Elon Musk, Tesla’s CEO, recently made headlines by suggesting that Warren Buffett’s Berkshire Hathaway should consider adding Tesla shares (TSLA) to its portfolio. Musk described the acquisition as an “obvious move” in a post on X, the social media platform he owns. However, the investment style historically favored by Buffett suggests a mismatch with Tesla’s financial profile, making such a move highly improbable.
Warren Buffett, renowned for his selective investment strategy, operates on the principle of choosing only the most appealing opportunities, akin to a seasoned batter in baseball choosing which pitches to swing at. Tesla, with its high price-to-book ratio and lack of dividends, does not align with the traditional metrics Buffett values. Berkshire Hathaway (BRK.A) (BRK.B), under Buffett’s stewardship, has typically pursued companies that are undervalued, stable, and financially conservative—traits that are not characteristic of Tesla’s current financial standing.
This analysis is supported by insights from a study published six years ago in the Financial Analysts Journal, titled “Buffett’s Alpha.” The research, conducted by Andrea Frazzini, David Kabiller, and Lasse Pedersen of AQR Capital Management, offered a formula that encapsulates Buffett’s approach to stock selection. The criteria identified include low price-to-book ratios, low beta values (indicating less volatility), high dividend-payout ratios, and strong profit growth.
Tesla, while exhibiting impressive profit growth, fails to meet the remaining criteria. It has one of the highest price-to-book ratios in the market, significantly exceeding that of 88% of stocks in the S&P 1500 XX:SP1500 index. Additionally, Tesla’s beta exceeds that of 94% of those stocks, and it does not distribute dividends. These attributes position Tesla far from the ‘cheap, safe, quality stocks’ category Buffett prefers.
At the recent Berkshire Hathaway annual meeting, Buffett reiterated his investment philosophy, emphasizing the importance of patience and selectivity in capital deployment, especially when managing a significant cash reserve, nearly $200 billion in Berkshire’s case. He pointed out that his investments are reserved for those rare, significant opportunities that meet his stringent criteria.
Further reinforcing the viability of the Buffett approach are the performances of funds that closely adhere to the criteria outlined by the AQR study. The AQR Large Cap Defensive Style Fund (AUEIX) and the iShares Edge MSCI USA Quality Factor ETF (QUAL) have shown returns that closely track the historical performance of Berkshire Hathaway’s investments. Since the dissemination of the study in November 2013, Berkshire has seen an annualized return of 12.5%, compared to 12.3% for QUAL and 11.3% for AUEIX.
In conclusion, while Elon Musk’s suggestion for Berkshire Hathaway to invest in Tesla might stir intrigue in financial circles, the fundamental investment principles that guide Buffett’s decisions are unlikely to deem Tesla a suitable candidate. Berkshire’s strategy has consistently favored financial prudence and stability, qualities that currently do not align with Tesla’s financial profile. For investors and market watchers, this serves as a compelling study in contrasting investment philosophies and the importance of aligning strategic acquisitions with core financial principles.
