Stig Brodersen  1:19  

Jake, on today’s show, you’ll be pitching Berkshire Hathaway. You’ll provide your estimation of the intrinsic value of the company. Though before your pitch, let’s hear more about your investment framework. 

Could you please elaborate on your stock selection process and how it has or hasn’t been influenced by Warren Buffett and Charlie Munger?

Jacob Taylor  1:55  

My investment process is kind of difficult to explain because it tends to be just looking for things that make sense to me. There’s no real Morningstar style box that you can check that says, “Buying things that make sense to me.” 

I end up being very opportunistic and going into a lot of different places, whether it’s just buying outright cheap assets, when they’re available, like a net-net, all the way up to hang up a little bit more for a good company that has good cap allocation and a long runway to redeploy capital at potentially high returns.

Obviously, Buffett early on was a very quantitative-based investor and bought only very cheap things. 

For most of my career, I’ve been more that way. It’s only until recently that I felt a little bit more comfortable paying up for a good culture. 

Where my thinking has evolved into that is one, I think you have to have read a lot and been in the game for quite a while to have the trust in yourself that you can recognize those kind of opportunities. 

The other problem is that it’s very difficult to get to that point in this particular market for me, because it seems like that’s kind of what everyone is realizing recently. Compounders have become very popular, and for good reason. It makes business and investing sense. 

It’s just the prices, I feel like maybe have gotten a little out in front of what might project into good returns for a lot of these businesses. While I recognize it, I’ve been pretty slow to actually implement it, because the price I felt like hasn’t quite been there yet. 

Another interesting thing I’ve been thinking about lately on that front is everyone’s looking for companies that have really high returns on invested capital. I’ve been wondering, if perhaps, that you might be better off looking for ones that are more moderate, maybe like the 10% to 15% range. 

My thinking is that if you have extraordinarily high returns on capital, that is a signal that other entrepreneurs may want to come and compete those away from you, or at least share in some of that high return. 

Maybe at the 10% range, you’re sort of flying under the radar. You’re able to compound for a really long time at 10%, as opposed to a short period of time. Let’s say, 50%.  

The better bet is to take the longer duration. The 10% one most likely. 

I’ve heard Peter Thiel talk about how companies who are actually monopolies don’t advertise it. They’re trying to hide it. 

Google will talk about how they’re only a certain percentage of the entire advertising industry. They won’t frame it as online advertising or search. Even worse, right? 

In the same vein, maybe the better bet is to look for more mid range kind of ROIC and see what you can find there as opposed to the highest flyer ones.

Preston Pysh  4:30  

Jake, on February 22, Buffett sent out his annual shareholder letter. I’m just kind of curious what your key takeaways were from the letters this year. 

Stig Brodersen  4:39  

I thought it was interesting that he removed the book value column for the first time, which kind of tells you how much book value maybe as a metric for Berkshire has decayed in Buffett’s mind. He’s been talking about it for a while, but he finally stopped reporting on that. 

Jacob Taylor  4:54  

You just look at that market value though from 1965 to 2019 at 20.3% return versus the S&P’s 10%. It’s such an amazing testament to doing something right for a really long time and just the obscene compounding that can take place. It’s just truly incredible to actually see it spelled out. 

Look at the float number: 1970, $39 million. Today, $129 billion. It’s absolutely unreal how big Berkshire has gotten. 

Then my last one was it was interesting to see him say that Ajit Jain and Greg Abel will be more involved in the meeting this year, which I think gives us some hints about succession planning. 

I thought it was actually a little bit odd that Todd and Ted wouldn’t be included as much. He didn’t mention them at least. 

Those were my takeaways from this year’s letter, but in general, I would have probably given it an average rating. Other ones I’ve liked more, but anytime you can hear what’s on Buffett’s mind is worth taking a few minutes to read.

Stig Brodersen  5:53  

For someone like you who has been reading all his letters, it is interesting to see how especially the last, say 10 letters, I think he’s given away less and less. I guess that’s how I look at it. There are still good lessons to be learned. 

However, it seems like he’s in a different mode. It seems like he’s a bit more in the legacy cutter mode than he is in the “let me educate you about business” mode. Though it’s definitely worth a read. We’ll make sure to link to that later in the show notes. 

Jake, could you talk to us about Berkshire Hathaway? I know we’re going to talk about the valuation at the end so we’ll get to that. 

However, talk to us about Berkshire Hathaway. How would you outline the business for someone who is not too familiar with the company?

Jacob Taylor 6:36 

In my mind, it’s a supercharged S&P 500. It’s a very US centric bet. Insurance operations are way above average in the industry. Then you have someone doing cap allocation that’s the greatest of all time. Typically, you’re buying it for less than the market’s typical price, due to some kind of a conglomerate discount. In my mind, it’s not a bad plugin, or an S&P 500 exposure, if you wanted that instead.

