How Berkshire Hathaway Could Use Its $144 Billion

Warren Buffett's most recent letter to shareholders reminded investors of the discipline he and his investing team at Berkshire Hathaway apply to their work each day. And while there's nearly $150 billion in cash on the balance sheet, Buffett still hasn't pulled out his famed "elephant gun" just yet.

In this podcast, Motley Fool analyst John Rotonti discusses:

• His top takeaway from the letter.
• Buffett's praise for Apple CEO Tim Cook.
• The case for Berkshire Hathaway buying semiconductor design company Arm Limited.

Motley Fool analyst Dylan Lewis and Motley Fool contributor Jason Hall discuss two unexpected companies that are winning due to higher inflation.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 3, 2022.

Chris Hill: Today we've got two hidden winners from higher inflation and a stock pitch for Berkshire Hathaway. Mr. Buffett, thank you for listening. Motley Fool Money starts now. I'm Chris Hill, joined today by John Rotonti. Thanks for being here.

John Rotonti: Hey, Chris. I always love being on the show.

Chris Hill: Yesterday Bill Mann and I talked a little bit about Berkshire Hathaway, the most recent report. I wanted to delve a little bit more into it because it did get a decent amount of attention in the financial community as Warren Buffett and his letters usually do. Let's start with that. What was the highlight of the letter for you?

John Rotonti: The highlight of the letter, which is nothing new, but he did emphasize it again, is that Berkshire has $144 billion of cash on the balance sheet, and the reason it's there is because the business generates a lot of free cash flow every year, and he said that he finds nothing that excites them right now, at least not in meaningful amounts, and so he can't find any businesses that he wants to buy out, and he can't find any stocks that he wants to take meaningful positions in either. So that cash just builds. It's got 144 billion. Then related to that, Chris, is the idea that he has found an alternative to making acquisitions or investing in stocks, and that alternative that he's happy with, but it is not his first choice, is to buy back Berkshire stock. In the two years, through 2020 and 2021, Berkshire spent $52 billion repurchasing about 9 percent of the shares outstanding and that has great effects on the economics of the business. One of the ones that he called out was that that actually increased the float per share by 25 percent over those two years. It is adding real per-share value. It's not his first choice, but it's a good alternative when Berkshire stock is trading at a discount to what Warren Buffett and Charlie Munger believe to be a conservative estimate of intrinsic value.

Chris Hill: Do you think his first choice is buying a business outright, or is his first choice finding essentially the next Apple? We can get into Apple in a second, but finding the next Apple for their portfolio?

John Rotonti: It's easier to find stocks trading at a discount on the public markets because, when you buy a company outright, there's always a premium that you pay, 30-40 percent, for example. So it's easier to find bargains on the stock market, but I think, all else equal, if he could find a bargain and purchase a business outright, that would be his preference. He has said that he has got his elephant gun ready, meaning that he's got the 144 billion in cash. Now, he won't use it all. He says that they will always keep a minimum of 30 billion, but that still leaves a 115 billion or so for him to make an acquisition, 114 billion, if I do the math in my head. A hundred and fourteen billion, he could spend on an acquisition, that's just using cash. But of course, Berkshire is an incredibly resilient business with a massive balance sheet. If he wanted to, they could take on a little debt as well. This is just my analysis. I think the upper bounce is Berkshire could make a $150 billion acquisition if they really wanted to while still maintaining at least $30 billion of cash on the balance sheet.

Chris Hill: One of the things about Warren Buffett that I think is a great lesson for all of us as investors is, if you look at his career, and while he has been grounded in some value-oriented principles for decades, he, as an investor, is still learning. He's still evolving as an investor. When I think about the, I'm trying to think of a not-terrible adjective, let's just say the 3G Capital, the deal for Kraft that just didn't go the way he wanted it to, I look at that, and I think, even in his advanced years, he's learning. I'm not doing this again. I'm not [laughs] going this route against. So when we think about what is he going to do with that cash? I think it's safe that he's not going to be going the route that he did before.

