Behind the Decision, a Lesson From a Mentor
Graham Taught the Future Billionaire Not to Hoard Funds; Berkshire B-Shares No Bargain After 50-for-1 Split
Warren Buffett's purchase of Burlington Northern Santa Fe Corp. is the newest chapter in the oldest story of his professional life.
Mr. Buffett's mentor, the pioneering "value" investor Benjamin Graham, trafficked for decades in railroad stocks and bonds. In the early 1950s, at the outset of his career, Mr. Buffett read every page in Moody's voluminous transportation manuals -- twice, to make sure he didn't miss anything. Working at Mr. Graham's fund, Graham-Newman Corp., Mr. Buffett analyzed a portfolio with 21% to 36% of its assets in railroads.
But there is a more subtle side to the story. Mr. Graham taught Mr. Buffett that at the heart of the relationship between management and shareholders is a profound conflict of interest. Managers, Mr. Graham believed, will always want to pile up cash to protect themselves in case they make mistakes. But that cash belongs to the shareholders, who may be able to put it to better use than the company's managers.
Graham also highlighted a painful paradox: The better the business and the more skilled its managers, the greater its profits, causing cash to pile up to unreasonable levels. And, to Mr. Buffett's own chronic discomfort, he and Berkshire Hathaway are living proof of Mr. Graham's paradox. Because of Mr. Buffett's extraordinary skill at picking stocks and buying lucrative businesses, Berkshire consistently generates far more cash than even Mr. Buffett thinks he can put to productive use.
As long ago as 1998 -- when Berkshire had $122 billion in assets and less than $14 billion in cash -- Mr. Buffett worried his company was getting too big for its britches. "We have always known," he wrote to a fellow investor, "that huge increases in managed funds would dramatically diminish our universe of investment choices." That's because investments of a few million dollars apiece could no longer make a material difference to Berkshire's fortunes.
By 2006, when Berkshire's cash mountain had risen to $37 billion, Mr. Buffett said, "We don't like excess cash...We would be much happier if we had $10 billion."
"Size is always a problem," Mr. Buffett told me last month. "With tiny sums [to invest], it's extraordinary what you can find. Most of the time, big sums are one hell of an anchor."
Mr. Buffett would rather not resort to the simplest way of solving this problem -- paying excess cash out to shareholders in the form of a dividend. Since he owns roughly 26% of Berkshire's shares, a cash dividend would saddle Mr. Buffett with one of the largest personal-income tax bills in American history. That's not the kind of thing at which he likes to excel. Mr. Buffett's reluctance to pay a dividend leaves him with little choice but to buy big companies outright....MORE