Stig Brodersen 7:07

Could you talk to us about the five major segments of the business?

Jacob Taylor  7:12

Sure, yeah. You have the insurance operations, which are big. You have a railroad inside of there, Burlington Northern. You have Berkshire Hathaway Energy, which used to be mid-American, and now is growing quite a bit. They put a lot of money to work in both energy and railroads and earn that interesting 10% kind of regulatory return like we were talking about return on capital.  

 

Then you have a marketable securities portfolio of a lot of blue chip companies that are baked inside of there. Then you have what’s called the MSR, which is the manufacturing, service, and retail. 

Those are a bunch of grab bags of different businesses, some bigger, some smaller. All the way down from Precision Castparts, which is making high tech aircraft manufacturing. All the way down to shakes and burgers at Dairy Queen and everything in between. You have the whole swath of the US economy.

Stig Brodersen  8:12  

Let’s specifically talk about the insurance division. The property casualty insurance business has really been the engine propelling Berkshire Hathaway’s growth since 1967. It was the year that both the national indemnity and the sister company, National Fire and Marine… 

Today, Berkshire Hathaway holds 6.4% market share. Their only trailing State Farm as the biggest underwriter in the country. 

The float, as you mentioned before, stands at $129 billion. How do you see Berkshire perform when it comes to market share and profitability in the next decade, specifically for the insurance division?

Jacob Taylor  8:52

I do recognize that they are very disciplined in their underwriting. The data point that I use to back that up is that they’ve underwritten profitably in the 16 of the last 17 years. That’s a pretty good track record, if you know the insurance industry. 

I found it very interesting that it seems like Geico has been a little slow to adopt telematics, which things like snapshot that Progressive has, which is basically trying to figure out how much risk do you actually take while you’re driving? Are you speeding or are you accelerating or slamming on your brakes all the time?

This is surprising to me given Geico’s history of targeting originally government employees. That’s the GE part of Geico. They were looking for populations that had lower risk profiles. 

One way of ascertaining that would be to keep track of how people actually drive and then base their insurance rates on this telematics idea. However, in the plus side of the category for them is that they’ve always had such a bulletproof balance sheet that they’ve been able to underwrite things that no one else would really be able to take on. 

They’ve always operated at one less deal than they could have been doing all along, or one less big insurance underwriting thing. 

Other companies, even in the insurance industry I’ve seen, they’re operating much closer to the full deals that they could do, or even sometimes taking on leverage to do one more deal than they could have done. Then they’re always kind of digesting that deal. 

What it allows Berkshire to do is to use a lot of that float and invest it into equities, which earn quite a bit more than what most people were earning in their floats, all the other insurance companies, because they’ve stayed so far away from the edge of like being bold deal, maximizers and full underwriting capabilities. 

Their conservative nature, in a weird paradoxical way, has allowed them to actually take more risk with their float and their security portfolio.

Stig Brodersen  10:48  

I’ve noticed the thing too about underwriting with a profit of 16 out of 17 years. 

Buffett has been very upfront by saying that he does not expect that to continue happening. You can put a lot of different things into that comment.

Obviously, one is that Buffett always likes to underplay whatever he’s saying. I mean, given the low interest rate level, you would expect for this to continue, at least for quite some time. 

The reason why I’m saying that is given the low interest rate, you’re supposed to underwrite for the profit, because the risk free return you can get elsewhere. A lot of that goes into equity, due to different regulations, not all that can be put into equities. 

There is this matching principle so depending on the length of the claim, you have to buy even long term bonds, which might seem a bit weird these days with the interest rate. Though that’s just the way it is. It’s not something we can do too much about. I’m sure Buffett would, if he could, but unfortunately, that’s not the case.

The other thing that I found really interesting about how Buffett has been addressing the insurance business is also that he had a concerned shareholder who was saying, “With global warming,and with everything that’s been going on, what can we expect in terms of insurance claims to Berkshire?”

[Buffett] replied, “Most of these things, by definition are renewed,” so he can set new premiums. What he’s saying is, as much as it might seem bad one year, if a lot of things are happening from an insurance perspective, it is actually a good thing, because the premiums would just go up. 

The more uncertainty there are in the market, the better it is to be an insurer, because so many companies just have to have insurance. 

Now, Jake, let’s talk about the growing cash pile. It has been heavily debated for years among the shareholders of Berkshire Hathaway. Today, cash and short term investments are $128 billion. 

When I say today, I don’t mean today, March 9, after the stock mug has been tumbling for weeks now. I mean, that’s the latest filing that we have. That cash pile was similar to what it was in Q3 of 2019. As far as we know, it’s not growing, but it stagnated at a very high level.

