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Commentators lately are engaged in an intense debate on whether Warren Buffett has lost his touch. Critics point to big declines in the prices of a large portion of the famed investor’s stock picks. Defenders stress his longer-term record that’s still among the best in history.
At stake is not only Buffett’s reputation, but also that of Berkshire Hathaway, the company he founded. . On that score, it pays to look beyond Buffett to the rest of Berkshire BRK.A, -0.52% BRK.B, -0.36% especially its shareholder base, a factor in the company’s future prosperity as it has been from the beginning.
Read: Why hedge-fund manager Bill Ackman says he dumped Berkshire Hathaway but held on to these winners
In 1979, Buffett drew on the 1958 book, Common Stocks and Uncommon Profits, by the legendary investor Phil Fisher. Just as restaurants do with their menus, companies attract particular shareholders by communicating a specific corporate message. Backed by action, this corporate menu produces a self-selected shareholder base to match, along dimensions such as time horizon, ownership levels, and engagement.
Buffett has always tried to attract only what he calls “high-quality” shareholders. Such buyers acquire large stakes and hold for long periods. They see themselves as part owners of a business, understand operations and focus on long-term results, not current market prices. They contrast with indexers, who may hold for long periods but never concentrate, and transient investors, who may hold large stakes but never for long — and neither of which put much effort into understanding given businesses.
Back in the 1980s, Berkshire attracted almost exclusively high-quality shareholders (hereafter shortened to QSs). Thanks to Buffett’s menu — elaborated annually in his famous shareholder letters (which I’ve collated since 1997 into a book Buffett endorses ) — 98% of Berkshire shares outstanding at year-end were owned by those who owned at the beginning of the year. Almost all Berkshire shares were held by concentrated investors — their Berkshire holdings being twice their next largest position.
“ Managers get the shareholders they deserve. ”
Buffett’s success in attracting QSs has been an important reason for Berkshire’s success. They gave him a long-term runway, helped promote a rational stock price, and deterred shareholder activists from seeking to break up the conglomerate as it grew. To repeat a popular paraphrase of Buffett’s 1979 letter to Berkshire shareholders, “eventually, managers get the shareholders they deserve.”
’Keep the wolves away’
Berkshire’s future performance will depend on whether it can continue to attract a high density of QSs, an increasingly challenging feat in corporate America where this cohort has been shrinking. The dominant shareholder cohort today are indexers, novelties through the 1990s, but now commanding some 40% of public equity. Equally prevalent are traders, many using artificial intelligence, to whom holding periods of a year or two are considered long-term.
Since neither dominant cohort focuses deeply on company specifics, the rise of indexers and transients created a vacuum in managerial accountability. Filling it are activists with a diverse range of horizons, commitments, and agendas. Variably controlling around 5% of total public equity, their campaigns amplify their influence. That leaves QS controlling only about 15% of total public equity, a figure closer to 80% for Berkshire.
All shareholders contribute to their corporate investees, starting with capital, and each cohort offers unique value: activists promote accountability; index funds enable millions to enjoy market returns at low cost; and traders offer liquidity. But all pose downsides: activist zealotry; indexer ignorance; trader myopia. A substantial cohort of QSs balances a shareholder mix, and counteracts each of these negatives.
At Berkshire, the dominant QS cohort has provided stability across five decades through thick and thin. They have overwhelmingly voted against the trendy governance reforms that indexers support, from climate change disclosure to board diversity. Being long-term, QSs offset the short-term preferences of transients; and while Buffett’s large stake has always deterred activists, Berkshire’s succession plan maintains its longstanding QS menu, and is designed to “keep the wolves away.” That’s the phrase Buffett used at Berkshire’s recent annual meeting when referencing how his shares will be slowly distributed to charities during the dozen years after his death, while his successors run Berkshire using the distinctive values he poured into it: trust; autonomy; decentralization and permanence.
For investors, the long-term concentrated strategy of the QS offers the potential for superior returns. True, the popular press often makes it seem as though passive index funds routinely beat managed funds after-fees. Ironically, in 2018, Buffett even won a famous bet siding with indexers over hedge funds — at least those charging particularly high fees.
But the research is more nuanced and shows the merits of a skillful quality strategy that includes longer holding periods and higher concentration levels. The vast majority of Berkshire’s shareholders have long known this. An initiative I am leading at George Washington University responds to the fact that the QS population has been shrinking.
Berkshire is the gold standard in attracting QS, without regard to debate over Buffett’s investment savvy or the performance of his portfolio during the pandemic. The man and the company modeled and molded the QS cohort, a legacy of profound importance and enduring value for Berkshire and corporate America alike.
Lawrence Cunningham is a professor at George Washington University. He is the author of many books about Warren Buffett including The Essays of Warren Buffett: Lessons for Corporate America (Carolina Academic Press; 5th ed. 2019) and Margin of Trust: The Berkshire Business Model (Columbia Business School Publishing; 2020). His new research article isThe Case for Empowering Quality Shareholders.
Don’t miss: On June 5, Cunningham will be hosting a webinar discussing his research and how to attract and empower quality shareholders. Click here for details.
