[00:02:30] Chris Bloomstran: Think about foundations, charitable foundations that give away 5% a year. Well, you’ve got liquidity needs, you’ve got 5% going out the door. This year, next year, within a 24-month period, you’ve got 15% leaving and so cash rarely helps investment performance, at least in the last quarter century, you take our equity returns, which have been good, 11 and a half percent or thereabouts per year.

[00:02:58] Chris Bloomstran: The S&P’s done a little over 7 and a half percent. So we’re almost 4 points just on our stocks. Before cash and before management fees, you think about having cash reserves and they’ve probably averaged high teens, I think, over time, well cash in the last 25 years, T bills earned 1.8% a year.

[00:03:18] Chris Bloomstran: So, the drag there winds up being about 170 and change basis points. So, take 11 and a half down to, you know, 9, 8, let’s call it. It seems pretty innocent. Well, over 25 years, compounding your stocks at 11 and a half percent, we’ve turned every million into 15 million dollars. 170 basis point, innocent sounding cash drag, shaves almost 5 million off of that.

[00:03:47] Chris Bloomstran: You grow a million to 10. Now, compared to the S& P growing to 6, you know, you’re still way ahead of the game. And even throwing in fees, you know, we’re still way, way ahead of the S&P 500, but over long periods of time it’s, so, interesting. So, 25 years, the S&P’s been negative in 6 years. We’ve managed to always be ahead of the S&P in all 6 of those years, and that contributes to the record.

[00:04:13] Chris Bloomstran: In 3 of the 6, we’ve made money and in 2 of those 3, we made a lot of money. In 2001, we were up over 20%. The market was down 9 and 12, I think. So, even though you had cash in a declining market, it didn’t help. It hurt the equity returns. 2 years ago, 2022, we made 1%, which was great, against the S&P, which was down 18. Nasdaq was down 30 something, 36, 37%, whatever it was, and bills at that point, interest rates were rising, and so, I don’t know, cash probably averaged three, so cash would’ve helped a little bit there. Rarely helps. Now, at institutions that come in often come in and want to be fully invested on day one. I like that because cash is never an issue.

[00:04:58] Chris Bloomstran: They want to own the separate portfolio right out of the gate. They have their own cash reserves, their own allocations. We’re running a sleeve of equity money. And so the decision to have cash as you’re implementing a portfolio is never an issue. Most folks, family offices, individuals, don’t put a gun to your head and say we want to be fully invested.

[00:05:18] Chris Bloomstran: So we’re a little more deliberate about the pace at which we put capital to work. In a 25 stock portfolio, at the moment, you know, we’ve only got we’ve got 15 or 16 of our companies that we’re pretty comfortably actively buying. Some are ridiculously cheap still. But we’ve got a number of names that are pretty fully valued and closer to trimming them or selling them.

[00:05:40] Chris Bloomstran: So you don’t want to be buying those names when money’s coming in and so, I love the line in Hemingway’s The Sun Also Rises. Well Bill, how’d you go bankrupt? Well, gradually at first and then suddenly. Well, I think about how we put money to work and it’s kind of like that. You go through periods like today and cash for deposits and new clients in the last six months, let’s say, has been penal because since October, we were up, I don’t know, 12% last year, and all of that came in the last couple months of the year, and we’re up, we were up a little ahead of the S&P 500 for the first quarter, so we were up, I don’t know, I haven’t even seen the final numbers, but probably 11%, 12%.

[00:06:19] Chris Bloomstran: S&P was up around 10, 10 and a half with new money. We’ve not gotten fully invested. We’re about two thirds invested, so cash has been very penal in the last few months. Now. Invariably opportunities come along one off a dollar general got really cheap last year and we had trimmed the position way back a couple of years prior and we built it up to 10% of our capital.

[00:06:39] Chris Bloomstran: The last piece took it from 3% to 10% at 113 bucks a share. So having cash on hand during those moments is great. Now, most of our clients, you know, once we’re fully invested, we try to stay fully invested. We like to do that. So I’m always selling something to purchase something else that I’m buying.

[00:06:57] Chris Bloomstran: Go back to the pandemic. So in the three or four months leading up to the pandemic to that second and third week of March, if we had cash reserves that we hadn’t fully committed, having cash at that moment in time when everything was down 30% was huge. And we had a number of clients hire us during the third week of March called and said, look, we’ve been reading your letters for years.

[00:07:19] Chris Bloomstran: We’ve been sitting on a big cash pile. waiting for an opportunity. And so that was an interesting year in that our fully invested portfolio. So we were way down and obviously the market recovered when the Fed got busy. Well, we, I think fully invested portfolios were up about 12 where we had these new accounts or accounts that had lots of cash that we put to work that were up 40%, 50%, 60 % during the year.

[00:07:43] Chris Bloomstran: Those are the singular moments where it makes sense. Our first client who I wrote about Mr. Smith in our letter two years ago. I mean, he had the most brilliant transaction of exiting a stock market and getting back in than probably has been done in all of time. I mean, he was a young stockbroker. In the mid-1920s, in 1928, got out of the market and early about a year and a half before the dow peaked.

[00:08:09] Chris Bloomstran: And so he would have got out when the dow was about 200. It peaked at eventually 384, maybe 381. So it looked pretty silly owning T bills and gilts and some railroad bonds. For a year and a half, but then the market fell 90%. And so at the lows, he literally went back into things like GE and other companies like that for less than net working capital.

[00:08:32] Chris Bloomstran: So a million dollars would have almost doubled to two would have fallen by 90% to 200 thousand. Well, his million, each million would have earned interest for a year and a half and then waited in and so at the point where the dow recovered from 41 back up to 200 and kind of meandered around that level up through 1937, he was up 5x.

[00:08:56] Chris Bloomstran: Well, so was anybody that lost 90% of their money. If they could stay in the game, if you could stay in the game, he had five times the capital. In a three or four year period of time than the rest of the world in the stock market. But that’s 1929, that’s a pandemic financial crisis. If you had cash laying around, it was a really great time to put money to work.

[00:09:16] Chris Bloomstran: But if you’re sitting on cash thinking I’m waiting for the perfect moment to get invested. If too much time passes, you know, you’re fighting retained earnings. You’re fighting an upward tilt in the stock market. And, you know, before long, if you’re clipping along at 10, 11% a year, we’re doubling money every 6, 7, 8 years.

[00:09:34] Chris Bloomstran: If you’re sitting there 6, 7, 8 years waiting for a decline, you’re so far behind the curve earning 1.8% a year on bills for the last 25 years that, that even on a 30% drawdown, you’re still going to be behind the game. So my, the lesson I take away is cash is generally to be avoided unless you’ve got liquidity needs that need to be funded and there, we have it.

[00:09:55] Chris Bloomstran: Plenty of clients that have cash reserves and it’s harmed the equity only track record for sure and I don’t think it’s generally helped having cash generally because you just, you’d rather be fully invested and I don’t know, I say that and you know, who knows what the next big downturn looks like.

[00:10:14] Chris Bloomstran: If you have another 1929, if you have another great depression and a giant sell off in the stock market. Well, anybody that’s got cash reserves is going to look pretty smart.

[00:10:23] Stig Brodersen: So, if I came to you today, Chris, and invested a million dollars with you, and I was one of those institutions that wanted to be fully invested. And I look here at your report and I said, 11.5% that’s for equities. I guess my question is, do you have different returns for your different clients? Because they follow different strategies, even though that you, as such, you look at the same equities, but you plow your money in at different times.

[00:10:51] Chris Bloomstran: So clients during the implement, what I’d call the implementation phase, whether it’s a week, three weeks, a month, six months, eventually, all the portfolios look alike.

[00:11:03] Chris Bloomstran: We own the same businesses. Any of the positions that we own that we’re trimming or then adding to, you always get sell offs. Again, Dollar General blows up last year. We can look through and talk about all the different reasons why we think the operational issues they’ve been dealing with, they’re generally fixable.

[00:11:19] Chris Bloomstran: We’ve shaved our original assessment of profitability to allow for things like higher labor costs. But, you know, there would have been a point a couple of years ago that we were trimming and selling off the dollar general and not actively buying it. But then. When you overall allocate to a name, everybody has the same 10% position.

