THE ANNUAL shareholders’ meeting of Berkshire Hathaway has been dubbed “Woodstock for capitalists”, so large is the throng it usually attracts. For the second year running, though, thanks to covid-19, the groupies have been denied their close-up love-in with Warren Buffett. The event on May 1st was online only, with Mr Buffett joined on screen by his longtime sidekick and fellow nonagenarian, Charlie Munger—a headline act that makes the Rolling Stones look like striplings. Nevertheless, Warren and Charlie outdid Mick and Keith for stamina, taking more than three hours of questions, covering everything from Berkshire’s first-quarter results, announced earlier that day, to the ways in which its subsidiaries do and don’t resemble children. For Buffettologists, the highlight was an apparent slip of the tongue by Mr Munger: “Greg will keep the culture”. The following day Mr Buffett, who had hitherto refused to publicly name an heir apparent, confirmed that the nod had gone to Greg Abel, the 58-year-old head of Berkshire’s non-insurance operations.

Mr Buffett has long held the stage as the world’s most celebrated investor, having turned a troubled textile firm purchased in the mid-1960s into a $630bn conglomerate spanning everything from railways and real estate to insurance and ice-cream parlours. Berkshire, which is essentially made up of two halves—a collection of owned or controlled businesses employing 360,000 people, and a $300bn portfolio of minority stakes in blue chips—has done long-term investors proud. Over the 56 years of Mr Buffett’s stewardship its stock has enjoyed a compounded annual gain of 20%, double that of the S&P 500 index (including dividends).

Berkshire’s more recent record looks less stellar, however—leaving some wondering if the company, like the Rolling Stones, is trading on its back catalogue, its greatest hits a thing of the distant past. That prompts another concern. At 90, Mr Buffett is still sharp and seemingly in good health. But no one lives forever. A change of front man, when it comes, will be a test of the endurance of Berkshire’s unique culture and its quirky (some would say anachronistic) governance.

It will also test whether the sprawling group can remain in one piece at a time when conglomerates are out of fashion. Berkshire has long enjoyed a sort of corporate exceptionalism, thanks to the halo over Mr Buffett. With disquiet growing over so-so returns, poor disclosure and more, that benefit of the doubt looks threatened.

You got the silver

Start with the financial performance. Operating profit—the number Mr Buffett urges shareholders to focus on—fell by 9% in 2020, to $22bn, after a flat 2019 (though it rebounded in the latest quarter, up 20% year on year). Berkshire’s shares badly underperformed the S&P 500 index in both years. Over the past ten years, its per-share market value has handily beaten the index just twice, while lagging far behind it four times. In truth, Berkshire’s performance relative to the S&P has been slipping for decades (see chart 1).

This loss of oomph is partly explained by the law of large numbers; the bigger Berkshire grows, the harder it is for any single successful investment to move the needle. Another factor is the dwindling of a past advantage. Berkshire has long used the float (premiums not paid out as claims) from its giant insurer, Geico, to funnel low-cost capital to its other operations. But these days capital is cheap for everyone.

Some wounds have been self-inflicted, however. Big bets on Occidental Petroleum and Kraft Heinz soured quickly. The consumer-goods giant, of which Berkshire owns 26.6%, is weighed down by $28bn of debt and bloated goodwill after a mispriced merger in 2015. Mr Buffett has admitted to overpaying for Precision Castparts, an industrial-parts maker that Berkshire bought in 2016, which subsequently triggered an $11bn write-down. Some of his timing has looks awry, too. Having built a big position in American airline stocks, Berkshire bulked up on more at the start of 2020, but lost its nerve as the pandemic spread, quickly dumping its holdings and crystallising a loss of perhaps $3bn-4bn. Within months the sector’s share prices had rebounded.

Indeed, the past year has given the lie to the received wisdom that Mr Buffett thrives in adversity. That was certainly true during the financial crisis of 2007-09, when Berkshire acted as an investor of last resort, striking highly lucrative deals to bail out GE and Goldman Sachs; the GE investment yielded a 50% return, most of it within three years. This time, though, with market liquidity less constrained, Berkshire has had less opportunity to pounce.

Nor has it been able to find an acquisition that is both good value and big enough to move that needle. Identifying “elephants” on which it could spend a sizeable part of its $145bn cash pile has become a parlour game in investment circles. When covid-19 first struck, many thought Mr Buffett would be spoilt for choice. But buoyant stockmarkets mean fewer bargains for value investors like him to snaffle up. And Mr Buffett eschews corporate auctions because they often involve paying big premiums.

Another turn-off is increased competition from private equity and SPACs. Berkshire’s biggest deal of 2020 was more bolt-on than blockbuster: the $10bn purchase of a gas-pipeline operator by its utility, Berkshire Hathaway Energy (BHE). That was less than half of what Berkshire spent over the year on buying back its own shares. (It has sharply increased buybacks over the past two years in response to calls for it to deploy more unspent capital, though the non-payment of a dividend remains a sacred cow.)

Perhaps the clearest sign that Berkshire may have lost its touch when it comes to finding attractive targets was the rapid in-and-out of Bill Ackman. The star hedge-fund manager, a lifelong Buffett fan, built a $1bn position in Berkshire in 2019 but had fully sold out by mid-2020, apparently after concluding he could find overlooked gems more effectively himself.