Jacob Taylor  13:02  

I woke up this morning and the market was down 5% plus, and we had circuit breakers going. On days like today, you kind of have to love that cash pile, right? It’s the optionality on it is growing with every tick down. 

I love the anti-fragility of that cash pile, when you combine that with Warren Buffett’s capital allocation skills. He’s proven that he can put up great numbers, especially when the opportunities come along, I should say. 

The only thing that I don’t like about it is that it makes me a little bit sad that it’s possible that he could be waiting for this one last chance to do some big deals that sort of cement his legacy. 

I’ve seen this before where grandparents are holding on to see that oldest kid graduate from college or something. Then once it happens, then they kind of let go a little bit. 

It’d be sad to think that a lot longer that we can delay a crash and him putting money to work, maybe the more time we get with him. I would be a little bit sad if he was able to bag that last elephant and now he’s like, “You know what? I’ve done everything I need to do in this lifetime and I’m ready to move on.” 

Stig Brodersen  14:08  

What people typically do is they look at the size of his portfolio and I think here in the year end it was around $240 odd billion. Then they look at the cash position and they say, “Wow, he has a lot in cash.”

That’s not how Buffett looks at it. He said actually, just two weeks ago, “I’m approximately 20% in cash right now. I’m that because I’m including the $300 plus billion in operating businesses. Plus, we have marketable securities and then we have cash.”

If you do the numbers is a different way of looking at it, he’s looking at it 80% equities, 20% in cash. Who knows? Perhaps with everything that’s been happening, he is not so much in cash anymore. 

That really ties into my next question. Warren Buffett kicked his stock buyback program into high gear here lately, sending $2.2 billion on share purchase in the last three months of 2019. That’s the most ever he’s done in a single quarter. 

Now, this is not significant compared to the market cap of more than $500 billion. A lot of investors see this as an opportunity to load up on shares. It should also be noted here that the trading volume of Berkshire Hathaway is exceptionally low. 

In that sense of buybacks, yes. Buffett is restricted differently than other CEOs, if he wants to repurchase a high number of shares, because he so easily moves the price. He’s been talking about how he looked within the other CEOs who could buy back at 3-5% without moving price. 

However, because of the volume of Berkshire Hathaway shares, that is just so low, he’s been talking about, or he at least has been hinting… He doesn’t talk too much about it, but he’s been hinting that just 1% can actually move the needle in terms of influencing the price. 

As much as we will talk about valuation later, what do you read into the stock buyback here, aside from the obvious fact that Buffett at times have found the shares modestly undervalued, as he puts it in his letter?

Jacob Taylor  16:04

A lot of people that I talked to like to think that this buyback program puts a floor under the stock. He’s talked before about in the 1.2 to 1.3 times book value range is sort of where Berkshire will kind of “defend the stock price.” 

 

Not sure if I think that that’s true or not. I think Mr. Market can do a lot of crazy things. It can still apply to Berkshire. They’d spent $5 billion dollars over the last year to buy back 1% of the company, roughly. That’s in the $200-ish share for the B shares. 

Who on the other side is selling? That’s something that I always like to ask myself. When it comes to Berkshire shares, most of them are locked up in families who owned the company. It’s not the typical company that’s owned by institutions, or even like index funds. It’s very under represented in indexes because of that.

Therefore, I don’t think that you may get as much panic selling either there. Maybe it’s unlikely to go on a crazy sale as much as other companies. I personally think that he would be better off looking for that next deal than buying out partners within Berkshire itself. 

I don’t think that there’s a lot of willing sellers that will part with their shares at the prices that are really mouth watering from a buyback perspective. It’s just not the dynamics that I see in the company and the ownership structure.

Stig Brodersen  17:28  

I think you bring up a good point, because if you look at the ownership manual, what he wants to do the least is to repurchase shares. He wants to buy wonderful businesses, even before that he wants to build or widen the moat around the existing businesses. 

He wants to buy shares in other companies before he wants to buy out his own partners, as he puts it. It is interesting, especially at these prices right now at the time of recording. Berkshire Hathaway is trading at 195. It would be interesting to see how much he loads up on his own shares. 

In Q4, if you look at the numbers, the average buying price just for that quarter was 215. It might be well, he would be buying back a ton. Though keep in mind that as the price of Berkshire Hathaway is now trading at much more appealing prices, so is more or less all the stocks on the planet.

Jacob Taylor  18:13  

You bring up a good point.

Part of good capital allocation is thinking of your shareholders as your business partners. If you’re buying back from them at crazy low prices, you’re benefiting one group of your shareholders at the expense of another. You’re neglecting your duty as a captain of industry, as an allocator of capital, and a steward of capitalism, by taking advantage of one party over another.