John Rotonti: I would agree 100 percent with that, Chris. He admitted that they paid too much for Kraft Heinz and that company is run with an efficiency-first model where they do zero cost budgeting. They try to cut costs to the bare bones. It can lead to good business economics, but it doesn't always lead to the best workplace culture and workplace environment. I don't think that's necessarily his first choice for the type of investment he wants to make.

Chris Hill: Two more things from the letter and then we'll move on. First, he had a lot of praise for Tim Cook.

John Rotonti: [inaudible 00:05:37]

Chris Hill: If you think about how that initial purchase of shares of Apple has grown over time, how they've added to that over time, I hear what you're saying about the all-in acquisition, but I don't know. I feel like if you could bet on one, it seems like the safer bet, the more likely bet is that they go out, and it seems crazy to say, they find another Apple. They find [laughs] another great business with a great leader at the top, and they say, we want to be part of this.

John Rotonti: I think so, Chris. Like I said, you have more frequent opportunities to find great companies trading at discounts in the stock market when you are buying a percentage of a company than when you're buying a whole company. You have to pay a premium for that whole. Apple is a one-of-a-kind business. I don't throw that phrasing around lightly. It's one of a kind because it's fully vertically integrated. They are experts at both hardware and software, as well as everything that goes in between, so the design, the supply chain, the operations. Apple has become one of the greatest semiconductor design companies on the planet, and they did so very quietly. Because of that vertical integration and that ability to excel at both hardware and software in a way that no other company on earth has shown that it can do, Apple is the greatest free cash flow generation company the world has ever seen. Buffett was able to buy stock in the company when it was trading at a discount to the market multiple. It was trading at a below-market multiple. I don't know if it's a once in a lifetime, but it's a once in a generation, once in a decade, or maybe even once in a two-decade type of investment that Buffett made. It was incredibly successful. It's going up more than 5X, and now it's $160 billion position. If I had to guess what the next company would be, like I said, it's really hard to find another Apple. I'll tell you, Chris, I wouldn't be surprised, hear me out here, if Virtue was to buy Arm out of the UK. 

Arm, it's the company that Nvidia tried to buy, but it was blocked by regulators, so Nvidia dropped their quest to buy Arm. They were going to buy it for about 40 billion. Berkshire could afford this easily just from cash on the balance sheet. It's based on the UK. They're a semiconductor and IP company. They make the instruction sets that power 90 percent of the world's smartphones. If we just think about sticking with smartphones, which obviously Buffett understands because of his investment in Apple, they could buy Arm. SoftBank is now trying to IPO Arm. The reason it got blocked by regulators is because their business model has [inaudible 00:08:58] to be neutral to sell to anyone. But if it was owned by Nvidia, regulators didn't think Arm would be able to remain neutral. Under Berkshire, Arm could remain neutral. Berkshire could get it for 40 or 50 billion, somewhere around there, and two last things, it sells this mission-critical software and technology that runs 90 percent of the world's smartphones, and it's got a recurring revenue, recurring cash flows, the types of economics that Berkshire really likes. So I think they should take a look at Arm. Then lastly, that would further build out the technology investments within that Berkshire Hathaway portfolio.

Chris Hill: I just think of all the times that Jason Moser has banged the table for Berkshire Hathaway to buy McCormick, the spice company.

John Rotonti: Why not? Sure.

Chris Hill: Why not? But you make a pretty compelling case for Arm, the quote making the round for those who didn't read the letter. We're not stock-pickers. We're business pickers. You almost don't even need to read the letter to take a benefit from that. To me, I read that line, and I thought, "Yeah, right, that's a good reminder in a market of increased volatility. Yeah, focus on the business, worry less about the stock."

John Rotonti: Even at the Motley Fool, we've learned from Buffett and some others that speak in that language, we consider ourselves on the Investment team here at The Motley Fool business analysts. Not stock analysts, not market analysts, not traders, but business analysts. We really spend 90 percent of our time trying to understand the business and understand what that business will look like over a long period of time, and then we do spend time at the end trying to value that stock. But most of the time is understanding that business.

