Will Warren Buffett retire? What to look for in his annual letter.

Buffett has also silenced critics from a year or two ago, who at the time were declaring him to be all washed up. At the top of the bull market in early January 2022, Berkshire Hathaway’s trailing 3-year alpha was at or close to an all-time low at minus 12.3 annualized percentage points—as you can see from the accompanying chart. Since then the company’s trailing 3-year alpha has bounced back impressively and is now solidly in the positive column.

Furthermore, and hopefully needless to say, Buffett’s long-term record remains simply outstanding. For the 58 calendar years through the end of last year, Berkshire Hathaway stock has beaten the S&P 500 by 10.0 annualized percentage points (with dividends included).

I nevertheless have it on good authority that Buffett, currently age 92, won’t forever be at the helm of Berkshire Hathaway. Since his recent performance shows that he hasn’t lost his touch, many investors are concerned that, once he’s retired, Berkshire Hathaway’s stock will suffer. Many are hoping that he will use the occasion of this year’s Berkshire Hathaway annual report to discuss when he plans to turn over the reigns to Greg Abel, his chosen successor. (The company hasn’t indicated when it will release its annual report; an inquiry was not immediately returned.)

On the one hand, I think it’s a safe bet that many knee-jerk investors will sell their Berkshire Hathaway shares if Buffett were no longer at the company’s helm—especially if the news were sudden. On the other hand, I think that such selling wouldn’t be justified. Gutsy investors therefore might want to use any Berkshire stock decline in the wake of Buffett stepping down as an opportunity to buy more.

The reason I believe Berkshire Hathaway can perform just as well after Buffett is no longer leading the company is that a stock picking algorithm has been discovered that, in back testing, has performed just as well as the company. Before this algorithm was discovered, Buffett’s rifle-shot approach to picking stocks seemed inscrutable and therefore unable to be duplicated—even by someone as able as Abel.

The researchers who discovered this algorithm are principals at AQR Capital Management: Andrea Frazzini, David Kabiller and Lasse Pedersen. Their study reporting this algorithm appeared in the Financial Analysts Journal in 2018, entitled “Buffett’s Alpha.” Though their algorithm is complex, it favors stocks with low price-to-book-value ratios, have exhibited below-average volatility and are from companies whose profits have been growing at an above-average pace and which pay out a significant portion of their earnings as dividends.

The existence of this algorithm suggests that in the future, odds are good that Abel will be able to do as well as Buffett would have if he were still running Berkshire Hathaway. For confirmation, consider performance since the researchers’ study first began circulating in academic circles, in late 2013; I wrote a column about it in The Wall Street Journal in December 2013. In that column I specifically mentioned an AQR mutual fund that closely follows the researchers’ algorithm—the AQR Large Cap Defensive Style Fund
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Since that column, the fund has very closely matched Buffett’s performance, gaining 11.7% annualized versus 11.6% for Berkshire Hathaway

Buffett and bear markets

Another topic you should be on the lookout for in Buffett’s soon-to-be-released annual report is his view of the stock market’s prospects. That is a crucial issue in its own right, of course, but especially for Berkshire Hathaway investors. That’s because its stock tends to outperform the market the most during bear markets.

You saw this in the chart above: Buffett’s 3-year alpha tends to suffer during long bull markets. In addition to it being significantly negative at the top of the bull market in early 2022, Buffett’s 3-year alpha previously was very negative during the inflation of the internet bubble.

This relationship between bear markets and Buffett’s alpha is an illustration of his infamous advice to be fearful when others are greedy and greedy when others are fearful. It will be interesting to see whether he thinks that the bear market over the last year has shifted his calculus in this regard. A year ago he was fearful; will he now be greedy?