Is Buffettism a bad thing for us? And to start with what the heck is Buffettism ?!
Earlier this week, the Financial Times published an article by Robin Harding, the paper’s Tokyo Bureau Chief, which claims Warren Buffett has broken American capitalism thanks to his desire to buy high-quality businesses, that have little competition and don’t take excessive risks.
The article claims that the “beating heart of Buffettism ” is to “avoid competition and minimise capital investment in the real economy.” Corporate America has taken these lessons to heart. Recent studies from Economists Jan de Loecker and Jan Eeckhout, as well as Germán Gutiérrez and Thomas Philippon, show a rise in corporate markups, a measure linked to profit margins, from 18% in 1980 to 67% today, while investment has fallen relative to profitability.
You can’t argue that Buffett is the sole driving force behind these trends, but he’s certainly had some influence.
- Warren Buffett Berkshire Hathaway CEO On CNBC [FULL ..
- The Buffett Series - Buffett on Book Value
The bad side of Buffettism
Kraft Heinz is the perfect example of the Buffett effect. The company, acquired by Buffett and private equity managers 3G, has cut costs to the bone driving up the group's operating margin to 24.7% -- nearly the highest in its industry. Seeing how lucrative this opportunity has become for Buffett, shareholders of Unilever and Nestlé have pushed for the respective company managements to adopt the same approach (operating margins 16.4% and 14.7% respectively).
Nestlé announced a share buyback program worth up to $21 billion just days after activist investor Daniel Loeb took a stake in the company. The group aims to gear up its balance sheet to fund the buyback targeting a ratio of 1.5 times net debt to earnings before interest, tax, depreciation, and amortization in 2020, almost double the 0.8 times at the end of 2016. Meanwhile, Unilever is targeting $6.9 billion in cost savings and a 20% underlying operating margin by 2020.
Even though these actions benefit investors in the short-term, the long-term impacts are unclear. Cutting costs and levering up the balance sheet might seem like a quick fix, but numerous studies have demonstrated the precedent that cutting costs by cutting people can have longer-term, damaging effects on company performance, in addition to the negative consequences for employees and their families. Once again, Kraft Heinz is the perfect example. The firm's sales have declined in five of the past six quarters as its owners target aggressive cost savings of $1.7 billion by 2018. Profits and margins continue to rise, however.
That being said, not all of corporate America has signed up to Buffetology, there are still risk takers and innovators out there. According to the National Science Foundation’s National Center for Science and Engineering, total spending on R&D reached $499 billion in 2015, an all time high and business spending surged, and the government pulled back. Of total US R&D in 2015, companies funded $355 billion, or 69% while the federal government, the second-largest funder of US R&D, sponsored an estimated $113 billion, or 23% of the total -- the lowest share since 1953.
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