I think you almost have a moral duty to try to keep your stock price trading close to the intrinsic value so that if some partner of yours, aka a shareholder, needs liquidity for something, perhaps they have to pay for a surgery or there’s a charitable thing that is really important to them, that they need the liquidity, you should do what you can to help them get the liquidity that they need to run their lives. 

I think that there’s a lot of good that can be done that no one really talks about in capitalism by a CEO who keeps one shareholder group from taking advantage of the other too much.

Preston Pysh  19:15  

That’s really interesting. Buffett has mentioned in his letter to shareholders that 98% of his shareholders going into the year are the same shareholders going out at the end of the year. I think it’s kind of an interesting metric because it shows you how strong his share buybacks can be, if he decided to use his significant cash position to conduct those buybacks. 

Something else I want to ask you about, Jake, is your opinions on Warren and Charlie’s age. There are many people that will argue that they’re the true competitive advantage, or at least a significant portion of the company’s competitive advantage. 

However, as we all know, Warren is going to be 90. Charlie is 95 or 96 years old. What are your thoughts about the company with them eventually going to be replaced?

Jacob Taylor 20:04  

Yes. You really kind of have to get comfortable with answering the question: is Berkshire a man or is Berkshire a culture? Or is Berkshire an ethos? Or even maybe like an operating system for a business, super high integrity, decentralized to the point of abdication, as Munger has said? 

Capital allocation, stock selection, insurance, underwriting, taking advantage of opportunities. All these things are in the ethos of the company.

I personally believe that they’ll generally be okay. It’s hard to imagine that there isn’t some impact. If I kind of go through each of the businesses, like the insurance operations, I think those don’t change a ton. I think they’ve got plenty of brain power with Ajit to still manage that part. I know Buffett helps Ajit, but deal flow, I think absolutely has to be impacted. 

How many business founders sell their business for less than they could probably get somewhere else to sell to Buffett specifically? That I think is a very real advantage that he’s built as a way of cashing in on his reputational capital that he’s built over the last 50 years of doing business the right way.

He deserves to be paid less than the market because he has done such a good job with his reputation. I also think the performance of any CEOs in the subsidiaries of all these different companies could go down. 

I mean, when you are having to send a letter to Warren Buffett about your operations for that year and report to Uncle Warren how you did and you want to make him proud… He’s not around, it could slip a little bit. I mean, I think that’s just sort of natural human nature. 

I think the portfolio management side of things will be just fine with Ted and Todd. I think both those guys are really sharp, but it’s hard to imagine that there isn’t less of a moat post Warren and Charlie. Just mostly probably because of the deal flow aspects. 

They have to get in line and pay what everyone else is paying for acquisitions. You’re just not going to get the same kind of deals, Therefore, the same kind of returns on the businesses that you’re buying, because you’re probably going to have to pay a little bit higher price for everything. 

On the net, it won’t be as good, but the ethos still makes it one of the better companies in the world, as far as how clean they are and how they do business.

Preston Pysh  22:20  

Jake, real simply: what’s the biggest threat to Berkshire Hathaway, in your opinion?

Jacob Taylor  22:24  

I would probably say complacency. That can come in different ways. I think that this management team that’s been around since 1965 deserves the benefit of the doubt on all things. They’ve earned it. 

However, as a shareholder, you can get complacent about when things start slipping a little bit. 

For instance, picking the book value out of the report. It’s a little bit of changing the goalposts somewhat I mean, the timing of when he’s done it. There have been a few other changes. I won’t go into them, because they’re down in the weeds for most investors. 

However, if you want to read a deep dive on that, I would suggest checking out Semper Augustus’ letter. I don’t know if you’ve ever read that one, but Chris Bloomstran is one of the best analysts on the planet. 

Chris Bloomstran does call it a 50-ish page write up of Berkshire every year. He’s a true expert at this company. 

Anyway, he’s highlighted some of the places where they will change a little bit of things in reporting or move parts of the business. It’ll be a little bit less clear, like how that business did or what the returns on equity were for that segment of the business. Mostly in the name of trying to make the numbers easier for the average person to understand. 

However, for the very deep dive analyst, it clouds some of what we used to be able to know about the company. Those little kinds of things can slip here and there, the disclosures part of things, because the management has earned such a reputation, you can get complacent about just assuming that they’re always doing the right thing all the time. That can get you into a dangerous place.

Stig Brodersen  23:59  

Interesting. 

Speaking of those analysts and those people who are really into it, I have a very nerdy, geeky question for you here now, Jake. How do you value the earnings retained by Berkshire as non-controlling investments in public companies, given that only dividends are reflected in operating income? 

Perhaps you can just explain the framework behind why is that even a topic worth discussing.

