world's worst investment, except doing something dumb that you're doing for a longer term. I would much rather have that number be $30 billion.
Here's the big worry
So why isn't Berkshire Hathaway's cash position smaller? One answer could be that it hasn't found the right needle-moving transaction yet. Buffett hasn't been shy about his belief that any acquisition his company undertakes will have to be substantial to move its top and bottom line. These so-called needle-mover transactions aren't cheap, which may have persuaded Berkshire's board to build up an adequate cash position.
It could also be suggested that as Berkshire Hathaway has grown, its need to maintain adequate capital on hand has as well. Remember, this is a company with major financial roots, and is thus required to be adequately capitalized.
But the big worry, and the reason investors should be paying close attention to Buffett's actions and commentary, is that the Oracle of Omaha may not see anything of value to buy.
To be clear, even though Buffett has preached the value of long-term investing, he, like the rest of us, still wants to get a good deal when investing in a company. After all, there's a big difference between taking a minority stake in a multibillion-dollar business and shelling out $40 billion, or even $100 billion, to acquire an entire company.
With the exception of taking a 38.6% stake (worth nearly $2.8 billion) in Pilot Travel Centers, the owner of the Pilot Flying J truck stop, in 2017, it's been three years since Buffett acquired a 100% stake in any company. The last time Berkshire Hathaway went three years without an encompassing acquisition was between 1992 and 1995. The fact that Buffett and his team haven't pulled the trigger after three years may suggest their leeriness toward current stock valuations.
As evidence, I turn to the Shiller price-to-earnings ratio of the S&P 500. This particular P/E ratio is based on the average inflation-adjusted earnings from the previous 10 years. Its current reading of 33.1 is higher than on Black Tuesday during the Great Depression, and only topped by the dot-com bubble at the beginning of the century. By all estimates, the stock market looks to be frothily priced, and that might be persuading Buffett and his team to holster their cash.
The question we have to ask as investors is this: Does Buffett's willingness to invest a few billion in a handful of stocks here and there outweigh the company's unwillingness to make acquisitions? If it doesn't, it could be a warning that rougher times lie ahead for the stock market.