Is Warren Buffett’s Nightmare Scenario Coming True?

• Earlier this year, Berkshire Hathaway chairman Warren Buffett discussed his nightmare scenario. In short, this situation would occur when the stock markets look inflated and Berkshire Hathaway stock is also fairly valued.
• Berkshire Hathaway’s buying activity has been quite subdued over the last three quarters. The company’s second-quarter share buybacks were also quite low.

Berkshire Hathaway (BRK-B) (BRK.B) chairman Warren Buffett is famous for his witty yet insightful quotes. Earlier this year, in an interview with the Financial Times, Buffett shared his “nightmare.” The interviewer asked Buffett, “What happens when Berkshire’s shares are trading at a fair price, and companies and stocks look expensive too?” In his characteristically witty fashion, Buffett replied that such a scenario would be his “nightmare.”

Berkshire Hathaway’s cash pile has grown steadily. At the end of the second quarter, the company had more than $122 billion in cash and cash equivalents. Berkshire Hathaway has invested most of this cash in short-term Treasury securities.

Notably, Buffett has rued the absence of value in listed securities. Despite the sharp fall in equity markets, he did not open Berkshire Hathaway’s cash coffers in the fourth quarter. He also did not add more Apple (AAPL) shares despite the 30% fall in Q4. On the contrary, Berkshire Hathaway sold some Apple shares. However, it wasn’t Buffett but a different investment manager who sold these Apple shares.

Earlier this year, Buffett revealed that Berkshire Hathaway had taken a stake in Amazon (AMZN). Again, it was not Buffett but a different investment manager who bought the Amazon shares. On his part, he admitted that he had missed out on companies like Amazon and Alphabet.

Buffett noted earlier this year that he’s looking at a big acquisition opportunity. However, he also spoke about the lack of such opportunities at a reasonable price. As a value investor, he does not see a lot of exciting opportunities in current markets.

Berkshire Hathaway’s fully owned businesses generate a lot of cash, and the company receives dividends from its portfolio investments. Due to the lack of investment opportunities, Berkshire Hathaway’s cash pile has continued to grow.

Share buybacks could be an attractive avenue for Buffett and Berkshire Hathaway. Last year, the company revised its buyback policy to give more leeway to Buffett and vice chairman Charlie Munger.

However, Berkshire Hathaway’s buybacks have been modest. In the second quarter, Berkshire Hathaway repurchased only $442 million of its shares compared to $1.7 billion in the first quarter.

Berkshire Hathaway has underperformed the S&P 500 by a wide margin this year. Pershing Square Holdings’ Bill Ackman revealed a new stake in Berkshire Hathaway. Ackman said that Berkshire Hathaway is “trading at one of the widest discounts to its intrinsic value in many years.”

While Ackman sees Berkshire Hathaway as significantly undervalued, Buffett doesn’t seem to agree, as is reflected in the company’s modest buybacks. According to Buffett’s interview response, the current scenario looks like a “nightmare.” While equity markets look inflated from a value investor’s perspective, Buffett doesn’t appear to believe that Berkshire Hathaway is undervalued either.