[00:11:38] Chris Bloomstran: Now, somebody that has assigned a 20% permanent cash reserve, at the moment, I take Dollar General to 10%. They’re only going to get 8% of their overall portfolio invested in Dollar General because there’s a 20% permanent cash reserve. So generally over a not too long period of time. All of our separate accounts generally look very similarly and there’s a very tight correlation on returns, but a little bit different during the implementation phase and it’s almost a coin flip as to whether doing it that way or just getting fully invested on day one is the right thing to do.

[00:12:13] Chris Bloomstran: I still think opportunistically adding new capital only into positions that are fundamentally undervalued instinctively. And I think there’s enough evidence behind at least our record that says that’s generally a pretty good way to do it but you know, for the, during those periods, like we’ve had in the last few months, we’ve definitely got a drag on return.

[00:12:35] Chris Bloomstran: If you take a lot of our accounts that are up 11, 12%, you know, those that have a third cash, because they’re not fully invested, they’re up 7%, 8%. So we’re a couple hundred, 300 basis points behind now. The next big selloff either in a handful of names or in the overall market and that cash will be beneficial and that then becomes the offset to the penalty of being methodical on the way in.

[00:13:01] Chris Bloomstran: And I still don’t know what the right answer is. I talked to all my friends and, you know, folk, other investors that I admire a lot. And I don’t think any of us have come up with the right answer on how to put cash to work again. I like the institutional approach because it’s not our decision.

[00:13:15] Stig Brodersen: Yeah, I think you can probably statistically argue that it’s the right approach even though it might also seem sometimes like you’re not buying at the right price. Yes, I know what you mean, Chris because I’ve seen so, so if I take one step back, you know, we had so many wonderful guests and we always ask for the track record whenever we can and in your case, it’s very easy because I can just read your letter and we always get these, you know, this is the track record, this is equities only, and this is with cash.

[00:13:42] Stig Brodersen: And it’s always better if it’s, you know, equities only for the reasons that you just mentioned. And so one could draw the conclusion, why wouldn’t everyone just be invested from day one, but then you come up with your arguments why, you know, some clients have different needs or different perspective. And, you know, that’s also part of the game.

[00:14:00] Chris Bloomstran: Yeah, if Warren didn’t have cash in 1974 and cash coming in from operations. From the textile business that he was diverting away from the Berkshire record, wouldn’t be the same. I mean, having cash coming in or having some cash on hand at the moment where you do get a genuine kind of, you know, once in a decade, once in a generation buying opportunity, is helpful, but typically I’ve found it’s a drag over time.

[00:14:28] Chris Bloomstran: I mean, it’s clearly a drag for those folks that have to have cash registers. I’m at a loss in a world of low interest rates, why big institutions hew to some of the asset allocations that they do. I mean, fixed income generally is a terrible asset class. If you own a business that generates good returns on equity and retains a portion of earnings, unless they’re spending all of their retained earnings buying their stock back to offset dilution on the shares, they’ve given themselves as compensation.

[00:14:57] Chris Bloomstran: But if business generally has an opportunity to reinvest in themself, at a good return, contrast that to a 4 and a half percent, 30 year treasury where your interest is reinvested back in interest. I mean, you’re going to get the yield plus or minus, whatever your reinvested yield is, and those yields are not being invested at 15%.

[00:15:17] Chris Bloomstran: They’re being invested at fixed income yields. Huge difference between owning the right kind of public equities or equities in general. Just the equity asset class. versus a fixed income component. And it wouldn’t have been as penal for much of, well, up until the financial crisis, when you had higher interest rates, when fixed income was yielding 6, 7% and stocks averaged 10 and a half percent over the long haul, you had a 3 or 4% equity premium when interest rates are zero at very low levels.

[00:15:48] Chris Bloomstran: You had a disparity in good businesses. You know, the kind of things that we like. If you can buy those things at 10% earnings yield when interest rates are 0 or 1, well, that’s a striking differential that leads to the conclusion. Why would you ever have a permanent bond portfolio?

[00:16:04] Stig Brodersen: You know, Chris, I was speaking with a well-known asset manager here the other day, and you know, he has a track record of beating the S&P 500 for decades now, and not too many people can talk too much about that.

[00:16:14] Stig Brodersen: And so it was a confidential conversation and I won’t mention his name because I don’t want this to come across the wrong way. So I had this idea and I could be wrong that, you know, in asset management, either you’re in or you’re out, like it’s such a, it’s such an intellectual game and you have to put so much energy into it.

[00:16:31] Stig Brodersen: And I’ve been thinking about that and we’re, him and I were talking about how much time one could spend on other activities and so he’s, he talked to me about some of his volunteer work and, you know, some of his hobbies and so I asked him, so Is that a drag on your client’s portfolios that you’re, I don’t know, playing golf, whatever.

[00:16:50] Stig Brodersen: And he’s like, no, you’re doing these different hobbies and doing volunteer work. That’s really good. Because he mentioned different reasons why it was actually good for his clients. He spent time on that. So my point of saying this is not to challenge that premise but my point is more to say, what if it is so that whenever you do spend time away from work and you’re spending on different hobbies, if it is not good for your clients, how much are you morally obligated to make sacrifices in your personal life to do the best possible thing for your investors and how much is it not?

[00:17:24] Chris Bloomstran: I don’t know another way to do this other than to do it all the time. And, you know, I like to say it’s an 80 hour a week hobby. I mean, when I write my letter, I’m literally, I work probably 120 hours a week because all I do is run the business during the day and write all night and sleep six hours and try to catch up on sleep on Saturday, Sunday, don’t travel, don’t have a glass of wine.

[00:17:45] Chris Bloomstran: Yeah, you have to have balance. Warren plays bridge played some golf, Charlie played a lot of golf. But, you know, they’re reading all night. I’m reading all night. We manage other people’s money and, in most cases, in a lot of cases, we manage all of their capital. I like the way you said it. You’ve got a moral obligation.

[00:18:04] Chris Bloomstran: I mean, if we screw things up because we’ve made a mistake on our assessment of a business that’s turning around that doesn’t turn around and we impair capital. Well, that’s on me, but if I’m out screwing around and not dedicated to the task all the time, look at our website. We’ve got a tab for our client letters.

[00:18:27] Chris Bloomstran: And as you read the letter, I know I’ve written this very long letter generally annually for a very long time. Well, there’s a gap there. where I said, I don’t want to spend all night, four weeks, five weeks, six weeks, seven weeks writing a long annual letter because I’m going to coach my kids, basketball teams, baseball teams, softball teams.

[00:18:46] Chris Bloomstran: One of the great joys was coaching my son’s football teams from second grade all the way through middle school. And I may go back and do that again, even with no kids and my family on the team, because I enjoyed that, but you’ve got to compartmentalize that. And maybe this guy you’re talking about makes up for it by working all night.

[00:19:05] Chris Bloomstran: But I just loved what I love this. Warren talks about half dancing to work. I don’t know any other way to be really good at this. If you’re not. So intellectually curious about it because it changes all the time. You’ve got so much to keep up with that you’re not constantly thinking about it. I find myself waking up in the middle of the night, checking all your foreign markets and where your futures are on the open and any news that’s coming out and commodity prices, all your interest rates all over the globe.

[00:19:31] Chris Bloomstran: It’s just a nonstop thing but I can go to the beach with my family and run around and do what I do in town. I’ve gotten into walking and tried to get in shape. I lost about 60 pounds in advance of having my hip replaced in December. And so I started walking a couple hours a day last May. So I lost about 60 pounds.

[00:19:48] Chris Bloomstran: Well, that’s time that you’re not going to get back. And so. I find myself now listening to earnings calls, augmenting my reading of a lot of transcripts, listening to way more podcasts. I listen to way more of you and I love it. Thank you. So I can get a lot done and listen to my, and just, you know, listen to my earbuds and, but I’m doing things that I’m going to do otherwise, whether I’m reading or listening, I’m a way more efficient reader than I am listener.

