A Response To The Economist’s Hatchet Job On Warren Buffett And Berkshire Hathaway by Whitney Tilson,
The Economist’s recent article about Warren Buffett and Berkshire Hathaway is completely wrong-headed.
The article concludes that “he is far from a model for how capitalism should be transformed.”.
Buffett, both as a person as well as a CEO, is an exemplar and The Economist should be celebrating, not criticizing, him.
The Economist recently published a highly critical article about Warren Buffett entitled The other side of Warren Buffett: An investing hero is not a model for how to reform America's economy, which concludes that "he is far from a model for how capitalism should be transformed." As an investment manager who has owned Berkshire's (NYSE:BRK.A) (NYSE:BRK.B) stock personally and professionally for more than two decades and who has attended every annual meeting over that period, I am confident that nothing could be further from the truth: the U.S. and global economy would be far better off if every CEO had Buffett's integrity and skills as both an operating manager and capital allocator. Companies would invest for the long run without any consideration for beating quarterly "whisper numbers"; they would no longer take on reckless amounts of debt; they wouldn't waste corporate cash on top-of- the-market share buybacks and mindless acquisitions pursuing non-existent "synergies"; ethical scandals would be a thing of the past; overcompensation of top management would cease; corporate waste would diminish; and shareholders would be treated fairly. Who wouldn't want this?
Regarding the specific critiques in the article, most are far off base:
- The most damning and wrong-headed charge in the article is that Berkshire doesn't pay its fair share of taxes: "Berkshire's tax payments have shrunk relative to its profits. Last year the actual cash it paid to the taxman was equivalent to 13% of its pre-tax profits - this is probably the fairest measure of its burden-making it one of the lightest taxpayers among big firms."
This is a highly misleading statement (made worse by the chart accompanying the Economist article) for a number of reasons:
- In 2015, Berkshire's "Earnings before income taxes" were $34.9 billion and "Income tax expense" was $10.5 billion, equal to a 30.1% tax rate. If anything, this is on the high side for large American companies.
True, the cash taxes Berkshire paid were lower, but this is largely because the company invests so heavily in hard assets in industries like railroads and utilities, resulting in a large, tax-deductible depreciation expense (in 2015, Berkshire's cap ex was an enormous $16.1 billion, up from $11.1 billion only two years earlier, and "depreciation of tangible assets" was $6.7 billion). It would be a boon to this country if every company were reducing its cash taxes in this way: by investing heavily in America's future. (This high level of investment is also completely contrary to the Economist's assertion that Buffett focuses on businesses with "low investment needs.")
- Berkshire's cash tax rate was artificially depressed in 2015 due to a $6.8 billion "phantom" gain when the company was required to write-up its investment in Kraft Heinz (NASDAQ:KHC) ommon stock, despite the fact that it didn't sell this position and hence didn't realize any taxable gains. This inflated Berkshire's reported pre-tax income by nearly 25% yet had no effect on cash taxes paid, which therefore reduced, for one year only, Berkshire's cash tax rate, making the Economist's chart highly misleading.
- Berkshire's MidAmerican Energy utility is investing heavily in alternative energy (primarily wind and solar), which qualifies for favorable tax treatment designed to encourage the expansion of clean energy. Berkshire's investment in this area, through which it earns tax credits, is something that should be celebrated, not criticized.
- Buffett's long-term investment philosophy (which the article rightly praises him for) reduces Berkshire's taxes because capital gains taxes aren't owed until an investment is sold and the profits realized. For example, the 400 million shares of The Coca-Cola Company (NYSE:KO) that Buffett has purchased over the years have a cost of $1.3 billion, but are worth $17.5 billion today. As such, Berkshire has a $16.2 unrealized gain, which is part of the $72.2 billion of "income taxes, principally deferred" on its balance sheet as of the end of Q2. These taxes will eventually be paid, of course, but it is in Berkshire's interest to delay doing so as long as possible. Again, the fact that Buffett is investing for the long run is something that that should be celebrated, not criticized.
- Unlike so many other ultra-wealthy individuals and large corporations, neither Buffett personally nor Berkshire as a corporation utilizes expensive lawyers and bankers to find and exploit dubious tax loopholes, often by setting up sham subsidiaries in tax havens. When the Panama Papers were revealed, I didn't even have to look to know that neither Buffett nor Berkshire would be involved in any way.
- The article points out that for one Berkshire investment, a non-controlling interest in Kraft Heinz, the number of employees has dropped by 10%: "Since 3G engineered the merger of Kraft and Heinz (Berkshire owns 27% of the combined firm) last year, staff numbers have dropped by a tenth."
Why is this bad news? If 3G can operate the business with fewer, better managed and more productive employees, this is cause for celebration, not only for owners of the business (which has seen profits soar), but also for society as a whole.
- The Economist rightly decries the following: "Last year S&P 500 firms reinvested only 45% of the cash flow they generated. Protecting margins and cutting costs is the priority. Economic growth suffers as a result."
But Berkshire isn't a company that should be cited to highlight this problem: in 2015, it generated operating cash flow of $31.5 billion and reinvested nearly all of it back into its businesses in the form of cap ex ($16.1 billion) and buying new businesses ($10.2 billion) (in addition, for its investment portfolio, Berkshire acquired a net of $6.0 billion in bonds and $1.5 billion of stocks). Notably, Berkshire didn't spend a single dollar paying out cash to shareholders in the form of either dividends or share repurchases.
- The article correctly argues that "what America needs right now is more risk-taking, lower prices, higher investment and much more competition."
But, again, Berkshire isn't a company that highlights this problem: it is investing heavily in its major businesses, making a long-term bet on the future of America - a course that is certainly more risky than simply paying out its prodigious cash flow to shareholders, as so many other companies do.
As for lower prices, not only are Berkshire companies not known for price gouging, low prices are, in fact, the hallmark of many Berkshire businesses, from GEICO to McLane to Nebraska Furniture Mart to Borsheim's.
- The article claims that Buffett has a "fondness for oligopolies" which is contrary to the need for "much more competition."
Buffett does indeed like to invest in companies with "moats" that protect them from competitors eroding their margins and profits over time. What investor doesn't? But creating oligopolies