15 May 2025
State of Markets
The past several weeks have highlighted the fundamental difference between two investment approaches: trying to predict what the markets will do next and focusing on underlying businesses. While historically, I have done my best to transition from the first group to the second, I was not entirely immune from the market influence. This stopped me from deploying cash in a few attractive opportunities, which I discussed with Premium Subscribers earlier.
I still think there are quite a few interesting opportunities in the market and probably even more will emerge later this year.
While the worst has been avoided, the fundamental challenges faced by both US and Chinese economies remain. The US government spends about $1tn on interest expenses, which accounts for 3% of its GDP, while the federal budget runs at c. $1.8tn (2024), or 6%. In other words, half of the deficit is spent just on interest expenses.
Moreover, US government debt (at $36.5tn) has now exceeded the size of the economy (GDP), which means that the country will remain in a debt spiral unless its economic growth exceeds interest rates on debt or the country goes through a high inflationary period. The latter may cure the immediate debt problem but has its own long-term consequences.
Valuations are not cheap and are relatively high for some sectors and stocks. Investors got used to high growth rates and improving margins, which, to a high degree, is the result of the previous fiscal stimulus, low rates and tax cuts.
Given the state of the budget, these instruments may not be readily available for the regulators to extend economic growth in the medium term.
China, too, has its issues, especially in the property market, demographics, and business climate.
My conclusion is that markets are not particularly cheap, and it is better to be cautious and selective. This is not one of those moments when staying generally invested is more important than what exactly you own. I do not see a high risk of missing the boat by keeping part of the portfolio in cash.
But waiting for the crash is also not helpful and has rarely been a good strategy. Markets are self-correcting. Even the Chinese economy is much more market-driven than some developed countries. It has plenty of excellent entrepreneurs and a strong business drive.
My current focus is on cheaper stocks with high net cash positions, above-average dividends or buybacks and potential special situations. I am less interested in looking for great compounders as their valuations have not come down despite more macro uncertainty.
As Peter Cundill used to say, "There is always something to do."
I still think there are quite a few interesting opportunities in the market and probably even more will emerge later this year.
While the worst has been avoided, the fundamental challenges faced by both US and Chinese economies remain. The US government spends about $1tn on interest expenses, which accounts for 3% of its GDP, while the federal budget runs at c. $1.8tn (2024), or 6%. In other words, half of the deficit is spent just on interest expenses.
Moreover, US government debt (at $36.5tn) has now exceeded the size of the economy (GDP), which means that the country will remain in a debt spiral unless its economic growth exceeds interest rates on debt or the country goes through a high inflationary period. The latter may cure the immediate debt problem but has its own long-term consequences.
Valuations are not cheap and are relatively high for some sectors and stocks. Investors got used to high growth rates and improving margins, which, to a high degree, is the result of the previous fiscal stimulus, low rates and tax cuts.
Given the state of the budget, these instruments may not be readily available for the regulators to extend economic growth in the medium term.
China, too, has its issues, especially in the property market, demographics, and business climate.
My conclusion is that markets are not particularly cheap, and it is better to be cautious and selective. This is not one of those moments when staying generally invested is more important than what exactly you own. I do not see a high risk of missing the boat by keeping part of the portfolio in cash.
But waiting for the crash is also not helpful and has rarely been a good strategy. Markets are self-correcting. Even the Chinese economy is much more market-driven than some developed countries. It has plenty of excellent entrepreneurs and a strong business drive.
My current focus is on cheaper stocks with high net cash positions, above-average dividends or buybacks and potential special situations. I am less interested in looking for great compounders as their valuations have not come down despite more macro uncertainty.
As Peter Cundill used to say, "There is always something to do."
Berkshire Hathaway
2025 meeting and Buffett’s succession
Unfortunately, I missed the 2025 shareholder meeting in Omaha and watched it at home. But I plan to come next year. The biggest news, of course, was Buffett’s announcement that he would retire by the end of the year and that Greg Abel will succeed him as the CEO from 1 January 2026.
While this is the change of era at Berkshire, which was built by Buffett, I view this as a positive development. It would inevitably have happened sooner than later. It is better for Greg to step in while Buffett is still around.
Moreover, the historical focus of Berkshire on acquiring businesses may need to change. Existing operations have become so significant (e.g., top US railway operator and utility provider) that they require more attention from Berkshire’s HQ. They may need investments to stay competitive but also to expand (reinvestment opportunities). This may be a better use of Berkshire’s time and capital than another $10bn investment in a large public stock.
Greg Abel gained experience in finance and utility business operations working under David Sokol at MidAmerican Energy. Berkshire acquired the company in 1999 and changed its name to Berkshire Energy. The company has delivered c. 16% annualised earnings growth from 2021 to 2024, with net profits rising from $142.7mn in 2001 to $4.3bn in 2024. The growth would have been even better if recent performance was not affected by wildfire expenses.
Like its parent company, Berkshire Energy has not paid dividends but is reinvesting all of its profits into the business.
One question I was pondering after returning from Omaha last year was why Berkshire’s subsidiaries did not grow to become world leaders or at least achieve national status. Everyone who tries Dairy Queen’s ice cream or See’s Candy would say it is one of the best they have ever eaten. And I agree, they taste nice. But then everyone would sadly admit they can only eat them in Omaha or other locations where they are sold (e.g. California).
But if consumers love the product, why not expand into other states and possibly countries?
Buffett’s willingness to give free rein to subsidiary managers and take cash from them as long as they had no better alternative for reinvestment may have been why these subsidiaries lacked ambition or were just too afraid to disappoint their chairman.
Abel seems to work much closer with Berkshire’s businesses, even investigating potential synergies by sharing best practices, new IT systems, etc.