[00:20:14] Chris Bloomstran: I don’t know. I think you’re right. I think you’ve got a moral obligation to people. I wouldn’t employ somebody unless they were so curious about investing and loved it so much that it was pretty much all they did. And nothing wrong with a few rounds of golf and hobbies. You know, I drink plenty of white and red wine and occasional bourbon and gin and tonic on Friday and Saturdays.

[00:20:34] Chris Bloomstran: And on weekend nights, I tend to shut it down. You’re still on your phone You’ve got to get away from it a little bit, but it’s just such a fun. It’s such a, we’re all blessed to be in the business because it’s so fun. I tell students, I have the luxury of being on a lot of college campuses. I’ll be at Notre Dame next week.

[00:20:51] Chris Bloomstran: And I always tell students find something that if you’re looking at the clock at four 55 every day, waiting, you can’t wait to get home and do something else. You’re probably doing the wrong thing. And if you can find, if you’re lucky enough to find something that you I absolutely love that you can make it your hobby.

[00:21:07] Chris Bloomstran: Make your profession your hobby. Everybody I know that’s really good at this, does it all the time and I tell them when they have kids, okay your life’s going to change, you watch. And so a friend of mine would find himself laying on the carpet outside of the bathroom when his babies and his young kids were taking their baths, trying to keep up with his anti-reports.

[00:21:27] Chris Bloomstran: And in reality, everybody that has kids love it and they say, oh, it’s such a life changing thing. But they all still do it. At least my circle of peers that do what we that do what we do it all the time.

[00:21:37] Stig Brodersen: I’m not saying everyone doesn’t have a right to a family life that’s not the point I’m trying to make at all but like the whole thing about, yes, if you’ve been outperforming the S&P with say 4% or 5%, could you then have outperformed with 7%? Or, you know, if we just use a metaphor, you know, from the world of sports, is it fantastic to win the Superbowl? It is. Is it fantastic if you have the talent to win it three times?

[00:21:59] Stig Brodersen: Is it then good enough to do it once? And, you know, it’s more like, I don’t want this to come across as like shaming people who have hobbies, but more like the intellectual question of what is your moral obligation? And so thank you, Chris, for shedding light on how you think about it. I don’t know if there’s a right or wrong solution to that.

[00:22:14] Stig Brodersen: And I think some investors, you know, they I think some investors might be investing with someone who is hardcore and they dedicate their life to that. And then other investors might be thinking, hey, they want their life outside of work because they look at work as work, if I can put it like that. And perhaps they’re right about making a little less return if that is the cost of having X, Y, Z hobby.

[00:22:34] Chris Bloomstran: I think Charlie and Warren are right. You don’t get that many big opportunities. And when you do, you’ve got to be aware of what they are. When we bought refiners for the first time in the fall of 2020, we, I’d never owned a refiner in my life, but I’d read a lot of annual reports on each of the refiners and it’s, and when they traded at one and a half or less times cashflow and nobody wanted to own energy.

[00:23:02] Chris Bloomstran: There was no ramping up on learning how the industry worked and learning who the best players were in the industry. We trimmed Dollar General from 4% to 1% to finance a portion of our purchase of what was then Holley Frontier and OHF Sinclair and Valero but if I hadn’t done years and years of work, on refiners with no expectation of ever owning them, wouldn’t have been prepared to do it.

[00:23:27] Chris Bloomstran: And when the dynamics of that industry changed and we developed a shortage of refining capacity in Europe and in North America, that industry got better. Margins kind of permanently got better and had I not spent a lot of time and if I was on the golf course two or three times a week not working on refinery and refining and all the other things you work on, I don’t think you’d be ready for that.

[00:23:49] Chris Bloomstran: I don’t think the big opportunities, the big fat pitches that Warren swung at, I think a whole bunch of that’s a byproduct of his just sitting around and reading all the time.

[00:23:59] Stig Brodersen: So Chris, speaking about Buffett, I look forward to two letters every year. One is from Mr. Buffett and not to make a blast, the other one is the one that you write.

[00:24:08] Stig Brodersen: And I always appreciate your observations about Berkshire Hathaway, your analysis and we’re going to talk a lot more about Berkshire Hathaway later on this call, but I also really appreciate how you’re looking at the S&P 500. And of course, since you wrote the letter, the S&P 500 has been up and to the right.

[00:24:24] Stig Brodersen: So that’s making the expected returns even lower. But could you please elaborate on the five factors that you outlined that determines the total returns of common stock or the S&P 500?

[00:24:35] Chris Bloomstran: Yeah, for the last three years, we’ve had a section in the letter what I wanted to show those that owned the index passively or that pseudo closet indexed where returns had come from and define what I’ve come to know is really the five factors that make up investing.

[00:24:57] Chris Bloomstran: So conventionally, everybody knows that total return can be derived from the change in earnings per share. and the change in the multiple, the price paid for earnings, right? You, it’s, those two would be multiplicative. If there’s a dividend paid, a dividend yield, that’s additive. So you really have those three factors.

[00:25:16] Chris Bloomstran: But when I think about business, I’m always trying to figure out how fast the top line is going to grow in dollar terms. I want to know how much I’m being diluted or created by any changes in the share counts and the prices at which shares are issued to employees, the prices at which shares are repurchased.

[00:25:30] Chris Bloomstran: I want to know how the profit margin, any change in the profit margin impact. So, when you deconstruct the earnings per share component, not the PE component, but the earnings per share, that can get sub broken down into dollar sales change in the share count and change in the profit margin. So without the, so the first four, if you put them all together, after you deconstruct earnings per share, those four become multiplicative factors.

[00:25:56] Chris Bloomstran: So one plus the change in each of the factors across the four, and then your dividend yield being additive, that gets you to total returns. So if you looked at the decade, I’ve got a chart in this year’s letter of rolling 10 year returns. And I think 2021 was a secular peak. It’ll go down and rival 2000, 1929, the late 1960’s.

[00:26:19] Chris Bloomstran: So when you get these periods where you’ve got rolling 10 year returns, it doesn’t need to be 10, it doesn’t need to be a special number, but a long enough period where you’ve had a very long runway where stocks have either massively overperformed the historical average, kind of the Ibbotson 10, 10 and a half % or underperformed.

[00:26:38] Chris Bloomstran: Well, the decade leading up to 2021, you had a massive expansion in the profit margin from 9 to a record 13.3%. The PE multiple over that 10 year period rose from 13 to 22.9. I think it was, you had very little sales growth in dollar terms, 3.4% for the decade. You had 7 tenths of 1% reduction in the share count despite companies spending two thirds of their profits buying their shares back.

[00:27:06] Chris Bloomstran: There was so much dilution on the front end again from stock option compensation and a 2.3 or so percent dividend yield. Well the PE expansion and the multiple expansion drove two thirds of the return and you got a 16.6% trailing 10 year and You had to make assumptions then about how each of those factors might change over time.

[00:27:27] Chris Bloomstran: And this is just math. And so you had a bloodbath in 2022 because the multiple and the margin got crushed. They took the record 13.3% profit margin down by almost 200 basis points, 210 basis points. The multiple came in from almost 23 to I think 18. Sales actually were off the charts because of inflation.

[00:27:50] Chris Bloomstran: Sales were growing over 9% a year for two years in a row. But despite that, S&P was down 18%. Then in the past year, you had a big recovery in the multiple, almost back to where you were 22.3 or 22.4 against 22.9. Very high P.E. by historical and anytime you apply a high PE, high multiple to very high margins, that tends to be a bad combination.

[00:28:13] Chris Bloomstran: Well, the margin didn’t recover much. I mean, earnings per share for the S&P 500 at the end of 21 were 208 and change. I think last year they were 213. So even though you had 9% per year sales growth, you had no change in the profit margin. In the last year, I mean, you cut it by 200 basis points and so essentially over 2 years, you made no money.

[00:28:36] Chris Bloomstran: And when I say price, the price of the S&P 500 was almost identical over a two year period of time. So you basically got a 1.7 % average dividend yield. I take those factors and apply them to the Magnificent Seven previously to what I called the Fab Five. Then you threw in the Tesla and the Nvidia, but applied to the S&P 500, you just run the math and you can make any set of assumptions about how fast dollar sales are going to grow.

