The easy answer is, “Nothing.”
Buffett doesn’t try to predict the short-term movements of the stock market. He looks for good businesses selling at good prices. If he finds one of those businesses (in whole or in part), he buys it. If he can’t find one, he waits, and the cash produced by Berkshire Hathaway keeps piling up. So we can assume that as markets rise and get more expensive, Buffett will buy less and less. And his cash pile will grow and grow.
Today, Berkshire Hathaway has more cash on hand than it’s ever had. How big is the Berkshire cash position? And how big is it in relative terms compared to past cycles? Does that mean anything or not?
The raw cash balance of Berkshire has grown considerably in the past ten years. But it’s misleading to look at it in isolation. We need to consider two factors:
- Buffett always keeps a cash reserve. In the past, he’s said he’s not willing to go below $20 billion; and
- We need to compare the cash balance to another balance sheet metric, equity in particular.
The Berkshire cash reserve
Buffett has often said that he refuses to go below $20 billion in cash. The lion’s share of Berkshire’s business is insurance. It makes sense that he’d want to maintain a large “rainy day fund”. The advantages of having one were well-demonstrated in 2008. Buffett sunk billions into the markets at nosebleed prices.
Buffett would only rarely go below $20 billion, presumably in some catastrophic circumstance. It’s akin to a company with imposed debt covenants on cash balances, i.e. restricted cash. With Berkshire, this restricted cash is self-imposed, rather than imposed by a lender.
Because of that limitation, to only examine the current cash balance would be misleading. The real question is, “How much cash has Berkshire accumulated over and above its minimum balance?”
To borrow a term from Buffett that best describes this excess cash, let’s call it “dry powder”.
Cash as a comparison to what?
Besides the considerable growth in Berkshire’s cash, equity growth has also been substantial. If they had grown at the same rate, the margin of cash to equity (and “powder” to equity) would be the same.
By comparing the cash and powder balances to equity, we’ll get a better picture of the relative growth of each. That way cash and powder aren’t examined in isolation.
Then we can answer the important question: “Relative to the amount of investor capital left inside Berkshire, how much dry powder is on hand?”
| Cash | Equity | Cash : Equity | Powder | Powder : Equity | |
|---|---|---|---|---|---|
| 2007 | 44,329 | 120,733 | 37% | 24,329 | 20% |
| 2008 | 25,539 | 109,267 | 23% | 5,539 | 5% |
| 2009 | 30,558 | 135,785 | 23% | 10,558 | 8% |
| 2010 | 38,227 | 162,934 | 23% | 18,227 | 11% |
| 2011 | 37,299 | 168,961 | 22% | 17,299 | 10% |
| 2012 | 46,992 | 191,588 | 25% | 26,992 | 14% |
| 2013 | 48,186 | 224,485 | 21% | 28,186 | 13% |
| 2014 | 63,269 | 243,027 | 26% | 43,269 | 18% |
| 2015 | 71,730 | 258,627 | 28% | 51,730 | 20% |
| 2016 | 86,370 | 286,359 | 30% | 66,370 | 23% |
| Q3 2017* | 109,300 | 311,852 | 35% | 89,300 | 29% |
* The 2017 balances are as of Q3 2017, not the whole year. If the 2016/2017 growth rate continues, the cash and powder margins could be as high as 35% and 31% respectively.
Looking at the data and charts, two things become clear:
- Buffett rarely goes below 20% in cash. Even in 2008, when it seemed that things couldn’t get any worse, he didn’t go below 23%; and
- If we only look at cash, it seems that Buffett has amassed almost the same amount relative to equity in 2017 as in 2007: 37% and 35% respectively; but
- If we subtract the $20 billion minimum cash balance, then we see a very different picture: 20% in 2007 versus 29% in Q3 2017.
Is $20 billion still a relevant minimum?
Perhaps Buffett’s real minimum for cash is 20% of equity, not $20 billion in cash. As an insurance company that takes on more and more risk, it would make sense that the “rainy day fund” would need to grow alongside its obligations.
Cash or powder?
Is the relevant metric 35% cash or 29% powder? Either way, it seems clear that Berkshire isn’t finding many businesses that are attractively priced. In the past, this wait-and-see approach has preceded many market corrections, all of which Buffett was well-prepared for.