While this is the change of era at Berkshire, which was built by Buffett, I view this as a positive development. It would inevitably have happened sooner than later. It is better for Greg to step in while Buffett is still around.
Moreover, the historical focus of Berkshire on acquiring businesses may need to change. Existing operations have become so significant (e.g., top US railway operator and utility provider) that they require more attention from Berkshire’s HQ. They may need investments to stay competitive but also to expand (reinvestment opportunities). This may be a better use of Berkshire’s time and capital than another $10bn investment in a large public stock.
Greg Abel gained experience in finance and utility business operations working under David Sokol at MidAmerican Energy. Berkshire acquired the company in 1999 and changed its name to Berkshire Energy. The company has delivered c. 16% annualised earnings growth from 2021 to 2024, with net profits rising from $142.7mn in 2001 to $4.3bn in 2024. The growth would have been even better if recent performance was not affected by wildfire expenses.
Like its parent company, Berkshire Energy has not paid dividends but is reinvesting all of its profits into the business.
One question I was pondering after returning from Omaha last year was why Berkshire’s subsidiaries did not grow to become world leaders or at least achieve national status. Everyone who tries Dairy Queen’s ice cream or See’s Candy would say it is one of the best they have ever eaten. And I agree, they taste nice. But then everyone would sadly admit they can only eat them in Omaha or other locations where they are sold (e.g. California).
But if consumers love the product, why not expand into other states and possibly countries?
Buffett’s willingness to give free rein to subsidiary managers and take cash from them as long as they had no better alternative for reinvestment may have been why these subsidiaries lacked ambition or were just too afraid to disappoint their chairman.
Abel seems to work much closer with Berkshire’s businesses, even investigating potential synergies by sharing best practices, new IT systems, etc.
Thoughts on Berkshire stock
I disagree with investors who are concerned about Buffett leaving Berkshire. Indeed, he is one of the best investors the world has ever seen, but the success of Berkshire is not just about making correct decisions on the new investments. Especially today, given its size. People often miss its unique structure with one of the world’s largest reinsurance operations, leading capital-intensive businesses (energy utilities and railways), plus dozens of smaller high-quality companies and an extensive liquid investment portfolio. There is also a unique culture that centres on integrity, focus and relentless drive.
I don't see the stock severely overvalued to the extent that it will hurt future returns.
Its latest Mkt Cap is $1.1tn, and it has a net cash of $357.4bn (incl. fixed income instruments) and a portfolio of listed securities worth $263.7bn (as of 31 March 2025). This leaves the EV of its core operations at an enterprise value of $478.8bn.
These operations generated $24.7bn of net operating income (after tax and interest) and $9bn in insurance underwriting profit.
Last year was exceptional for the insurance operations, so using a more conservative $7bn profit and applying a 12x P/E multiple (peer average), we get to a rough valuation of $84bn.
The industrial companies (mostly energy and railways) have generated $24.7bn of net operating profit, which could be worth 15-20x P/E (or $371-$494bn).
So, the two unlisted segments (insurance and industrial businesses) combined could be worth $475-578bn. This is a little higher than the implied EV of $478.8bn (Mkt Cap less Cash and Stocks).
With the stock being valued at a fair level, the future returns should be driven by the returns of the underlying businesses. I don’t think there is a very scientific way of predicting this, but an assumption of c. 10% return on capital seems fair (and probably conservative). Positive cost of float (3-4%) should contribute to total returns of 13-14%.
Plus, Berkshire has over $350bn dry powder that is more valuable in a more uncertain environment. This offers an additional option value.
The only obvious risk is the de-rating of Berkshire stock as investors remove ‘Buffett premium’ from their calculations. Firstly, I am not sure there is a significant premium in the price. P/B (which is well above 1x) is not very helpful given the high proportion of acquired businesses that are recorded at ‘depreciated’ values today but that, on aggregate, are worth significantly more than when they were first acquired.
More importantly, the company can always use buyback should the share price drop significantly.
I don't see the stock severely overvalued to the extent that it will hurt future returns.
Its latest Mkt Cap is $1.1tn, and it has a net cash of $357.4bn (incl. fixed income instruments) and a portfolio of listed securities worth $263.7bn (as of 31 March 2025). This leaves the EV of its core operations at an enterprise value of $478.8bn.
These operations generated $24.7bn of net operating income (after tax and interest) and $9bn in insurance underwriting profit.
Last year was exceptional for the insurance operations, so using a more conservative $7bn profit and applying a 12x P/E multiple (peer average), we get to a rough valuation of $84bn.
The industrial companies (mostly energy and railways) have generated $24.7bn of net operating profit, which could be worth 15-20x P/E (or $371-$494bn).
So, the two unlisted segments (insurance and industrial businesses) combined could be worth $475-578bn. This is a little higher than the implied EV of $478.8bn (Mkt Cap less Cash and Stocks).
With the stock being valued at a fair level, the future returns should be driven by the returns of the underlying businesses. I don’t think there is a very scientific way of predicting this, but an assumption of c. 10% return on capital seems fair (and probably conservative). Positive cost of float (3-4%) should contribute to total returns of 13-14%.
Plus, Berkshire has over $350bn dry powder that is more valuable in a more uncertain environment. This offers an additional option value.
The only obvious risk is the de-rating of Berkshire stock as investors remove ‘Buffett premium’ from their calculations. Firstly, I am not sure there is a significant premium in the price. P/B (which is well above 1x) is not very helpful given the high proportion of acquired businesses that are recorded at ‘depreciated’ values today but that, on aggregate, are worth significantly more than when they were first acquired.
More importantly, the company can always use buyback should the share price drop significantly.
Airbnb
Results
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