[00:29:01] Chris Bloomstran: What’s going to change in the share count? Are you going to get any contraction in the PE multiple? Any change in the profit margin? And in a scenario where you hold today’s margins and multiples constant, you’re just going to get essentially sales growth. and dividends. And at the same rate of sales growth per share that you’ve had for the last two decades, a little over 4%, you get to a 5.5% return. Well, S&P is up 10 % in the first three months and so you just borrowed against what was 5. 5 % from your end and shaved that by almost a point. So now your 10 year return holding all that constant is four and change. If you take margins and multiples back up to what I think were 2021 secular peaks, grow your sales at three, four, shrink the share count by seven tenths of a percent.

[00:29:50] Chris Bloomstran: You were at seven and a half, shaved that by almost a point. So now you’re 10 year using those very aggressive assumptions, in my opinion, because I think 13-3 is probably a number we’re not going to see again. And then I’ve got a couple of sets of assumptions that allow for more inflation, which may or may not be back in the bottle.

[00:30:08] Chris Bloomstran: And if you run sales at almost double the rate, kind of getting back to a 1970s mentality, I believe if you have rolling inflation higher than the Fed’s 2% target, you’re going to get a contraction in profit margins and if you get a contraction in profit margins, nobody likes to see your profits declining.

[00:30:27] Chris Bloomstran: And you’ll bring the, you’ll bring the multiple in. So you take the multiple back to the long term historic average of 15, and then you start talking about 0% returns. Over a decade, if you bring the margin and the multiple way down, you start talking about negative returns. And so, I think things are frothy and if you’re an institutional allocator of capital, or even if you’re a 401k investor and or you’d listen to Warren and say the S& P is the right thing.

[00:30:52] Chris Bloomstran: If you have real capital, I mean, if you’re a family and your dollar cost averaging your 401k, the S&P 500 is a perfect solution because you take all those frictional costs of fees out of the equation, but if you have real money, you own this thing today that has seven stocks that make up a third of it.

[00:31:07] Chris Bloomstran: They’re trading it over 30 times. Their sales growth has been cut in half in the last couple of years versus the prior 10. It was 20, now it’s 9 and a half. You’re paying on this year’s run up, you’ve got the, you’ve got the multiple back to where it was. You’re back to 23, you’re probably closer to 25 trailing, maybe 22 or 23 forward.

[00:31:28] Chris Bloomstran: So you’re paying a very full price for margins that have recovered this year. And I think it’s a wicked combination of, you know, it lends itself to very mediocre at best and probably a decade that, that looks not unlike. That coming out of the tech bubble and the 82 to 2000 bull market where stocks averaged 16% a year, almost 20% a year, very low trough to very high peak.

[00:31:52] Chris Bloomstran: You had a decade where you lost money. I think from 21 or if you measure it from today, because you’re kind of back to that secular high in many aspects. It’s just plug your, just play with the numbers. It’s simple algebraic math and you can run this for it. I use this. I think about companies the same way.

[00:32:10] Chris Bloomstran: I use the same math for every company that we’re looking at getting changes in those moving parts right is big. You know, when you have a business where you’ve got profitability depressed, it’s easier to identify a place where you think you’re going to get multiple expansion. It’s harder to find a place where you’re going to get margin expansion, unless margins are depressed for some reason, recession, mess, but if you get a changing dynamic in an industry, if you get refiners that are more attractive today than they’ve been historically, if you would have got the rails right when Warren bought the railroad, that was a huge deal in terms of how returns on capital and profits and profit margins were going to change over time.

[00:32:51] Chris Bloomstran: But you put the five together and I think it’s, I think you’ve got way more headwinds as the owner of an S&P or as an owner of the Magnificent Seven than I think most people think they’re going to wind up trying to sail into.

[00:33:06] Stig Brodersen: So, Chris, we’re going to continue talking a bit about Buffett here and you know, people are always trying to like figure out what is it really that he means and what does he really think about the stock market and people talk about the Buffett indicator and this and that, you know, if you go through the annual meetings, one of the things you’ve gotten back to a few times have been corporate profits and that as a part of a US GDP, how many percent that is.

[00:33:31] Stig Brodersen: And we’re currently around 11 percent-ish, which is historically is high. Now, do you think that considering that, you know, for the S&P 500, 4% of revenue is, you know, outside of the U.S and you’re for these high flyers you talked about, it’s even more than 4% but do you think speaking about how like 11% is corporate profits of US GDP, do you think that’s a good indicator?

[00:33:55] Stig Brodersen: Do you think we should look at perhaps they’re like, world market GDP whenever we look at that or, and then a smaller number, or how do you look at the overall valuation whenever it comes to corporate profits?

[00:34:09] Chris Bloomstran: Well, that’s in the case of. Mr. Buffett. There’s a couple aspects to that. One, kind of famously, he’s got, you know, the world looks at what is now become known as the Buffett indicator, market cap to GDP.

[00:34:23] Chris Bloomstran: That’s an upward trending series over time in that it’s at an all-time high. It’s been an all-time high in the last few years. If you, 1929, And so in 2000, when it was approaching 140%, you’d look at a long term chart of market cap GPs and say, oh my god, this is, you know, we’re, so we’re way beyond where you were in the peak of.

[00:34:45] Chris Bloomstran: You know, leading up to the great depression, roaring twenties. Well, think about to your point about international profits. There was very little trade. The US was a net exporter to the tune of 4% of GDP. And we were importing 3%. So we ran a 1 % trade surplus in recent years, trades closer to it got up to 20.

[00:35:06] Chris Bloomstran: It’s been in decline for the last few years and I think there are things going on in China where trade is a percentage of overall global GDP is probably going to decline. But so you’ve got to adjust for, because again, to your point, if you’re doing more and more business abroad, and it becomes a larger percentage of your revenues and your profits, you’re going to capitalize a larger revenue base and a larger profit base at a higher number.

[00:35:27] Chris Bloomstran: Similarly, how much business was done in the 1920s by, publicly traded companies versus the private sector. Well, we were still only three or four decades in from the outset of the industrial revolution of the United States. Most of the economy in the 1920s was still agrarian. It was still private businesses.

[00:35:49] Chris Bloomstran: You didn’t have Amazon, you didn’t have Walmart. You didn’t have giant retailers. It was mom and pop. And so you’ve got to adjust again, your market cap to GDP for an upward trending series in the amount of business done now by publicly traded companies, which dominate the global economy. They certainly dominate the economy in the United States and then to profit margins to your point.

[00:36:13] Chris Bloomstran: Warren had an article in Fortune in 1999. Again, the tech bubble was developing and the market had gotten expensive. And he essentially said profit margins have reached a level on a mean reverting series where it makes today’s prices even that much more dangerous. He was wrong. He wound up being a hundred % wrong.

[00:36:34] Chris Bloomstran: So profit margins got up to 8.9% in 1929. And then but following for most of his investing lifetime. You had a range of four to six and a half percent net profit margins for the overall stock market. You were mid sixes in the late 1960s. Inflation raged, it ground margins down, it ground multiples down, and you had a 4% profit margin in 1982.

[00:37:02] Chris Bloomstran: And we capitalized it at eight times earnings. So stocks traded at 32% of sales. Whoa. Here in the last couple of years, they’ve traded at 10x that 300% of sales in part, because the margin got up to seven and a half % when he wrote that article for fortune, but we got up to 13.3%.

[00:37:21] Chris Bloomstran: Well, he wouldn’t have seen, he wouldn’t have expected before the financial crisis. Nobody would have expected 0% interest rates. I had my series of predictions in my 2000 letter that said interest rates would get down to 3% and there were 7 at the time. 3 was an outlandish thought.

[00:37:38] Chris Bloomstran: But it would have involved deflation, and I thought credit levels were so high already in 2000 that you would wind up ultimately with deflation. We may get deflation, but 0% interest rates and a compression of credit spreads allowed our publicly traded companies, it allowed our society, our government, it allowed households, but it allowed business, it allowed corporate debt to grow to levels of relative to revenues and profits that you’ve never seen.

[00:38:05] Chris Bloomstran: But rates were zero and spread and spreads were so tight that you could finance your debt at almost nothing. And so that low interest burden, interest expense on a very high amount of corporate debt helped the profit margin by 3%. So of that 13.3% peak margin three came from interest rates. You wouldn’t have seen the tax rate change from 35 % to 21 % with the 2017 TCJA.

