Susan Decker’s recent panel discussion comments pointed out some of the magic behind Berkshire Hathaway’s returns. There is nothing new for Berkshire followers and investors, except the tax-free comment that Decker made got me thinking. Buffett’s baby is simple conceptually (i.e. float-supported — Decker didn’t mention float, by the way — with cash flow rich capital allocation to, and flow back from, operating subsidiaries and portfolio securities) and has performed brilliantly in terms of the annual and cumulative profits/investment returns achieved. See’s Candies is one heck of an example (see the BBB link below).
Taxes or a lack thereof have played a key role in enhancing returns and additional investments for Berkshire. An enviable virtuous cycle. Dividends paid to a parent company by 80% or greater owned subsidiaries are not taxable. This is huge for Berkshire, which also pays a reduced tax on dividends from portfolio investments (only 30% of distributions are taxable; 40.5% taxable apparently for distributions received an insurance company). Something interesting I came across is past controversy surrounding Berkshire’s issuance of debt to purchase income-producing securities — i.e. a company, from the IRS’s standpoint, should not be able to deduct the interest expense on debt and also pay the reduced corporate dividend rate. Insurance float in itself has been even better than interest-free for Berkshire (since premiums received often exceed claims AND underwriting expenses) and float is also tax beneficial when it comes to tax-deferred unrealized gains.
Buffett/Munger have long favored low-capex, high-ROE/cash flow yielding businesses. See’s, again, is an exceptional case with such low-capex (new stores are less than $300K to setup; and hence limited depreciation) and high-profitability (thanks in part to low overhead). It doesn’t seem like Buffett/Berkshire is interested in any lease-backs or other schemes and apparently has See’s send the excess after-tax CFs straight up. It is interesting, however, to note the matter of hard asset scale and corresponding capex depreciation as concerns the wholly-owned Berkshire Hathaway subsidiary, BNSF, for example. Deferred-tax float has become a significant and increasingly important source of investment capital for Buffett/Berkshire.
Considering the “magic” …, that any sort of “conglomerate discount” has been applicable to Berkshire Hathaway (BRK.A, BRK.B) is almost absurd. It’s a little easier to accept that there are often equity discounts for companies like Leucadia (LUK) and Loews (L), which are far less diversified and more cyclical in composition (not to mention more frequently involved in spinoffs and liquidations), though I am appreciative for the availability of discounted shares. Also, Loews is at least a longtime and meaningful purchaser of its own shares; no comment on its majority-owned CNA Financial (CNA). Handler and co. at Leucadia might have something to learn from the Tisches when it comes to share buybacks. Meanwhile, I am intrigued both by Leucadia’s string of investments since the Jefferies merger and Loews’ opportunistic, counter-cycle approach to acquisitions.
The following is an excerpted Susan Decker comment from the Monday, December 8th event at Stanford University #corpgov center: Berkshire Hathaway post-Buffett (see ValueWalk); Larry Cunningham, author of Berkshire Beyond Buffett, was a key event organizer.
“The magic of the returns has been in this collection of businesses, some of which generate more cash than they need, and others of which have attractive investment opportunities for that capital, like Burlington Northern and a few others. Berkshire Hathaway can transfer excess capital from businesses that don’t need it to businesses that do need it, tax free and in a way that enhances compound annual growth rates,” Decker said. (San Francisco Business Journal)