Berkshire has also taken flak for largely missing out on the tech boom of the past decade owing to Mr Buffett’s preference for mature businesses. There is one glaring exception, though: its 5.4% stake in Apple, which has produced a whopping $90bn gain over five years. Moreover, the economic pendulum may be swinging back towards the sort of industrial firms he favours: they should benefit from trillions of federal dollars earmarked for infrastructure upgrades as the economy recovers from the pandemic. BNSF, Berkshire’s railway network, can expect to profit as more heavy stuff needs shifting around for all these projects.

Some investors have grown increasingly vocal in pressing Berkshire to eke out more from its main divisions. Mr Buffett has described BNSF as one of the conglomerate’s four “jewels”, along with Geico, BHE and the Apple stake. But when Mr Ackman crunched the numbers in 2019, he found the railway’s operating margins to be five percentage points below the average of its peers. Geico has many virtues, including making a profit on its underwriting most years (unlike many rivals, which rely on investment gains to offset underwriting losses). But its margins, and its use of analytics, lag behind those of an arch-rival, Progressive.

Shine a light

The answer, says one large investor, is for Mr Buffett to be more hands-on with subsidiaries. That, though, would go against the grain of the idiosyncratic management structure and governance long in place. Division bosses are given almost total autonomy; it is not unheard of for them to go months without speaking to Mr Buffett. Berkshire’s head office is tiny, with just 26 people; subsidiaries have their own legal, accounting and human-resources departments. They report to head office, but it reports little to the outside world. Berkshire does not hold analyst calls or investor days. It gives out scant financial information beyond mandatory filings, says Meyer Shields, an analyst with KBW (who has long been shut out of Berkshire’s annual conclave because of his sceptical views).

Mr Buffett is proud of being different. Whereas other big companies have moved to a command-and-control approach, Berkshire’s remains rooted in trust: he trusts the divisions to get on with it, and shareholders are expected to trust that he will make more right calls than wrong ones.

This approach is increasingly at odds with corporate trends. At this year’s AGM, Berkshire faced shareholder proposals on its skimpy climate-risk disclosure and diversity policies (though both were defeated). It is also under fire over executive pay, which at Berkshire is heavily weighted to base salary, owing to Mr Buffett’s long-held suspicion that stock incentives encourage managers to manipulate the share price. Big proxy-advisory firms like ISS have backed some of these criticisms. Some have also taken aim at the board for being too old (four of its 14 members are 90 or over), too entrenched and too close to the boss. Berkshire has become a “very attractive lightning rod”, says Lawrence Cunningham of George Washington University, who has written several books about Mr Buffett.

Mr Buffett has little time for ESG metrics, diversity targets and the like. He has said he doesn’t want his managers to have to spend their time “responding to questionnaires or trying to score better with somebody that is working on that”. A lot of what is considered good governance today doesn’t fit with Berkshire’s heavily decentralised approach.

Even if so, pressure for change is growing, and is likely to intensify further once the founder no longer calls the shots. Moreover, the post-Buffett leadership is likely to be more diffuse, which those hoping to shake up Berkshire may see as an opportunity to apply more leverage. Mr Abel is the CEO-in-waiting, but Mr Buffett’s role as chairman is set to go to his son, Howard. His third role, as investment chief, will probably go to one of the group’s two top equity-portfolio managers, Todd Combs and Ted Weschler.

The most forceful efforts to impose change may come from those seeking to break up Berkshire. When he is gone, Mr Buffett conceded last year, “everybody in the world will come around and propose something, and say it’s wonderful for shareholders, and by the way it involves huge fees.” Some on Wall Street would see it as a coup to “release value” by, for instance, splitting the conglomerate into three bits, focused on insurance, industrial assets and consumer businesses.

Few doubt that Berkshire trades at less than the sum of its parts. But even the sceptical Mr Shields thinks the discount is only around 5% Others think it may rise above 10% once its leader departs. Mr Buffett insists that a well-run conglomerate has enduring advantages. One is not being associated with a given industry, meaning it feels less pressure to maintain the status quo—“if horses had controlled investment decisions, there would have been no auto industry,” as he once put it.

A crunchier benefit relates to tax: Berkshire can move capital between businesses or into new ventures without incurring any. And taxable income at one subsidiary can help generate tax credits at another. Mr Buffett has claimed this gives BHE a “major advantage” over rivals in developing wind and solar projects.

On with the show

How vulnerable to centrifugal forces Berkshire proves to be will depend more than anything else on the composition of its shareholder base. Currently, it affords protection. The typical large American listed company is mostly owned by institutional investors. Berkshire is different. Mr Buffett has around 30% of the voting share; another 40% is held by an estimated 1m other individuals, many of them long-term loyalists (with whom he has spoken of having a “special kinship”); the rest is owned by institutions. If a vote were held today, it would overwhelmingly reject a break-up or wrenching strategic shift.

Mr Buffett and his retail kinsmen may not form such a powerful block for much longer, however. Many of the loyalists are getting on in years. The children who inherit their shares may show less zeal. Even some of the faithful may sell once the Oracle of Omaha has gone. Moreover, Mr Buffett’s stake will be sold into the market after his death, albeit over more than a decade: he has bequeathed it to various foundations on condition that they sell the shares and spend the proceeds on good causes. Posthumous shifts in the shareholder base are Berkshire’s “Achilles heel”, reckons Mr Cunningham.

As a keen student of corporate history, Mr Buffett will doubtless know that James J. Hill, a 19th-century railroad baron who led an operator that would later become part of BNSF, once declared that a company only has “permanent value” when it no longer depends on “the life or labour of any single individual”. Berkshire’s greatest challenges will come only after its grizzled rock star has left the stage.■

Editor’s note (May 3rd 2021): This article has been updated since it was first published.