[00:38:37] Chris Bloomstran: Well, if the government share, you know, goes from 35 you know, if they’re going to take the differential shareholders now own 79% of corporate profits versus 65% of corporate profits, so divide your 79 by 65, that’s a 21.5% increase in your profitability, apply that to the 50% or thereabouts of revenues and profits that are done domestically, and that added a percentage point to the profit margin.

[00:39:05] Chris Bloomstran: And nobody would have seen the cap light businesses, the mag sevens, with the exception of an Amazon that needs, you know, a lot of leverage in the capital structure, but there’s some capital intensity and data centers, but largely these have been very cap light businesses. Well, the collective profit margin of that group of seven.

[00:39:23] Chris Bloomstran: is over 20%, something like 20.7 or 20.8%. It’s almost double that of the overall S&P 500. So a bull case would be these seven businesses or businesses like this that have very high profit margins well above today’s 11.5% continue to grow their revenues and their profits as a proportion of the overall economy.

[00:39:45] Chris Bloomstran: And you could make a case then that the overall profit margin can be north of 13.3%. I’m not sure you’ll be able to do it for long for a whole host of reasons, regulation, competition from outside, competition with each other. Capitalism being doing what it does and regulators doing what they do are going to push back on that.

[00:40:04] Chris Bloomstran: In any event, it’s an interesting thought experiment, but it’s two places where I think Mr. Buffett kind of missed some things that nobody would have seen. And I don’t know what the right answer is. I mean, to me, 13.3 is very full because I think the mag seven at 33% of the S&P 500, 20% of S&P 500 profits, smaller percentage, you know, 11 or 12% of sales.

[00:40:31] Chris Bloomstran: I think those are very high for a group of seven businesses and again, going back to the five factors applied to the companies applied to the overall market, the profit margin is a big component and where it goes is a big deal. Again, if you have inflation margins are coming down, they’re not going up.

[00:40:48] Stig Brodersen: Yeah, I would say that if there are any students out there, perhaps see if you can ask for a tuition fee and get a refund of that. It is probably going to be a bit tricky, but if you can get your tuition fee back, go to buffett.cnbc.com. The best things in life are free. Then watch all the videos.

[00:41:04] Stig Brodersen: And then whenever you’re done watching the first time, then make sure to read Chris’ letters and then watch it another time but also be worried about when is it that Buffett is saying X, Y, Z. Of course, Buffett can also be wrong, like we just talked about, Chris. But I also think it’s important when we start quoting Buffett.

[00:41:19] Stig Brodersen: Like Buffett said this, yes, but he might have said this in, you know, 1984, whatever, like, and the world looked different. So I think that’s a, that’s another component that we should consider. You wrote in your wonderful letter that the intrinsic value increased by 11.3% and then thanks to attractive price share repurchase and increase the intrinsic value per share to 12.8%.

[00:41:43] Stig Brodersen: Now, later you wrote that the earnings power per share grew by 6.3%. I know I’m throwing a lot of numbers here at the listeners right now, but I think what I wanted to get at is why is an increase in intrinsic value, not the same as an increase in the earnings power?

[00:41:58] Chris Bloomstran: Interesting. When I work up what I call Berkshire’s earning power.

[00:42:05] Chris Bloomstran: I probably shouldn’t call it earning power. I should probably call it I think a better measure would be accounting adjusted smooth earnings, so I’m trying to get to the economic. I’m trying to get the economic earning power of the business But so I have a number of methods on how I appraise Berkshire in one set, I simply take reported earnings, gap earnings, and make a whole series of adjustments.

[00:42:31] Chris Bloomstran: You can find these every year in my letter. Taking out realized and unrealized gains, losses, putting in the retained earnings of the publicly traded companies that Berkshire owns. I normalize the underwriting margin cycle. I pull out last year’s giant under, underwriting profit and replace it with a 5% pre-tax.

[00:42:52] Chris Bloomstran: Number, I strip out the losses that from an accounting standpoint developed because of the periodic payment annuity and the retroactive insurance businesses. And that’s deep into the weeds. Adding back a portion of intangible expense, I kind of normalize what Berkshire will earn on its cash reserves over time, particularly when rates are zero, taking out the loss reserves that they’ve established for Pacific Corp’s wildfires, and now again, we’re deep into the weeds.

[00:43:23] Chris Bloomstran: I go through all those adjustments and that gets me to a normalized, call it 55 billion in what I call earning power for Berkshire. The reason you can get a disparity between the intrinsic value change and that is, is I capitalized that gap earnings number at a certain rate. What I’m not doing there is making any cyclical adjustments for how each of the businesses within Berkshire are performing.

[00:43:48] Chris Bloomstran: So, today, I think the railroad has been facing declining car loadings, some operational issues. And I think they’re under earning by almost 2 billion home services, the real estate brokerage business where they own some agent brokers, they own some agencies, they franchise some agencies, but rising interest rates have crushed transactional volume.

[00:44:12] Chris Bloomstran: There are very little mortgage refinancing. So you’ve got a number of subsidiaries inside of Berkshire that I think are under earning. And at times you’ve got some subs that are over earning. I don’t put that in the accretion of the earning power number. And so when I’m looking at the intrinsic value, I’m assuming the railroads are going to get back to the level of profitability at which I think it will exist on a more normalized basis.

[00:44:37] Chris Bloomstran: And so there’s a couple billion dollars there. So if you look at my sum of the parts, I’m normalizing the profitability of the railroad. I’m saying I’m going to pay 18 times for the railroad. I think it’s worth 130 billion, but it’s worth 130 billion, not on current depressed earnings, but on what I’d call normalized earnings.

[00:44:54] Chris Bloomstran: So that’s how you can get a disparity between the two. I mean, on a book value basis, the stock portfolio was up so much last year that the change in book value per share was something like 18%. It was way above the increase in what I think the increase in intrinsic value per share was. And both measures well above what the earnings was, because a portion of that, what I call earning power is actually the reported earnings on cyclically depressed businesses that I’m not making an adjustment for.

[00:45:23] Chris Bloomstran: So a lot of math and a lot of moving parts, but that’s how you can get that to spin and, you know, I thought about it when I wrote, I said, it’s going to, I said, I’m going to confuse a whole bunch of people by having these two disparities. I’m glad you asked, because I don’t think I clarified it in the letter.

[00:45:38] Stig Brodersen: One of my favorite things about reading your letters are the wonderful tables you have and I think the best one this year was on page 96, if anyone is going to browse after listening to this, or perhaps while they’re listening to this episode. And perhaps you said it best, Chris, because you said capital allocation is Berkshire, and Berkshire’s capital allocation, I just found that to be wonderful of you to put it that way. And so, what does that data table on page 96, what does that tell us about Berkshire’s capital allocation?

[00:46:10] Chris Bloomstran: Yeah, I think anybody interested in how managements allocate capital ought to look at the table, because there are only so many things you can do with money, and so what I wanted to show going back to when Berkshire started buying its stock back in 2018.

[00:46:25] Chris Bloomstran: You have this business that now has over a trillion dollars in assets and over 165 billion dollars of cash. So you have these giant numbers. When you think about the role of Omaha on a capital allocation front, you’re not really dealing with the enormity of Berkshire Hathaway. I mean, Berkshire is not a mutual fund where it can trim some shares of the Burlington and add to some shares of the Burlington. They can’t trim or buy any of the electric utilities or the pipelines. I mean, these are permanently held businesses. All of the MSR businesses are permanently held. So those are, that’s capital that’s permanently deployed, buys businesses, they stay in Berkshire.

[00:47:10] Chris Bloomstran: They’re not doing a lot of horse trading and so you can invest the cash reserves, and I’ve got a table and a letter that will show you that since the Gen re-deal in 98, cash reserves, cash is a percentage of total Berkshire firm assets is average 12, it’s a little higher today. They were a net seller of stocks last year, and that took the cash up to about 16% assets but it’s not out of line with where it’s been for the last quarter century.

