COVID-19 and the Great Disconnect

COVID-19 and the Great Disconnect Student Help Bertrand Guillotin
 

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Berkshire Hathaway: COVID-19 and the Great Disconnect
 
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Warren Buffet, 1986 Letter to Shareholders1
 
Synopsis
This investment strategy had proven powerful for Berkshire Hathaway, Inc. It had transformed a bad textile company into a diversifed investment company, ranked as the 12th largest company in the world in 2019, right behind Apple.2 It had made Warren Bufet a billionaire and countless of his shareholders millionaires. At the end of 2019, Berkshire’s shareholders included Fidelity Investments and the central bank of Norway. The company’s stock was considered the number one retirement stock in America.3
Amid the 2020 coronavirus pandemic, U.S. fnancial markets crashed at record speed (–35% between February 12 and March 20, 2020), including the biggest single-day drop ever of –12.9% on March 16, 2020, eclipsing the record of October 28, 1929.4
Expected to be greedy when others are fearful, Bufet was a net seller of stocks and remained on the sideline during that period. His inaction, combined with an unusually cautionary tone at the annual shareholders’ meeting, triggered heavy criticisms. Some of his loyalists sold their stocks. As he was approaching his 90th birthday, many started to wonder whether Warren Bufet had changed his time-tested strategy. Was he disconnected from reality? Was he fearful himself?
Berkshire Hathaway, Inc., During the 2020 Historic Crash
On February 24, 2020, Warren Bufet, interviewed by CNBC’s anchor Becky Quick, made clear that, as the outbreak caused fears of a global economic slowdown, his long-term outlook remained unchanged.5 With US$128 billion6 in cash then, he had plenty of options.
During this crash, Wall Street’s fear gauge or volatility index (VIX), invented by Dr. Bob Whaley, had gone from 13.74 on February 12 to 82.69 on March 16, 2020.7 With everyone fearful, Warren Bufet, who had experienced many fnancial crashes, was expected to be greedy; i.e., he was expected to buy vast amounts of stocks at a deep discount during the fastest bear market correction in history. However, he did nothing of the kind, especially by Berkshire’s standards, only buying a net amount of US$1.83 billion of stocks during the frst quarter8 and selling approximately US$6bn worth of, for example, airline stocks in April. His stock portfolio plummeted by 27% from about US$242 billion to US$176 billion during the frst quarter of 2020. As the stock market recovered most of its losses in April, criticisms multiplied, some long-time shareholders sold their Berkshire Hathaway stocks,9,10 and the company’s stock (NYSE ticker BRK.A) price continued to slide (see Exhibit 1). On May 2, 2020, the tone at the annual shareholders’ meeting changed from typically cheerful to more serious; it was a rare history lesson, combined with risk management advice.11 Bufet did not try to convince shareholders that everything was going to be just fne; rather, he reassured them about what they could count on, amid this unprecedented uncertainty.
 
Copyright © 2020 Tunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise. Tis case was written by Professor Bertrand Guillotin for the sole purpose of providing material for class discussion. It is not intended to illustrate either efective or inefective handling of a managerial situation. Te author may have disguised certain names and other identifying information to protect confdentiality. Any reproduction, in any form, of the material in this case is prohibited unless permission is obtained from the copyright holder.
 
 
This great disconnect between expectations and behaviors, both during the meltdown (buying opportunity of a lifetime; see Appendix A) and at the annual shareholders’ meeting, was raising many questions, such as what factors may have prevented Warren Bufet from buying heavily during this historic sell-of and when is it time for any CEO to reconsider a time-tested strategy?
Warren Bufet
Known as the “Oracle of Omaha,” Warren Edward Bufet was born on August 30, 1930, in Omaha, Nebraska, one of three children.12 His father was a stockbroker who became a member of the U.S. House of Representatives in 1942, and his mother was a homemaker. Gifted for mathematics, Warren Bufet started investing at age 11, enrolled at the University of Pennsylvania at age 16 to study business, and assumed control of Berkshire Hathaway in 1965. He was also known as one of the richest people in the world with an estimated net worth of US$68 billion as of May 2020, who had donated close to $28 billion between 2006 and 2017, according to USAToday .13 As Berkshire’s Chairman and CEO since 1970, Bufet remained the majority shareholder of the company.
A very witty and folksy personage, Bufet was also known for his enduring personal habits; i.e., living in the same house since 1957 and earning the same salary of US$100,000 (very modest compared to other CEOs) since 2006. The following quotes, collected by M. Frankel, a Certifed Financial Planner,14 described some of his values, especially in regards to his disciplined and strategic approach to investing:
On Money, Price, and Opportunities
· “Rule No. 1 is, never lose money. Rule No. 2 is, never forget Rule No. 1.” (Warren Bufet’s golden rule).
· “Price is what you pay. Value is what you get.”
· “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”
· “Widespread fear is your friend as an investor because it serves up bargain purchases.”
· “The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
On Valuation and Long-Term Ownership, as Opposed to Frequent Trading
· “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
· “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
· “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”
· “An investor should act as though he had a lifetime decision card with just twenty punches on it.”
· “Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least fve years. Those who seek short-term profts should look elsewhere.”
On Temperament and Patience
· “The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”
· “The stock market is a no-called-strike game. You don’t have to swing at everything—you can wait for your pitch.”
On Market Crashes and Prudence
· “The years ahead will occasionally deliver major market declines—even panics—that will afect virtually all stocks. No one can tell you when these traumas will occur.”
· “The best chance to deploy capital is when things are going down.”
· “Predicting rain doesn’t count; building the ark does.”
On Strategic and Sustainable Competitive Advantage
· “The key to investing is not assessing how much an industry is going to afect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.”
 