Chris Hill: Before I let you go, I would be remiss if I did not mention the fact that the last time you were on the show, we talked about Ford Motor. This was over a week ago, Ford Motor and the possibility of CEO Jim Farley splitting off the electric vehicle part of the business, and sure enough, Wednesday morning, that's exactly what happened. I just keep thinking about the conversation we had and your statement that the others are going to follow suit. It's just like, Mary Barra at General Motors, your move.

John Rotonti: Your move. Over to you, Mary. Exactly. I just think it makes sense. Forward stock traded up on the news, I don't know if it's seven or eight percent on the day. I do think it's a way to highlight the great things these companies are doing from an EV standpoint, and that could lead to the market rewarding these companies with higher multiples. In that, higher multiple allows them to raise capital more easily. It allows them to compete with Tesla on a more equal footing. It's not equal yet. Tesla has a lead here. Let's call it what it is, but it would allow them to compete with Tesla on a more equal footing. Yeah, I think the next part of this prediction is that the other companies follow suit.

Chris Hill: John Rotonti, great talking to you. Thanks for being here.

John Rotonti: Thank you, Chris. Thanks, Fools.

Chris Hill: All the talk lately of higher prices has investors asking which companies can thrive with inflation on the rise? Companies with pricing power, of course, but who else? We'll look at two unexpected beneficiaries of higher inflation. Here's Dylan Lewis.

Dylan Lewis: You know how inflation affects the broad economy and your wallet, but inflation's effect on individual companies, to understand that, we have to dig a little bit deeper. Jason Hall joins me to talk through some of the characteristics of companies that keep winning even during periods of inflation. Jason, at a very simplistic level, as a business, to be able to comfortably weather periods where things are becoming more expensive, you need to have one of two things working for you. Either upside in the price you charge for something, or control over the cost you pay for things. If you can get both, that's even better, but you really need one of those two things to be in the driver's seat.

Jason Hall: Absolutely. Of course, we're talking about pricing power, the ability to raise prices for various reasons, then, of course, to [inaudible 00:13:52] cost advantage, that you're actually paying for the inputs to make whatever it is that you're selling. I think sometimes, honestly, Dylan, your typical inflation environment where costs go up 1-2 percent, 2.5-3 percent a year, maybe sometimes we project a little bit there, and we find a company that we love, and then confirmation bias kicks in, and we maybe assign a little bit of these advantages, and maybe they're not real. Can it really raise prices at will? Does its scale really add up to those true cost advantages? Are they really durable? I guess that's what I'm thinking because it's really easy to pick a big profitable company. Sometimes the pricing power or sometimes the cost advantages, maybe they're not really as durable as we expect.

Dylan Lewis: We often think about pricing power through the lens of major consumer brands, like Chipotle, like Starbucks. We've talked about it a lot on the show. The loyalty allows them to charge more, but it's an active decision that the customer is going to see those higher prices, is going to see that they're paying more every single time they're getting that product. There are businesses that structurally have pricing power built into the relationships that they have for their customers in a way that I would argue is maybe a little bit more durable than those everyday purchases that consumers are making when we're often talking about pricing power.

Jason Hall: Starbucks is a great example. We've certainly seen that they do have the ability [laughs] to raise prices. But customers also have the ability to consume less of that product. One of the risks with these consumer discretionary companies, like Starbucks or Chipotle, if we get to a point where everything else becomes so expensive, these are the first things that come off the list of the splurge or the spend. That's a risk with those businesses. The ones that really have those advantages are the ones where the buying partner doesn't really have another choice. That's where pricing power is really powerful.

Dylan Lewis: What do you think is a good company that does a good job of illustrating that?