[00:47:37] Chris Bloomstran: So I took from 18 by year, I wanted to show the really the five or so levers and so starting with cashflow from operations, but that’s the cashflow statement, that’s the cash that’s actually coming into the business. Well, there’s a claim. There’s an immediate claim on the initial portion of that cash from operations and that’s maintenance capital expenditures, which to my mind in the Berkshire world is going to roughly equate to their depreciation expense.

[00:48:07] Chris Bloomstran: So on what’s averaged, oh, 40 billion dollars a year for the last six years, ten of that is required maintenance. Cap X on your tangible assets and so that has left about 30 billion now Berkshire gets bigger by year. So these numbers are running closer to 50 billion in cash from operations today and 35, 36, 37 billion in investable cash after you cover your maintenance CapEx.

[00:48:36] Chris Bloomstran: So, what’s left? Share A purchases, growth CapEx, which is largely being deployed in the energy business, building out wind and solar and the grid that goes with it, acquisition of businesses like the Allegheny deal a year ago within the investment portfolio of the insurance operations, net selling or buying of common stocks, and then any change in debt and any change in the cash position.

[00:49:00] Chris Bloomstran: And so by line, you can show by year what Berkshire was doing with that 30 billion per year. And, you know, up until prior to last year, net purchases of their shares was the biggest component because they were big buyers. And I think it was 2020 and 21. It might’ve been 19 and 20, but they were buying about 25 billion a year.

[00:49:22] Chris Bloomstran: So they bought over the 6 years, 75 billion, they’ve retired 12 and a half percent of the outstanding shares over six years spent 75 billion to do it but they were a big net seller of stocks to the tune of 26 or 27 billion last year and so share buybacks became the big. They’re spending on growth CapEx.

[00:49:41] Chris Bloomstran: Well, now pushing 8, 9 billion, but what’s averaged about 5 or 6. Well, that’s largely the retained earnings of the energy business. None of which goes to the parent, all of which goes into, again, the building out of the energy assets. So it’s a fun exercise. I mean, it shows you that Berkshire really has.

[00:50:01] Chris Bloomstran: When I think about their cash position at 12% on average historically here for the last quarter century, I don’t think it’s going to come that far off of that. You know, he talks about 30 billion is kind of permanent cash reserves. Well, I also think there’s a permanence to cash reserves to cover the amount of cash losses that the insurance business pays.

[00:50:20] Chris Bloomstran: And that’s running, pushing 50 billion. So to my mind, you’ve probably got 70 or 80 billion dollars of the cash that’s just always going to be there. They may take it down below that, but it’ll get replenished. So you’ve got maybe 80 billion, call it half, call it 80 billion of the 160 and change. They can do something with if an elf, if an elephant comes along or they bolt on another Allegheny or something like that.

[00:50:42] Chris Bloomstran: And so what you’ll see is when they were the big buyer, when the 50 billion of the 75 billion of Share A purchases took place. It took place when the stock was cheap. I mean, they’ve spent $75 billion buying 12.5% of the company. The market caps currently 90 billion. Well, the market cap was a hell of a lot lower than 900 billion when they were buying those shares at much more.

[00:51:02] Chris Bloomstran: At much wider discounts to what I think intrinsic value is than it is today. Still buying because there’s not that much to do with money and the stock still trading in a discount to intrinsic value but there’s not of total assets, it’s not that much but I think these are the things by which the analyst to be judging any business under study.

[00:51:23] Chris Bloomstran: It’s what, what is, what does management do? When do they take on debt? When do they shrink debt? How do they use the share? Do they abuse it? Are they good to the shareholder? Where do they spend money on CapEx? Do they have the ability to reinvest in the business or don’t they? And a lot of places screw it up by making acquisitions.

[00:51:41] Chris Bloomstran: That are terrible deals and that they never want to look in the rearview mirror and assess whether they made a terrible deal. So I think running a study of any business. You’ve got to look to the cashflow from operations and then realize how much money is being produced and where does it go and this is just, you know, analysis 101.

[00:52:00] Stig Brodersen: And yet one could be surprised how few management that would do that, or at least appear to or do it well or do it well, I should say. Yeah, so let’s talk a bit about Berkshire’s equity portfolio. I really like in your letter how you’re tracking the performance of that. And since 1999, the CAGR has been 8.6 CAGR.

[00:52:20] Stig Brodersen: So compound annual growth rate 7.6 in comparison for the same period of time from the S&P 500 but I should also say that this is more impressive than it sounds because the stock portfolio it’s so massive and Buffett’s investing universe is so small but I think there was another element to it that I would like to speak with you about, Chris, because you mentioned that.

[00:52:39] Stig Brodersen: The advantage to the stock portfolio is not because it will beat the index anymore, though it has, and often quite a bit, but the advantage of the stock portfolio is that it is a stock portfolio, end quote. Could you please elaborate on what you mean by that?

[00:52:56] Chris Bloomstran: So a number of, so a couple of interesting things, I think, regarding the stock portfolio. One, to your numbers, Berkshire did 8-6. They beat the S&P 500. Well, both they and the S&P were coming off a period where stocks were expensive. I mean, Coca-Cola was a third of the stock portfolio and was trading at 50 times earnings. You had to work off Coke’s overvaluation. They should have sold it. They didn’t.

[00:53:21] Chris Bloomstran: Did the next best thing and bought Gen Re and acquired a mountain of cash essentially and took the stock portfolio down from 115% of shareholder equity, and it had been levered at more than a 100% for the prior 25 years. Took it down to 69%, diversified the stocks by buying a bond in cash portfolio, which was genius, but what that allowed Berkshire to do was then go buy the American energy the next year. I mean later by the railroad. It enabled Berkshire to take capital out of the stock portfolio as a percentage of Firm assets. Gen Re brought 45% of the combined Berkshire assets post-merger to the party and they got 18% of the ownership and it was an all-stock deal.

[00:54:04] Chris Bloomstran: Berkshire was trading in almost three times book when Mr. Buffett used the shares as currency. So you had to work off overvaluation, which they did. So, but Berkshire as a whole, if you compound Berkshire’s book value and its intrinsic value and its market value, Berkshire’s done a couple hundred basis points better than the stock portfolio because they reduced the stock portfolio.

[00:54:24] Chris Bloomstran: And then they all in turn, each of those components, Berkshire itself, Berkshire stock portfolio did better than the S&P. I’ve got another table that I think is really interesting and should be interesting to those that want to really get under the hood of Berkshire, and that’s, you know, we all have to report our 13F holdings every quarter, 45 days, you know, no later than 45 days post the quarter.

[00:54:45] Chris Bloomstran: So Berkshire posts their 13F until the last two years. They’ve had a table in the letter that lists the top positions both by cost basis and by market value. That’s gone missing, which is frustrating because I like seeing what they paid, at least in terms of what they paid for the current positions that are still in the portfolio.

[00:55:01] Chris Bloomstran: At least the big ones and you’ve got to do a little more work to try to figure out some of that stuff but underappreciated is the degree to which Berkshire has been a really good investor in non U.S. businesses. So at Semper, if you look at our 13F holding, people quote our assets under management, they quote our number of there are positions.

[00:55:22] Chris Bloomstran: Well, we have 20% of our capital invested in 10 internationally headquartered companies, only 3 of which we disclosed through the 13F. The SEC is if you don’t have a direct US listing, you don’t have to disclose and there’s a list of things you have to disclose. Businesses, well, we’ve got 7 that the world does, generally doesn’t know that we are unless I talk about them with you on a podcast or talk about it in the letter.

[00:55:44] Chris Bloomstran: Our clients know what they are, of course, right? That may change interesting sidebar. There’s a new proxy voting rule where even though you’ve got a hall pass on disclosing some of your international holdings, we’re going to, I believe, we believe, and we’re really trying to get to the bottom of this, but we believe that we’re going to have to disclose how we vote all of our proxies on things like management compensation, which may require we, Berkshire, everybody to disclose their foreign holdings.

[00:56:12] Chris Bloomstran: Well, we all know that Berkshire has the five Japanese trading companies that have been home runs. They’ve essentially doubled in value since they started buying them in 2019. BYD was a home run. They’ve got a little position in Diageo, but prior to those, there are a number of investments they made where they knocked the cover off the ball.