Jacob Taylor  24:46  

Sure. If you imagine these companies that are owned by Berkshire, inside of Berkshire, but they’re publicly traded companies and they’re doing their own business. They’re generating their own cash flows. Sometimes they’re paying dividends to Berkshire.

Last year, their 10 largest holdings in their securities portfolio delivered $3.8 billion in dividends that got sent to Omaha. Checks that showed up in the Berkshire checking account. 

Well, those companies had another $8.3 billion in retained earnings last year. That’s money that’s created inside of companies that they own, but that Berkshire doesn’t really have control over it. It’s still within the company. 

When I say that $8.3 billion, that’s figured out by taking the percentage that Berkshire owns of the company and then applying that percentage to what the total amount was. 

Just to make the math easier, let’s say that they own 10% of Apple. Apple earned $100 billion. Well, inside of that, you could imagine that Berkshire kind of earned $10 billion through their ownership of Apple.

I think you can’t assign $1 for dollar valuation to those earnings, it could very likely be the company that is making the decisions on that dollar, where it goes, could be making bad cap allocation decisions. 

Even making that dollar worth zero. We’ve seen that before with companies that make stupid choices with the money that’s generated. It does not accrue as shareholder value ends up disappearing. 

The first kind of metric that we have to look at is what do they do with the money. I think Buffett’s obviously trying to choose companies that have the ability to invest in projects that will generate further returns on capital and keep this engine running and even growing. 

You can kind of start to see why he’s such a big fan of buybacks is because instead of that dollar inside of that portfolio company going off into maybe a project that is destroying value, maybe it gets bought back now and his share of the company now increases. 

Obviously, the price paid matters for that as well. If they’re overpaying for their buybacks, then they are destroying value for the remaining shareholders, including Berkshire. 

Then the other part that I think you should think about there is that money stays within Apple, Wells Fargo or wherever it is that Berkshire owns. Berkshire is not having to pay taxes on it at the moment. There’s already, call it a 15 to 20%, maybe even 21% savings by not sending that money to Berkshire to then control. 

So there’s no easy answer here because it’s very fluid on what do they end up doing with the money? That determines the future value of what that retained earning was worth. 

However, those are some of the parameters that I think about when I look at the retained earnings inside of the portfolio companies.

Preston Pysh  27:17  

It’s fascinating. This is a topic that Buffett has been talking about a lot lately. I think this is a great accounting discussion. It’s something that many young investors don’t understand. 

I know Stig and I have talked about looking through earnings for the non-operational subsidiaries numerous times on this show. It’s really neat to see him bringing it up more and more. I think it’s important because there’s a lot of value there that’s not immediately evident, if you’re simply looking at the consolidated income statement for Berkshire Hathaway. 

Okay, with all that said, talk to us about your intrinsic value for Berkshire Hathaway today.

Jacob Taylor  27:58  

Well, I think there are different ways of doing it. I tend to be more on the simplistic side of my investment stuff. If I can’t write it on the back of an envelope, or on a short piece of paper and a few sentences, then it’s probably too complicated for me to take a swing at. 

Anyway, for Berkshire, the first pass to look at it, and this will sound a little bit glib, because the answer is going to be kind of silly. However, if you imagine Berkshire as a bond that yielded 10%. I think that’s a reasonable actual approximation, because their return on equity has been 10% for quite a while. It’s likely to be around 10% for a long time, just based on the projects that they’re putting money into. Taking specifically regulatory yield of BNSF and BH Energy. 

So if you imagine a bond that yielded 10% and you could reinvest the coupons in the business at a continuing 10%, what would you pay for that bond today? How much would the market pay for a bond that yielded 10%? 

In my mind, safer than treasuries. Today’s rates right now are like approaching… It goes towards infinity, right? I mean, that’s why I said this is sort of like the glib answer. It’s a ridiculously high number, which I think is more a reflection of today’s rates being, in my mind, kind of ridiculous and not so much a reflection of Berkshire. 

Let’s go to a more real answer then. 

Some of the parts is a very popular way of analyzing Berkshire, which is basically just taking all the different little business lines, adding them up, and coming up with some kind of a number. 

My back of the envelope math for some of the parts is, let’s call BH Energy worth about $50 billion and the railroad worth about $100 billion. The MSR ,the manufacturing service, retail, is call it $150 billion. Insurance, call it $30 billion and then an investment portfolio $370 billion-ish. You add all those up and it totals up to about $700 billion, which implies about $280 per share for the B shares. It’s quite a bit north of where we are right now. 

Another way of looking at it, the business would be, let’s just do a simple… What has Berkshire typically traded around as far as price to book goes? The answer there is roughly, let’s call it 1.75 times price to book value. 

