Warren Buffett is the greatest investor of his generation, if not of all-time. His unparalleled investing acumen transformed Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) from a sleepy textile manufacturer into a $285 billion conglomerate consisting of some of the greatest businesses on earth. No other person – not even Charlie Munger – added anything close to the value that Buffett added to Berkshire.
However, as the enormous holding company grows ever larger – it is the fifth-largest public company in the world as measured by market capitalization – each additional investment Berkshire makes becomes less and less important to the intrinsic value of the overall company. As investors scramble to determine the impact of the 83-year-old Buffett's inevitable departure, one has to wonder if he still adds significant value over that of a capable successor.
No, Buffett has not lost his skill
Before addressing the main argument – that Buffett is no longer a critical component of Berkshire's intrinsic value – I want to eliminate any possibility that readers think I'm saying Buffett is not as good as he once was. On the contrary, he's better than he has ever been.
The headlines that will persist from now through the annual meeting will be some variation on Berkshire's book value growth not keeping pace with the S&P 500 for an extended stretch since Buffett took over in the 1960s. For years, Buffett has warned that future returns will not be as good as past returns because of the difficulty of finding enough high-return investments to deploy ever-larger sums of cash. However, until now, he has always grown book value faster than the S&P 500 over long stretches.
All of the headlines may make some investors believe they would be better off investing in an S&P 500 index fund than investing in Berkshire – but they would be wrong. The comparison of Berkshire's book value to a QE-fueled bull market is unfair. If you move back to before the financial crisis, Berkshire has outperformed. This period represents a full market cycle, or close enough to it, and is therefore a better measure of Berkshire's performance.
There is countless other evidence that Berkshire is still prospering under Buffett, but it all leads to the same conclusion: investors would rather have Buffett at the helm than anyone else.
Buffett is not as valuable as he once was
In Berkshire's early days, most of its cash was invested in publicly traded securities rather than operating businesses. Now, Berkshire's investment portfolio makes up less than one-quarter of its $484 billion in assets.
But even that proportion is misleadingly high. Buffett has intimated that Berkshire's top four investments – Wells Fargo, Coca-Cola, American Express, and IBM – are permanent holdings. He outright said that he would never sell a share of Coca-Cola and, if history is any guide, he will only add to his holdings in the other companies. Buffett is a buy-and-hold forever investor; he unloads stocks only when they are no longer great businesses that can compound money at a high rate over a long period of time. As a result, the $65 billion market value of the top four holdings should be treated as wholly owned subsidiaries.
This knocks Berkshire's equity portfolio down to just $52 billion. Todd Combs and Ted Weschler each manage at least $7 billion, which leaves Buffett managing $38 billion – a mere 8% of total assets.
Of course, Berkshire's insurance subsidiaries write billions of dollars in premiums each year that must be invested, but the bulk of Berkshire's book value appreciation comes from the operating subsidiaries – not the investment portfolio.
Management style removes Buffett from equation
By now, most investors are familiar with Buffett's hands-off management style. Mutual fund manager and longtime Berkshire shareholder Larry Pitkowsky explains:
Part of his genius is that he's created a hands-off culture that encourages entrepreneurs to sell their private companies to Berkshire, and they keeping showing up for work every day without worrying that they are going to get a call from headquarters telling them how to run things.
Managers like Buffett because he does not get involved in their businesses. Except when managers seek his advice, Buffett's primary interaction with Berkshire's subsidiaries is in allocating capital. Properly distributing capital among the subsidiaries is an important task, but it is unlikely that a capable successor will perform materially worse in this capacity. Many of Berkshire's subsidiaries have a long history of stable returns on capital, making the successor's task easier than it may be at other conglomerates.
Moreover, post-Buffett Berkshire will still have its conservative culture, allowing it to provide liquidity – for a price – to distressed companies at opportune moments. Although Berkshire's crisis-era investments in Bank of America, Goldman Sachs, and General Electric were given the Warren Buffett Stamp of Approval, Berkshire's practice of holding ample cash reserves should enable it to score similar deals during future crises.
Since taking control of Berkshire in 1965, Buffett has grown book value per share at a compound annual rate of 19.7% -- that's 9.9% better per year than the S&P 500 over nearly five decades. It is unlikely any other person will accomplish that feat again – including Buffett.
Berkshire Hathaway is no longer reliant on Buffett's uncanny investment acumen. Instead, most of Berkshire's value is derived from operating subsidiaries that require little direction from the front office. As a result, Buffett's presence does not add as much value as it used to – and his departure will not put a huge dent in the stock's intrinsic value.
Unlike Steve Jobs, Warren Buffett built a company that can endure without him. Shareholders should rejoice.