Buffett/capital allocation: Berkshire’s cash earns big interest while deal hunt continues

The US Securities and Exchange Commission wants to require US-listed companies to explain their share buyback philosophies more clearly to their shareholders. Warren Buffett has already done so, at the multi-billionaire investor’s Berkshire Hathaway annual shareholder meeting in Omaha.

He and his partner Charlie Munger fielded questions as usual about Berkshire’s capital allocation choices. For the first time in more than a quarter of a century, however, US base interest rates have rocketed to more than 5 per cent. Despite the usual questions about what to do with Berkshire’s cash balance — now up to $131bn — the opportunity cost on deploying that cash was finally meaningful.

Buffett notably said he believed that Berkshire shares were cheap. That might confuse the average investor given that its market capitalisation of more than $700bn exceeds by about 40 per cent its book value or accounting value of equity. Nevertheless, in the first quarter, Berkshire bought back $4.4bn of its stock.

Sure, he said, he would love to buy a $50bn to $100bn business. But public company processes are often time-consuming and excessively competitive on price. He prefers opportunistic rescue financings or investments in the $5bn to $20bn range, such as with Occidental Petroleum in 2019.

His much-vaunted “float” from Berkshire’s insurance segment now totals $165bn. This cash from premiums paid is essentially free for it to invest, and is stable relative to bank deposits, an apt comparison this year. Meanwhile, Berkshire remains so well-capitalised, it should absorb any property and casualty claims from its customers.

Note that Berkshire’s stake in Apple, about 6 per cent ownership of the company, is worth $155bn. The iPhone maker recently announced a $90bn buyback, which contrasts with Buffett’s almost religious zeal to retain profits and cash flow to invest later.

Instead, his investors still get no dividend and just a modest buyback. They must accept Berkshire passively earning 5 per cent risk-free on its cash.

Simplistically, that reflects just how low a multiple is needed to pass muster for a deal. Take the reciprocal of that 5 per cent and 20 times earnings is the rough break-even purchase price to beat those cash returns. Above that multiple and the deal is not worth it. Berkshire’s big game hunt could continue for some time.