Today’s book value, let’s call it $445 billion, that gets us to a $740 billion range of potential valuation. Okay, like that’s in the ballpark of are some of the parts, if that makes sense. 

All of these things are just triangulation data points, like any one is not better than the other, but if they’re all kind of telling you the same story, then maybe you’re onto something. That’s how I think about this. 

Then maybe the last one would be a two pronged approach. That’s basically adding up all of the investments, trying to put some multiple on the actual earning businesses, and adding those together. 

What does that number tell you? In my rough calculations, let’s call it $260 billion for equity securities, another $130-ish billion for cash, that gives us a $390 billion for prong one.

For prong two, we’ll take the $24 billion dollars of operating earnings and multiply that by 10. That gives us $240 billion. Add those two numbers together and you end up with $630 billion as another mark. All of them in the $700-ish billion valuation range.

Stig Brodersen  31:27  

Just to recap that, you’re saying that the price of the B shares that’s right now trading around $195, we’re looking at around $280 plus-minus. Very interesting. Thank you for breaking that down for us. 

It is interesting what you would mention there about the potential discount because it is a conglomerate. I guess you will even have people saying that is actually the competitive advantage of Berkshire Hathaway, that it is a conglomerate, so the money would go where it’s best used. 

I guess there was also a discount to Berkshire Hathaway, because it has not been performing as well here for the past five years. It’s actually been trading the S&P 500. I think that’s probably also one of the reasons why when I talk about it being a good price and all that, I think most analysts will already know I am long Berkshire Hathaway. 

Do you take it for what it is when I’m complimenting Jake about why Berkshire is such a great investment… I am obviously biased. 

It kind of leads me into the next question, which is something about position sizing because it’s just always such an interesting topic to discuss, especially for a company like Berkshire Hathaway. 

Many investors have different rules whenever it comes to position sizing. For example, an investor might have a rule that he or she won’t build a position in a single stock with more than 10% of that portfolio. 

Now, Warren Buffett has previously in his letters to shareholders commented on how many investors are holding Berkshire Hathaway as their biggest position in the portfolio, most noticeable is himself with more than 99% of his net worth.

He would estimate that more than 90% of the shareholders have Berkshire Hathaway as by far the biggest position. 

Please elaborate on how you see position sizing, and if Berkshire Hathaway is an exception to the rules that we may have imposed ourselves, given that it’s such a diversified company already and may have the downside protection that you mentioned before.

Jacob Taylor  33:24  

It very much comes down to your own personal preferences and risk tolerance of how much exposure you’re willing to take on any one facet of a business or economy or any one person. 

The first thing you have to ask yourself is about the opportunity cost. Do you have anything else that might do better than a relatively safe? Call it 10% per annum type of return profile. 

If you do, then Berkshire may be sort of an anchor in your portfolio. Maybe you don’t want too much of it. 

I don’t think that Berkshire is terrible as a bond proxy, maybe especially for someone who’s a little bit younger, relative to the prices of bonds today. 

How much do you want as a bond allocation? Berkshire may fit the bill of that a little bit, like we just talked about, if it was a 10% bond.

A lot of portfolio managers who I’ve talked to and respect, they often will use Berkshire as a cash proxy. If they don’t have anything else to invest in, rather than hold cash, they’ll just stick it in Berkshire. I don’t think that’s a terrible strategy. 

However, the whole point of cash is that it doesn’t move around at all. Berkshire definitely moves around. I mean, in 1998, Berkshire was trading at three times the price to book value, right?

Typically, it’s been 1.7, but we’ve seen it below book value also. Therefore, I think that it’s just this like, solid anchor that never moves around and provides the liquidity that you want when you need it, I’m not so sure about that. 

The last thing I would say is that because it is so US centric, it could form a bit of a home country bias. That is common for a lot of shareholders. People tend to own more of whatever country that they live in, because they just feel like they know it better. 

If so, if you are a US investor and you already own a lot of other US based securities and things that are tied to the US economy, then being long Berkshire is just more of that same thing. You may not have as much diversification, geographically speaking, and you may end up suffering even stronger to a home country bias. 

Though all in all, I mean, it’s pretty hard to imagine that Berkshire in 10 to 20 years is not worth more than $500 billion. If you have the stomach for long term, you could sleep comfortably at night earning probably a 10% roughly return on equity over a long period of time. There are definitely scarier and harder ways of making money.

Stig Brodersen  35:52  

I think you bring up a really interesting point and a good point. 

Jake, thank you for your thoughts about Berkshire Hathaway. It’s always a pleasure to hear how people think about that business that we’ve been following since the very first episode here on The Investor’s Podcast. 

Now, speaking of that, I wanted to end the interview on a slightly more abstract note, because not only are you a great Investor yourself, you are also one of the thought leaders in the value investing community. I would like to relate this to when I first started becoming interested in value investing, I think my motivation was like any other. 

