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Kass: Buffett's Moats Are Breached

I start almost every column I have ever written about Berkshire Hathaway (BRK.A)/ (BRK.B) with the sincere message that, similar to many investors, I worship at the investment altar of Warren Buffett and Charlie Munger. But that adulation doesn't preclude me, as an investor, from questioning their and the company's direction/strategy nor does it inhibit me from being short Berkshire's stock (which I have been over the last nine months).

  • Recent earnings reports at Coca-Cola (KO) and IBM (IBM), two large Berkshire Hathaway investments totaling almost $30 billion, suggest that the companies' moats appear to be vanishing.
  • Healthier drink choices and the penetration of the cloud seem to have weakened the previously seen moats and have damaged the profit results at Coca-Cola and IBM.
  • In the past Warren Buffett has hunted gazelles (that are undervalued); he is now hunting elephants (that are fairly valued to overvalued).
  • I remain short Berkshire's shares.

Last year Warren Buffett labeled me a "credentialed bear" and invited me to ask some hard-hitting questions at Berkshire Hathaway's annual shareholders meeting. I did quite a lot of research in preparation for that day, and I think that is what Warren expected of me and why he invited me.

It was important for me to balance my hard-hitting and pointed questions with a courteous and respectful delivery, considering the extraordinary accomplishments and the respect we all have of the men that I was addressing and the unique invitation to a short seller who was negative on their company. Initially, each of my original six questions was far too lengthy (500-1,000 words). Given the setting and Warren's crafty ways of answering questions, my mission was to condense each into a tightly worded question.

Upon reflection, I was pleased with the questions as well as Warren and Charlie's responses -- my mission was accomplished.

Question No. 1 -- Size Matters

Q: As it is said, Warren, "Size matters!"

In the past, Berkshire bought cheap or wholesale -- for instance, Geico, MidAmerican Energy, the initial Coca-Cola purchase and Benjamin Moore. Arguably, your company has shifted to becoming a buyer of pricier and more mature businesses -- for instance, IBM, Burlington Northern Santa Fe, Heinz (HNZ) and Lubrizol, which were done at prices to sales, earnings and book value multiples well above the prior acquisitions and after the stock prices rose.

Many of the recent buys might be great additions to Berkshire's portfolio of companies, however, the relatively high prices paid for these investments could potentially result in a lower return on invested capital. In the past you hunted gazelles, but now you are hunting elephants.

To me, the recent buys look like preparation for your legacy, creating a more mature, slower-growing enterprise. Is Berkshire morphing into a stock that has begun to resemble an index fund that is more appropriate for widows and orphans rather than past investors who sought out differentiated and superior compounded growth?

In the past, you have quoted Benjamin Graham, saying "price is what you pay -- value is what you get." Are your recent deals and large investments bringing Berkshire less value than the deals done previously?

A: Warren admitted that Berkshire won't grow as rapidly in the future as it has in the past but it will still generate a lot of incremental value. "We think we will do better than the giants of the past," he said. Charlie chimed in and said much of the same. Warren then exclaimed, "Doug, you haven't convinced me to sell the stock, but keep trying!"

-- Doug Kass, "My Berkshire Q&A Recap"

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