 
 
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This last quote, in particular, clearly indicated that Bufet was as much of a strategist as he was an investor. His strategy was to focus his research on a handful of industries and sectors, buying businesses that were well-managed and competitively dominant, enjoying the returns over time.15 It was this long-term view, holding stocks for an average of 7.5 years but sometimes for decades (e.g., Coca Cola, American Express) as compared to less than one year for retail (individual) investors, that played the biggest role in Bufett’s and Berkshire’s long-term success.
Amid the typical bustle of activities and billions that changed hands within seconds among stock market participants on any given day, Bufet was known to act calmly. His buy-and-hold strategy enabled Berkshire to defer any capital tax payment until the company sold any shares.16 In addition, the fact that Berkshire did not pay dividends eliminated any tax liability on dividends earned by shareholders.
His ability to think diferently about these important long-term implications had produced outstanding and unparalleled results since 1965.
Results
From the time he assumed control of Berkshire Hathaway, mathematical calculations indicated that “US$1,000 invested with Warren Bufett since 1965 would be worth more than $27 million today,” whereas the same amount invested with the S&P 500 would be approximately $200,000.17
Along the way, Warren Bufet and Berkshire Hathaway made several large acquisitions, especially during the 2008 global fnancial crisis (see Exhibit 2).
Major Crises

2008
Whereas Warren Bufet had kept a relatively low profle throughout his career, he took center stage during the 2008 fnancial crisis, defending capitalism and America. A month after the implosion of Lehman Brothers, he published an article in the New York Times on October 16, 2008, titled “Buy American, I am.”18
However, the stock market, measured by the S&P 500 index, continued its downward spiral, tumbling from 946 on October 16, 2008 to 666 in intraday trading on March 6, 2009.19 For those dates, respectively, the VIX index (Wall Street’s fear gauge), had changed from 67.61 to 49.33.20
Called the Great Recession, the crisis of 2008 was addressed through several government bailouts and stimulus packages which totaled close to $1.5 trillion while unemployment reached 10% in the U.S. in 2009.21 Considered a fnancial crisis that started with the 2006 subprime mortgage crisis, the 2008 crisis could have turned into a global depression if left unaddressed. Meanwhile, Bufet made an estimated US$10 billion during that crisis, fnancing diferent several billion-dollar deals and making strategic acquisitions (see Exhibit 2).
Economic crises were known to happen from time to time in a capitalist system. However, the crisis of 2020 was triggered by a public health crisis and a planned shutdown of the economy as a result of the pandemic, caused by the novel coronavirus or COVID-19.
COVID-19
As a consequence of the global pandemic that caused so many tragedies and casualties, the U.S. economy was shut down by governing authorities to stop the spread of the virus. Naturally, the stock market plunged in February– March 2020 with unprecedented magnitude and speed, as mentioned above. After years of low volatility, fear came back (see Exhibit 1) and unemployment numbers increased with the same unprecedented magnitude and speed that had caused the crash (see Exhibit 3).
However, the swift and powerful rescue packages passed by Congress and the Federal Reserve system, led by FED Chairman Jerome Powell, injected US$3 trillion of liquidity22 into the economy and fueled renewed optimism.
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Right after the late March coronavirus sell-of, billionaire investor Bill Ackman acquired between US$219 million and US$255 million worth of Berkshire Hathaway.23 This move increased his US$5.7 billion hedge fund’s stake in the Oracle’s company from 11% to 13%, since he believed, as a longtime shareholder and seasoned investor, that “Berkshire will emerge from this crisis as a more valuable enterprise. ”In addition to this purchase of 1.4 million BRK.B-class24 shares, Vanguard Global Advisers, LLC, purchased fve million BRK.B shares on March 31, 2020.25 This LLC was part of the Vanguard Group, Inc., an investment company and the largest institutional investor of B-class shares in the world with a stake worth US$25.8 billion approximately. It was also important to keep in mind that more than 70% of B-class shareholders were institutional investors, which are typically more conservative than individual shareholders.
At the end of April, Brian Meredith, a respected analyst at Union des Banques Suisses, cut his estimate about Berkshire’s A-shares 12-month price target down to US$358,000 from US$393,000, due the impact of the coronavirus, using some-of-the-parts (SOTP) analysis to value the complex conglomerate.26 Bill Ackman added that he was “surprised they [Berkshire] haven’t done anything yet that’s visible, but my guess is they’ve been buying stocks, a lot” before concluding that “big opportunity for Berkshire is Berkshire itself,”27 a major buyback of shares. Interpreted as votes of confdence, buybacks (companies buying their own shares back, thus boosting their own stock price) had been instrumental in the longest bull market since 2009, reaching US$1.8 trillion in 2018

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