Here’s the Real Reason for Buffett’s Big Cash Pile

What Happened?

Warren Buffett’s investment company, Berkshire Hathaway [BRK-A] holds a record amount of cash.

According to the latest quarterly filing last week, its cash balance stands at $325 billion.

To put that in context, Berkshire could take that cash balance and buy outright any one of Walt Disney Company [DIS], McDonald’s [MCD], American Express [AXP] or International Business Machines [IBM].

Each of those companies has a current market capitalization of just under $320 billion. Or put another way, if Berkshire’s cash pile was its own separate stock listing, it would be the thirty-seventh biggest company in the world.

So, what’s the deal? Why does Warren Buffett’s company hold so much cash?

We’ll share our thoughts, and it’s not for the reason many in the press seem to think…

Why it Matters

If you read the press, it suggests a single reason for the big cash pile — that Buffett considers the market too expensive. The commentary then extends that to conclude that a major crash is coming.

Both could be true.

It’s certainly true that Buffett has built up big cash balances in the past. However, the interpretation of that cash history is somewhat misleading.

For instance, Bloomberg notes that Buffett’s cash pile increased to 12.7% of his company’s assets in September 1998. That was prior to the dot-com crash. Impressive and prescient. Except for the fact that the cash pile had dropped to 3.7% just before the crash hit in 2000.

What about the Great Recession? Bloomberg points out that Buffett’s cash holdings reached 24.5% in June 2005. It’s true that was the peak of the U.S. housing market, but it’s also true that stocks didn’t peak for another two years after that.

In addition, by June 2008 (before the collapse of Lehman Brothers, but after the collapse of Bear Stearns) Buffett’s cash as a percentage of total assets had fallen to 11.2%.

In other words, Berkshire Hathaway was buying as the market was falling from the peak.

Warren Buffett is the greatest investor of all time. But that doesn’t necessarily mean a big cash holding equates to a crash warning. In fact, our bet is there’s a much different reason for it.

How it Affects You

Warren Buffett isn’t young anymore. He’s 94 years old. Last year, his long-time friend and business partner, Charlie Munger, died at the age of 99.

In our view, what’s happening now is a case of ‘corporate estate planning’. That is, Buffett and his senior officials are beginning to plan for ‘life after Buffett’.

This makes complete sense. The appeal of Berkshire Hathaway stock is that it has Warren Buffett standing behind it. And so there are no doubt concerns within the company about how the market will react to Buffett’s eventual passing.

The most likely outcome is the company will do two things.

First — and this is part of the reason for the big cash pile — is the company will pay either a dividend, special dividend, or a capital return. Whichever it chooses (which means whichever is most tax effective) it will be a huge cash payout.

Remember, Berkshire Hathaway has never paid a dividend. That’s because Buffett has always believed he can invest the cashflow better than the average investor. Investors trust him on that. But they don’t yet trust the guys who will take over from him.

Second is that the company will split into two entities. One will hold the company’s listed stock portfolio. The other will hold the private interests.

Effectively what you will have is an active funds management business under one listing, and a private equity business under another. As for any remaining cash after the monster payout, they’ll split it among the two businesses.

For investors, that creates an opportunity. Buffett’s background is all about value and minimizing and managing risk. The next generation will likely think differently, resulting in more use of leverage and unlocking value by creating more focused business units.

Of course, this may not happen for many more years. But it’s a good reason for continuing to hold on to that Berkshire Hathaway stock.

[Note: The author owns stock in two of the companies mentioned, Berkshire Hathaway and McDonald’s.]