Berkshire Hathaway stock gained only 10.9% in 2019, 20.6 percentage points lower than the S&P 500’s total return. Berkshire’s annual shareholder letter is expected to be released on Feb 22 and is usually a must read for every investor. But, this year, Warren Buffett has some explaining to do. In Berkshire’s entire five-decade-plus history, Buffett has grown its net asset value (NAV) at an annualized rate of 18.8%, versus 9.7% annualized for the S&P 500’s total return. Buffett’s worst performance in any prior calendar year, as judged by the difference between Berkshire’s net asset value and the S&P 500, was 1999, when it lagged behind by 20.5 percentage points.

The answer may lie in the so-called “Buffett Indicator” – the ratio of the total stock market to GDP. It got its name two decades ago when Buffett said that the ratio is “probably the best single measure of where valuations stand at any given moment.” Anytime the ratio is below 1.4, Buffett does well and when it is higher, he tends to pile up on cash waiting for the correction. The ratio has been higher than 1.4 since late 2018 and Berkshire is now sitting on $122 billion in cash.

And that is why Wall Street is so eagerly awaiting his annual shareholder letter, which is expected to be released along with the company’s earnings next week.

Future Wealth’s View

Our view is that Warren Buffet is highly unlikely to drop his endorsement of Market Cap/GDP indicator. Instead, he is more likely to double down in his newsletter. His cash pile of $122 billion, sends an bearish message and with interest rates as low as they are, Buffett’s only hope to outperform the market is for the stock market to fall. 

We expect him to highlight why it is so difficult to find a company to invest in – that is big enough to make a meaningful difference to his company’s bottom line. His sidekick – Charlie Munger put it succinctly when he said “Think of the basic intellectual dishonesty that comes when you start talking about adjusted EBITDA (earnings before income taxes, depreciation and amortization)”. Adjusted EBITDA is one of the primary metrics for valuing a business and of course, the CFOs (Chief Financial Officers) of every public and private company are aware and manipulate EBITDA to mask any under-performance of the company.

We, at Future Wealth, are eagerly waiting for the annual letter, because we took a similar position with our clients’ portfolios by going defensive in 2019. An endorsement of our strategy by Warren Buffett would be good to have – don’t you agree?