By Lawrence Cunningham and
Commentators lately are engaged in an intense debate over 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 his company. On that score, it pays to look beyond Buffett to the rest of Berkshire Hathaway
, especially its shareholder base — a factor in the company’s future prosperity, as it has been from the beginning.
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 them 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 that 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, managers, eventually, 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, as 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 QSs controlling only about 15% of total public equity. That figure is closer to 80% for Berkshire.
All shareholders contribute to their corporate investees, starting with capital, and each cohort offers unique value: activists, by promoting accountability; index funds, in enabling millions to enjoy market returns at low cost; and traders, in offering 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 holders, 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 on an after-fees basis. 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 QSs, 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 is titled “The Case for Empowering Quality Shareholders.”