I wanted to replicate, if possible, how Warren Buffett picked stocks. That was why I was interested in the first place. 

Then after starting value investing for years and reading and rereading Buffett’s wisdom, I slowly realized that it really wasn’t just about the money. It’s really the community around Berkshire Hathaway and Warren Buffett. It’s not so much about business, but just as much about investing in a life well lived. 

In your amazing letters that you send out to your clients, you talk about how much of the human actions we see in the world can be explained by deeply embedded scripts designed sort of into hierarchies.  

I know that we are going a bit abstract here just from talking specific numbers about Berkshire Hathaway. However, I think it’s a really good way of rounding off the interview to talk about value investing, like very specific. Then to look at more the grand scheme of things. 

Could you please elaborate on that specific quote and how you see this?

Jacob Taylor  37:27  

I think you’re right to highlight that these guys are heroes for a lot of us, but I think the amazing thing is that they’re such good teachers. We’ve benefited from them being willing to share all that they’ve learned. It would have been very easy for them to just hide out, never talk about any of this kind of stuff and share it with us, and just make all the money that they ever wanted to make in the world. We’d all be much poorer spiritually than otherwise. 

I tried to reflect back that same thoughtfulness when I can and that same spirit of sharing, being kind to others and paying it back that these heroes have been so intellectually generous. 

Whether I’m successful or not could be debated, but you mentioned one of the client letters that I wrote. In that letter, I looked at what lobsters and Warren Buffett have in common, and actually Buddhism as well. Those three very weird things. 

Here’s the punchline of that letter. Lobsters will fight each other for space and mates and territory. When they’re able to win in a fight and get that space, they have a bump in serotonin inside of the lobster. It’s this chemical that makes them feel good when they win. 

The lobster who loses has a decrease in serotonin and ends up often retreating and then dying not that long after. 

Nature has created this system where we have these chemicals that make us feel good when we’re at the top of the hierarchy. We have that exact same serotonin molecule floating around in our brains when we sort ourselves into hierarchies that the lobsters do and lobsters are really old. They’re older than dinosaurs. 

This serotonin mechanism has been with us and been with biology for a very long time. We’re just as subject to it as other creatures are. 

What does that have to do with Warren Buffett? Well, I think one of the key insights about Warren Buffett is that he’s always been willing to follow his own inner scorecard and not beholden to serotonin hierarchy sorting, trying to show off and be more than he is. He is very true to himself, including thinking for himself when it comes to investing and his personal life too that is very colorful. 

I think what the takeaway for all of us is to try to recognize when we are in a hierarchical situation and I can feel ourselves being drawn towards sorting, and instead trying to opt out of that. 

I think Buddhism has some interesting principles in it that are really about opting out of that serotonin matrix that a lot of us live in. 

Tie all those things together for your investment portfolio, thinking for yourself and ignoring Mr. Market, or taking advantage of Mr. Market when you can, all these things tie back together. Hopefully they also lead to a life well lived on your own terms that at the end of the day, you’ve minimized your regret and you feel like you did things your way.

Preston Pysh  40:27  

Jake, this is a great segue into your book, “The Rebel Allocator.” In fact, we have another show on our network that’s hosted by Sean Murray. It’s called The Good Life. He interviews you about all the different aspects of your book. We’ll have a link to that in the show notes if people want to check that out. I would encourage you to check that out. 

Talk to us a little bit about the book. Also talk to us about this idea of sorting and how it’s demonstrated in the book.

Jacob Taylor  40:53

A lot of the impetus of the book came from having studied a lot of different managers and the decisions that they make around cap allocation and seeing a lot of what to me seemed like unforced errors by people who were plenty smart to make the right decision. 

None of the math is hard, but the emotional quotient part of the equation and really following your own inner scorecard and doing what you think is right were ignored. That’s how the errors ended up coming together. 

People wanting to show off about some big merger and acquisition that was destructive for most of the shareholders, but they got to feel like they were the big man on campus because of it. That is a hierarchical sorting kind of thing: bragging about how much revenue you have, but not being profitable. We see that a lot.

I then wanted to write a book that hopefully would give those managers and then also through other proxies investors who could recognize managers who are doing that. It’s a little bit of a playbook on how to think for themselves and to have the confidence to do it. 

Crazy enough, I ended up deciding to write it in a fictional story format that hopefully baked the lessons in and were able to resonate with the reader a little bit more than just a dry nonfiction explanation of all of these cap allocation principles. 

If you look at what the book really is, it’s The Karate Kid if Mr. Miyagi was like a Warren Buffett character. That’s the kind of spoiler for the story.