Jason Hall: One that I really like is Mastercard. I'm a shareholder of Mastercard for a long time. It wins because of just the reality of its entire business model. It's all about activity. This is a tollbooth of a business as we get. It makes money every time a consumer buys something and that transaction goes on Mastercard rails. You go to a store, you pull out your Mastercard. You go to your favorite e-commerce website, you make a purchase, and it goes across the rails, the majority of their revenues or a percentage of that transaction. What that means is that this is a company that deal and literally benefits from high inflation because, in inflation, if something costs 10 percent more than it did a year ago, their revenue just went up 10 percent. That is incredibly powerful because they have a captive audience, and they are able to capture that right off the top.

Dylan Lewis: Those are those interchange fees that we hear so much about when we're looking at the credit card companies. It's a very different model than having someone pay a set fee basically or a regular purchase price for something that's a set amount of dollars rather than a percentage of this value that is changing and actually moving up because of inflation.

Jason Hall: Absolutely. The thing to me that's the most compelling about Mastercard here is that their benefit isn't the pricing power side. It's the cost advantage. Think about Starbucks. Typically, if they raise their prices, generally in this environment, what are they trying to do? They're trying to pass along higher labor costs. They're trying to pass along higher transportation to get the beans, and the cups, and all that stuff into their stores. They're not necessarily trying to make more profit off of it. They are just trying to cover their expenses. Mastercard's expenses are relatively low, and they're relatively fixed. It's dealing with labor pressure like everybody else, but it has a very highly skilled labor force, and it's more about trying to retain the best minds versus just stuff at stores. I want to give you some stats that just jumped off the page at me for Mastercard. If you look at Mastercard going back to 2010, its gross margin has generally been between 75 and 80 percent every year. That's a great gross margin. Its operating margin since 2011 has never been below 50 percent. That's just incredible. Just as a comparison, Starbucks gets, in its business, great operating margins at around 16 percent, compared to 54 percent over the trailing 12-months for Mastercard. That's a cost advantage.

Dylan Lewis: You build out that network and then you get to benefit from that network over time. That's a huge part of really why that business is as dominant as it is. I think there's a little bit of a recurring theme with some of these durable businesses. I know another company that you wanted to talk about was BIP, that's Brookfield Infrastructure Partners.

Jason Hall: Exactly. Brookfield Infrastructure Partners. Now, there's actually two tickers. I want to hit this real quick. There's Brookfield Infrastructure Partners, which is a limited partnership, and then there's Brookfield Infrastructure Corporation, BIPC. For our purposes, they're the same thing. They're identical economic interest in the same business and that business is very powerful. We call Mastercard a tollbooth business in maybe a metaphorical sense because it's a tollbooth for transactions. Brookfield Infrastructure is like literal tollbooths. So that's a business they actually use to operate. But now they have these businesses like telecommunications, so think about fiber optics, think about pipelines, made massive investments in literal pipelines, moving energy commodities around, electricity transmission, all of these businesses where they collect a fee, generally based on the movement of whatever that commodity is on it, whether it's data or whether it's oil or natural gas or electricity. So they collect, again, that tollbooth fee that they bring in.

This is a perfect example of their customers having one choice, and that one choice is that local monopoly that is the asset that Brookfield Infrastructure owns, or because of just the very high barriers to entry into building that asset billions of dollars to build a transmission line, ACME is not going to build one right next to it to compete. So you have that one choice, and that's very powerful. Then my favorite thing about the way that these sort of businesses work is, so you take that competitive advantage of it's the choice, you have to move your commodity to get it to your market, and then you structure your contracts if you're Brookfield so that, when inflation happens, your prices go up with the charge. Again, Mastercard, now it's not the same again, because Mastercard has as really high operating margins. The difference with Brookfield is most of its costs are capitalized. It's the infrastructure itself, it's the bricks, and mortar, and the steel pipes, that kind of stuff. It's not labor costs that necessarily flex up and down. They are higher, but again, they're relatively fixed. So inflation doesn't necessarily make its costs go higher. So when inflation happens, and it's able to raise its prices a little bit, a lot of that does come to the bottom line, and that's pretty powerful.