[00:56:31] Chris Bloomstran: PetroChina was huge. I got into the math of PetroChina in the letter two years ago, but POSCO, Tesco, Sanofi, they’ve owned Swiss Re, Munich Re. On most of those, they made a lot of money and so I’ve got a table that shows the, so we went back and calculated the returns. and then also pieced in to the degree that we could figure out the non-disclosed, non 13F positions, what each of those stocks did during the period of time they owned them.

[00:57:03] Chris Bloomstran: And we had to make assumptions during quarters at which price they might’ve sold them and I think we got it pretty close, but you added about 70 basis points of return to the 13F portfolio for the international businesses they’ve owned. So he’s been a very good investor abroad and it’s been materially beneficial to what’s now a 350 billion stock portfolio.

[00:57:24] Chris Bloomstran: Kind of to your point though, the most interesting thing about the stock portfolio is that it is a stock portfolio is. It exists largely 97, 98% of it is in the insurance operation. Well of all global insurers, Berkshire is allowed to own more common stocks as a percentage of insurance reserves and invested assets than any other insurance operation on the planet.

[00:57:39] Chris Bloomstran: And they can do so for a number of reasons. One, there’s a culture to the way they’ve run the thing since 1967’s purchase of national indemnity that says, we’re only going to try to write business when it’s attractively priced.

[00:58:05] Chris Bloomstran: And I think Berkshire followers know this. We’ll walk away from business. They had a bunch of years where they weren’t writing a lot of cat business. And when cat prices became more favorable a couple, three years ago, they started writing more cat business, but they’ve been willing to shrink volume. Very few public insurers, very few companies in the game do that.

[00:58:24] Chris Bloomstran: You know, they’re all kind of going for market share. Well, that’s allowed Berkshire to grow. Really negative cost float. I mean you’ve got this 130 plus billion dollars of float on the ballot sheet. It’s largely a net liability. There are some asset components to it, but the use of claimants money for a period of time, at a negative cost, is just remarkable.

[00:58:44] Chris Bloomstran: And so what that’s done over the years is allowed Berkshire’s surplus capital, its capital position, its book value as statutory surpluses defined by an insurance terms to grow to a level to where it’s about 330 billion. So when I compare Berkshire’s insurance operation, the biggest piece of the operation by value is the reinsurance business, national indemnity and Gen Re, which was bought in 98. So combined, they call that Berkshire Hathaway Reinsurance. GEICO is the largest insurance operation by premium volume. They’re writing 40 billion a year. Well, in auto, you can write three bucks in premium for every dollar in capital. So it needs maybe 15 billion of capital.

[00:59:26] Chris Bloomstran: I assign it a lot more. I think Berkshire assigns it a lot more. BH Primary, their specialty lines. Writing about 18 or 19 billion, you know, they need about a buck in capital to write that business. I give them more. So if you take Berkshire’s combined 330 billion and assign GEICO and primary 60. That leaves 270 billion, which I think is the right number that exists as statutory surplus in the reinsurance business.

[00:59:54] Chris Bloomstran: I’ve got another table in my letter that shows you global reinsurance capital, which got beat up in 2022, recovered a little bit through November or September of last year, all of the capital, all of the statutory surplus of all global reinsurers, Swiss Re, Munich Re, Berkshire’s businesses, totals, about 530 billion.

[01:00:16] Chris Bloomstran: And if you throw in alternate capital, so cat bonds, Insurance Link Securities, that adds another 100 billion, so you get to about 630 635 billion in global total reinsurance capital. Berkshire has 270 of that. They have half of traditional reinsurance capital and something like 45% if you include the alts.

[01:00:39] Chris Bloomstran: Berkshire’s premium volume is about 27 billion, so Berkshire is riding 0.10 on its own statutory capital of premium volume. Total premiums in the industry are over half of capital. I mean, there’s 350 billion. So Berkshire’s writing less than 10 % of industry premium volume, and it’s got half the capital.

[01:01:02] Chris Bloomstran: Now if you strip and so, you know, I’ve always thought, I always think reinsurers should write maybe 50 cents on the dollar, but they don’t. Swiss Re and Munich Re write a dollar of premium for every dollar of capital. So they have to recapitalize every time you’ve got a bad hurricane season. And they’re crappy stocks over 25 year periods of time, and they can’t own stock portfolios.

[01:01:23] Chris Bloomstran: They’ve got very small portions of their insurance reserves invested in common stocks. Berkshire, with its surplus mountain of capital, I mean, you know, they could write way more business, but instead, they’ve got a stock portfolio. And to our earlier discussion, a 170 basis point drag in our quarter century as Semper Augustus, the difference between a million growing to 15 or growing to 10 is huge.

[01:01:46] Chris Bloomstran: Berkshire’s ability to own common stocks if it earns the Ibbotson 10.5% per year compared to a bond portfolio earning four or five, you take a 400, 500 basis point advantage versus everybody else in the insurance game. That’s how you get to be the 800 pound gorilla that if you get a wicked, so on 635 billion, let’s say it’s total global reinsurance capital, you get two or three hurricanes in the U.S. Gulf Coast, you get an earthquake or two in California, you get a big earthquake in Tokyo, it’s just a whole, just imagine the worst of possible, you get a terrorist attack, whatever, you get another 9-11. Berkshire’s writing 27 billion, if they lose 100%, you know, they blow up 27 billion of capital. You know, if they have a loss, double their premium volume, they’re 27 billion out.

[01:02:38] Chris Bloomstran: That’s 10% of their statutory surplus. It would bankrupt almost every other reinsurance company in the world. So, you know, there are those that are trying to emulate and become Berkshire and some are really good at it. You’ve got Weston Hicks built a great insurance operation at Allegheny now.

[01:02:55] Chris Bloomstran: It’s a better business inside of Berkshire, but he did a marvelous job with Allegheny Capital. Markel has done a good job over the years, but nobody has the advantage of Berkshire and so when I say it doesn’t matter if the Berkshire stock portfolio beats the S&P 500 or not, does not matter. The embedded advantage of Berkshire is the size of their surplus capital relative to everything else that will finance the next railroad, the next elephant that Berkshire buys.

[01:03:21] Chris Bloomstran: Because that money comes from the conservatism to which they underwrite. It comes from the cost advantage that Geico has. Now everybody says progressive is beating GEICO and they have in the last few years, they’ve done better and things like telematics, but both of those businesses have a cost advantage over the rest of the auto insurance industry, which is a crappy industry.

[01:03:40] Chris Bloomstran: But as a low cost underwriter, that’s how, within a couple, three years, GEICO and Progressive and GEICO are going to pass State Farm for the number one position as writers. GEICO makes money over time, and most of the auto insurance underwriters barely break even, and most of them exist at a long term underwriting loss.

[01:04:00] Chris Bloomstran: They want that little bit of float, but for that, they’ve got to have bond portfolios. Berkshire, earning 10 on its stocks versus earning 4 or 5, run the math over decades? That’s how Berkshire got to be what it is, and that’s how Berkshire will continue to be what it is, relative to the insurance industry, and I think relative to the aggregate of the companies that make up the S&P 500, over the next 10, 20, 30 years. Huge structural advantage, by having a stock portfolio. Doesn’t matter what it earns, just don’t blow it up.

[01:04:29] Stig Brodersen: Chris, you always outline these four different evaluation models and, you know, pick your poison, you know, they have their distinctive weaknesses and strengths, but perhaps my personal favorite is the sum of the parts.

[01:04:41] Stig Brodersen: Now, using that approach, which valuation would you put on Berkshire Hathaway? And you also mentioned that subsidiaries would commend higher valuation if they’re not publicly traded. So I guess that’s the two part question I have for you.

[01:04:53] Chris Bloomstran: Yeah, to your second point, I think if you broke up Berkshire. Only because it trades at a discount to what I think is a very conservative appraisal of intrinsics. Some say Chris is, you know, crazy on assuming that there’s a tax advantage to using accelerated depreciation in the regulated businesses, the energy operation, the railroad, but that’s a billion dollars.