Stig Brodersen  42:23  

Preston and I are definitely huge fans of your book. Another person who was a big fan of the book is Charlie Munger. If you listen to the episode that Sean Murray did with you, Jake, you actually have a chance to hear what you and Charlie Munger talked about for 20 minutes after he called you, more or less out of the blue to talk about the book. 

We’ll definitely make sure to link to that in the show notes. This has been absolutely amazing. 

Jake, where can the audience learn more about you, your book and Farnam Street Investments?

Jacob Taylor  42:54

Yeah, I write quarterly letters for my clients but they’re publicly available. Those are at FarnamStreet.com. It’s pretty easy to sign up there. I go on Twitter, probably more than I should. It is a very fun place to be a lot of times in the financial space. So my handle there is @FarnamJake1. Pretty easy to find. 

I do a podcast with a couple of friends who you are well familiar with, Tobias Carlisle and Bill Brewster. It’s called  Value: After Hours. If three buddies got together after a long day at the office, buying companies, and then kind of we’re talking about the inside part of baseball for investing. That’s what the show is approximating. It’s a lot of fun to do. We do it once a week. 

If you know anyone wants to reach out to me, my email is fivegoodquestions@gmail.com. I’m not too hard to find. As far as “The Rebel Allocator: goes, it’s available on Amazon in print digital and audio. You can check it out there.

Stig Brodersen  43:57  

That sounds amazing. Again, we’ll make sure to link to all of that in the show notes. Jake, thank you so much for taking the time to speak with Preston and me here today.

Jacob Taylor  44:06  

Thanks for having me, guys. 

Stig Brodersen  44:07  

Alright, guys. At this point in time in the show, we play a question from the audience. This question is very timely. It’s from Nathan and the question is about Berkshire Hathaway.

Sender  44:16  

Hi, Preston and Stig. My question is about Berkshire Hathaway, the stocks it owns, and its portfolio. Berkshire already owns a specific stock in his portfolio. What do you think about considering buying more of it individually, taking into account the fact that you already have some exposure to the stock through Berkshire’s portfolio?

Stig Brodersen  44:33  

Nathan, I think that’s a great question. I don’t think that there are any issues with you getting a bit more exposure to any of the stocks in Buffett’s portfolio, because when you do the math, you have very little exposure to almost all stocks in his portfolio. 

Keep in mind that Buffett’s stock portfolio is less than half of the value of Berkshire Hathaway in the first place. They have a lot of operating companies too. Not even Apple. You have too much exposure to.

Now Apple is the biggest position in Berkshire Hathaway’s portfolio, which is more than 10%, of the market cap of Berkshire Hathaway in the first place. It’s almost a third of the entire public trade portfolio. But even so, consider if you have 10%, in Berkshire, and then 10% of that are made up of Apple shares, you would still only have 1% exposure in your portfolio to Apple. 

Now Apple is a little more, it might be closer to 1.5 or 1.7. In this example, if you have 10% in Berkshire Hathaway, but in any case, it is very little. Even for Buffett’s portfolio that is very top heavy…

Just an example, if you look away from the top ten holdings, the 11th biggest holding is just a bit more than 1% of Buffett’s entire public traded portfolio so it’s really not significant. 

It’s really my way of saying that you shouldn’t think of Buffett’s stock picks at all whenever you consider your own portfolio, unless you only hold Berkshire Hathaway in your portfolio, or very close to only holding that one stock. 

Where I do think that you should pay attention is that Buffett, like all other money managers with more than $100 million under management. has to disclose with surprise the buy stocks at. That may give you a good indication of which stocks that are currently undervalued. You can find those prices and those picks at *inaudible*. 

We even have a resource at TIP Academy where you can check out Buffett’s picks together but other super investors like Guy Spier and Mohnish Pabrai. You can take a closer look at their portfolio. We’ll make sure to link to both of those resources in the show notes. 

Then four times a year, the stock picks become available. It’s February 15, May 15, August 15, and November 15. That doesn’t mean that I’ll do the same thing as they do, but I do use Buffett’s picks and other super investors as inspiration and perhaps put a few of them on my mental watch list for further investigation.

Preston Pysh  46:57  

Nathan, great question, but I really can’t add much value beyond Stig’s response because I pretty much agree with exactly what he said. 

With that, Nathan for asking such a great question, we’re going to give you free access to our intrinsic value course. For anyone wanting to check out the course, go to TIPintrinsicvalue.com. The course also comes with access to our TIP Finance tool, which helps you find and filter undervalued stock picks. 

If anyone else wants to get a question played on the show, go to asktheinvestors.com and you can record your question there. If it gets played on the show, you get a bunch of free and valuable stuff.

Stig Brodersen  47:36  

Alright guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro 47:42  

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