Dylan Lewis: Something I think is interesting with a company that is so capital-intensive, and we lose sight of this sometimes when we're talking about inflation, is usually when we're in an inflationary environment, you tend to see interest rates go up. That's one of the central banks' main ways to keep inflation in check. What does that mean for industries that have relatively big build outs in order to build the business? It means that if you're borrowing money to do that, the cost of borrowing that money is going to go up over time as well. So anyone who is structured in a very capital-intensive business, or even homeowners, really, because they have their mortgage payments locked in at a certain interest rate, are going to enjoy cost-savings that newer competitors aren't going to be able to enjoy.

Jason Hall: For a business like Brookfield, so its sponsor Brookfield Asset Management is this massive alternative asset manager that's been around for three decades and has a very long track record of navigating inflationary environments, geopolitical environments, interest rate environments, and you build a structure, and you have a process so that you're really focusing on return on capital. That's one of the most important metrics that you look at. So you're thinking about changing interest rate environments. Number 1, you make sure you're the guy that always has money when nobody else does. You have access to money, and you build a business so that you can benefit when others are in that position. As we see rising interest rates, and return on capital start getting squeezed for these kind of businesses because the cost of money goes up, Brookfield is going to be the company that we're going to see that's buying assets at a lower multiple, taking advantage of that market, even though its cost of capital may be higher. As a buyer, when it can buy at a lower multiple, it's still able to generate those high returns for its investors. It's an amazing boring business that people ignore that has crushed the market since it existed.

Dylan Lewis: Jason, as is often the case, when we're looking for companies that tend to thrive during blank, you could fill in whatever blank you want there, it could be inflation, it could be high interest rates, it could be geopolitical risk, it could be stay at home, they tend to be quality businesses that are in a position to control their own destiny. That comes from financial fortitude. I think as an investor, these are just a couple of reminders that it's worth digging into how the top-line manifests itself for business and how much control a company really has over its cost.

Jason Hall: There's no doubt about that. I think one of the things that we've seen with this growth stocks sell off over the past year, Dylan, is that so many of those businesses are burning cash. There are some that they're not profitable on a GAAP basis, but they generate positive cash flow. Those are the ones that are going to make it. The ones that are burning cash are the ones that are going to get squeezed out of existence because they don't control their destiny. That's such a differentiator for these sorts of businesses because, like I said, you want to be the guy that has money when nobody else does. You want your phone ringing. You don't want to be the one having to make the call to somebody else. These are perfect examples of that. One thing I want to point out with these two, I think is important to remember too, is that there's a big difference between Mastercard and Brookfield besides all of the obvious, but that's in the risk factors. Brookfield moves data, moves power. All of those things are largely recession-resistant. So if we see this inflationary environment start to affect consumer spending, Brookfield is the business that's going to be the less affected by it. Mastercard wins today from inflation, but if that inflation leads to a recessionary environment, it quickly becomes a loser. So I think that's an important differentiator to make as an investor thinking about the near-term implications. These are both long-term winners, but I think just being aware of those dynamics is really helpful.

Dylan Lewis: On top of all the financial stuff we just talked about with the top-line and costs, I think it's important to remember, where does this money spend fit into the overall picture for whether it's an enterprise customer, if you're a software provider or an end-consumer, if you're a consumer-packaged brand like Starbucks or Chipotle?

Jason Hall: If your buyer can actively make a choice to stop buying from you on a moment's notice, that's a risk that's really important. So if you talk about those software companies selling to enterprise, the ones that have the long-term contracts and that recurring revenue, those are the ones to really focus on. The ones that have the short-term contracts where customers can walk away quickly, unless they're really sticky, they're really embedded, like Shopify, maybe there's a risk there that you don't even see. So it's always important to flip to the next page in that filing and start reading into some of those business risks.

Dylan Lewis: I'm always happy to flip through the next stage with you, Jason. Thanks so much for joining me in today's show.

Jason Hall: It's always fun, Dylan.

Chris Hill: As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.