[01:05:16] Chris Bloomstran: I mean, it’s a rounding air in the grand scheme of $55 billion in economic profit. Take the railroad. I mean it’s, it looks, it’s almost identical to Union Pacific. I mean, you know, perhaps because we haven’t done precision scheduled railroading, who knows? But our operating margins are a little bit below Union Pacific’s at the moment, but they’re very similar in terms of track miles, revenues, kind of long term profitability.

[01:05:40] Chris Bloomstran: Well, I’ve got the railroad appraised at 130. I think the Union Pacific trades at around 150 billion today. It’s had a cap as high as 170 or 180 billion dollars recently. If the railroad were public, it would have a market value North of my appraisal and way north of the 35 or 37 billion dollars that Mr. Buffett paid in 2009 for it and the majority of the railroad’s profits, by the way, have been upstream to the parent. for use elsewhere in the empire, but it would be, it would trade at a higher price. The energy operations, I run them at 15 or so times, but the energy business earns utilities in the last 15, 20 years of traded at 20x.

[01:06:26] Chris Bloomstran: They got beat up when interest rates rose in the last couple of years, but standalone, they’d trade for more. Now that said, you can do the same thing with the MSR businesses that I run at 18 to 19 times earnings, but they’re completely unlevered. There’s pretty much as much cash, in that group, offsetting the little bit of debt that’s used.

[01:06:45] Chris Bloomstran: If you put each of those businesses in the hands of private equity, they could lever them up, increase the earnings on a per share basis of those companies, just with the use of debt and if you listed them publicly, they would trade for a hell of a lot more than my conservative appraisal. So you could do that, but you would never want to do that because you’d get the one time blip, the one-time pop, break it up.

[01:07:06] Chris Bloomstran: Activists might love it. Short term investors might love it but so many of Berkshire’s subsidiaries so many of its operating companies are better businesses inside of Berkshire and they would be elsewhere. When Gen Re came in, when Allegheny came in, they don’t have to go to the retrocession market and lay off risk.

[01:07:22] Chris Bloomstran: Berkshire is so over capitalized, they can retain every dollar of premium that’s written and not lay it off to other reinsurers. Allegheny’s investment portfolio, which Weston did a brilliant job of, can own way more stocks than they could have being part of Berkshire than elsewhere. There are structural advantages across all of the entities where you use debt at the railroad in the energy operation.

[01:07:48] Chris Bloomstran: Even though it’s not hypothecated to the parent, don’t tell me that the rating agencies don’t look at Berkshire’s fortress balance sheet. and assign it strength for that very reason. The decentralized nature of the business at the top and the way it’s run eliminates layers of corporate overhead that would exist otherwise.

[01:08:07] Chris Bloomstran: So I think it’d be the most foolish thing in the world to break it up, but they would trade at a premium, assuming my appraisals, assuming my intrinsic value numbers are correct. And again, just comp by comp, I think they’re conservative because the sum of the parts gets you to a lower number. The sum of the parts at present, it has a disparity.

[01:08:25] Chris Bloomstran: To your point about intrinsic value, I won’t go into it again, but you know, at the moment, it’s roughly a trillion and forty, a trillion and fifty billion. On my gap adjusted, you’re 5% lower, but those all move back and forth. There are sometimes when your price, your simple price to book, kind of, kind of, I’m down at Berkshire’s worth about 175% a book.

[01:08:46] Chris Bloomstran: That’ll change over time in a year where stocks go way up, like last year, the book value per share grows. So the relationship of price to book changes in a year where the stock portfolio goes way down like the prior year. It’s a less useful measure, but it, Berkshire’s price relevant to book is more attractive at times when the stock portfolio is cheaper, only because there’s more upside in the stock portfolio, but yeah, I think for those that want to value it, best way to do it is trying to break out each of the subsidiaries and look through to what they are.

[01:09:16] Chris Bloomstran: And you can do it pretty easily with the railroad and the energy operation because they have their own publicly traded debt and they all follow their own K’s and Q’s. You can get deep into the weeds on each of the moving parts inside of Berkshire Hathaway Energy. How each of the pipelines are performing.

[01:09:30] Chris Bloomstran: How the LNG terminal is doing, each of the utilities. As much detail as you want to get and then Berkshire’s financials elsewhere are adequate. You can pull up the statutory filings for GEICO and you know, really go crazy with it but you know, you’ve got it a little over a trillion and you know, unfortunately today, the stock has moved up and for those that like to buy the shares, which I like to do with new cash coming in.

[01:09:53] Chris Bloomstran: And that I think Berkshire likes to do when the stock is cheap. Even though he’s increased the cadence. Warren has increased the cadence of buying in the first quarter. It’s probably for a lack of opportunity. The stocks up a bunch this year. It’s way ahead of the S&P 500. I’m not investing in it at present at a full weight.

[01:10:09] Chris Bloomstran: I like to make it 20% of client capital. I’m not buying it fully 20% only because the discount to what I think the fair value of the business is, which is a little over a trillion, is tightened up enough to where history being a guide, at least history being a guide over the last 25 years and I’d expect either through a flat stock or even a declining stock in an overall stock market decline.

[01:10:32] Chris Bloomstran: Shares will probably be a little cheaper relative to value at a point and so again, kind of back to the patience of whether you should put cash to work right away or not. Berkshire is less attractive today because the stock has done so well relative to its own internal fundamentals and also versus the S&P.

[01:10:48] Stig Brodersen: And could you, for the convenience of the listener, whenever you say a bit more than a trillion dollars, what is that roughly for the A shares and perhaps specifically for the B shares?

[01:10:56] Chris Bloomstran: Um, Do the math here. 1.45 A share equivalents out. So whatever that is on a, you know, so call fair value, a trillion and 50 billion, divided it by 1.45 and that gets you the number.

[01:11:11] Stig Brodersen: Yeah.

[01:11:11] Chris Bloomstran: And then divide your B shares by their equivalent 1500.

[01:11:15] Stig Brodersen: Yeah. This has been amazing as always. I would like to give you a hand off, where the audience can learn more about you, Semper Augustus, and then, of course, your wonderful letters. And also, if you have anything else to add, I know we covered a lot of ground, but it’s always great to chat with you, Chris.

[01:11:31] Chris Bloomstran: No, I love our conversations, Stig. I wish you were going to be in Omaha this year. The letters, I think the best place, so the best place to go is our website. We have a tab, we have an exclusive tab for the client letters and we’ve got them all the way back to 1999. Our conversation today, we’ve got another tab for interviews and podcasts, so as soon as you publish, you know, we’ll get it up there within a day or two.

[01:11:52] Chris Bloomstran: We’ve got an archive of a lot of our conversations. The one I think one of the greatest things you did was collaborating with William Green.

[01:12:00] Stig Brodersen: He’s fantastic, yeah.

[01:12:01] Chris Bloomstran: We had our conversation on his Richer, Wiser, Happier podcast last year that’s part of your group and that’s been really well received. That’s on our website.

[01:12:11] Chris Bloomstran: We’ve got a lot of great feedback on that conversation and that went down some rabbit holes that I wouldn’t have expected to go down but, and he’s such a good human being. That was just a fun talk and then of course I’m on Twitter or X, or maybe they should have called it Twix. I’ve not been very active of late, although, I don’t know if you saw this, but having flipped and flopped on verified accounts, when Elon took over the business, he freed up the verification process and let anybody buy a blue check.

[01:12:38] Chris Bloomstran: Well, those that didn’t want to spend eight bucks a month or whatever it was, just two days ago, I’m now a verified, I’m a non-paying blue checker, whether that means I’ll be back engaged on Twitter, but we’re coming up on the season where Kathy and Art presumably are going to put out their next test the report that says the business is worth 58 trillion last year was 9 stocks, 6% of better, you know, some she’s off by a little bit.

[01:13:03] Chris Bloomstran: Well, if she puts out another report, she and her team I’ll have some fun with that on X, but I’d say the website and then if anybody’s in Omaha, stop by and say hi and catch up with me there.

[01:13:15] Stig Brodersen: It was fantastic as always to chat with you.

[01:13:18] Chris Bloomstran: Thanks, Stig and maybe I’ll see you in Europe this summer.

[01:13:21] Outro: Thank you for listening to TIP.

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