Charlie Munger reveals why Berkshire Hathaway has so much cash
Investors are all cheering the markets on the dips, and buying in bulk stocks that are on sale. But the paradox is that the people who would be expected to reap the rewards of such falls do not seem to be reaping the rewards at all.
The latest figures showed that Berkshire Hathaway is holding huge amounts of cash in its accounts. This information in itself was not entirely unusual. Every company holds cash in its accounts. What is striking, however, is that the company is holding large amounts of cash and after declines over the past year. But Buffett and Munger don't think the stock is at a discount. After all, we've seen some significant purchases by the company in the past year. But why isn't the company continuing to make more purchases? The simple answer is that Munger has admitted that there is simply nothing they can buy right now.
This statement is somewhat strange, especially at a time when the stock is still far from its highs. Anyone would expect Buffett, along with Munger, to be the ones leading the buying crowd. But when you look at it from other angles, you see that the reasons are actually different.
The first, and the main reason, is the legislation surrounding the transactions of these well-known companies and big names. In short, this legislation adds to the complications for large institutions in buying large shares of companies. Most large institutions try to avoid this legislation in an arc so as not to add unnecessary worry and hassle.
Under the law, large financial institutions and billionaire investors cannot buy more than 5% of a company without filing a 13D filing as a beneficial owner with the Securities and Exchange Commission, which of course comes with extra worries.
Here, this legislation narrows the large financial institutions' choice of stock. Specifically, it makes it harder for these institutions to buy shares in small companies, which often hold enormous potential. Quite simply, if a financial institution wanted to buy shares in a small company, it would not make sense for it to do so, because it would not be able to spend a large amount of money. That would mean that companies would still have large amounts of cash in their accounts anyway. This begs the question that surely there are some companies that offer so much potential that it would be worth investing in the company and going to the trouble of filing a 13D.
A needle in a haystack
Surely there are small companies out there with huge potential, where they could maybe even decimate their value. At that point, you'd think it's worth the trouble, wouldn't you? Unfortunately for the big financial institutions, it's not worth the trouble, why? Large financial institutions have huge capital in the billions of dollars. In that case, if, for example, they bought a company for $50 million. If they bought a company for $500 million, and it multiplied its value tenfold over the next five years, they would sell it for $500 million. USD, at that point it would not add any real value to the company, because the company is operating with tens or hundreds of billions of dollars, and USD 500 million would not be worth USD 500 million. USD 500 million is practically peanuts for the company, if I'm going to exaggerate.
Let's use us ordinary investors as an example. We have a portfolio of $10,000. We decide to invest $100 in a company that promises great potential. Over the next five years, the stock price goes up and we sell the stock at a profit of $1,000.
If we had a portfolio of only $1,000, that would mean a 100% appreciation of our portfolio in 5 years. That's an appreciation of 20% per year. Since we have a $10,000 portfolio, our portfolio has only appreciated 10% in 5 years due to this trade, which is 2% per year.
I think you all see where I'm going with this, and I'm sure you all see the rapid difference. We now understand that big financial institutions and big investors don't invest in smaller companies mainly because it doesn't pay off. In short, with such a small amount invested, these large financial institutions are not able to generate a good enough return on their portfolios. On the contrary, it could be said to be detrimental to them.
The fact that large financial institutions are not investing in small-cap stocks is not because they see no opportunity here or find these stocks to be of poor quality, but simply because they are already too big. Even Charlie Munger himself said at the end of 2022 that he didn't happen to have anything to invest in and didn't like to hold cash himself.
In all my adult life, I've never hoarded money and waited for better conditions
In short, even great investors realize that holding cash in accounts for the long term is the worst thing you can do. Unfortunately, many times these large investors have no other choice, which is why we see large investors sitting on cash much longer than the average retail investor.
This is also one of the main reasons why you should not copy the portfolios of large investors. They have fewer options than we retail investors. But it is also the main reason why we retail investors can outperform large investors and financial institutions quite easily.
In short, we have one huge advantage here, and that is that we have a far greater choice of stocks than the big investors. So let us not be afraid to use this, and in the future we can together beat the big investors.
WARNING: I am not a financial advisor, and this material does not serve as a financial or investment recommendation. The content of this material is purely informational.