Even the great Warren Buffett is still striving to outperform this bull market, a hard reality is that there is a significant possibility that in the coming years, Berkshire Hathaway's stock will underperform the S&P 500 index.

This is not a critique of Berkshire Hathaway's Chairman and CEO Warren Buffett or his designated successors, but rather a simple matter of probability. Considering the substantial statistical noise in the market, luck plays a considerable role in performance, not just in the short term but also in the medium term. Moreover, bad luck is just as likely as good luck, so even someone with an exceptional track record like Buffett could underperform in the market.

As the market anticipate the release of Berkshire Hathaway's annual report later this month, it's a good prelude to reviewing Buffett's performance record and these probabilities. Berkshire Hathaway has yet to announce the exact release date of the report.

In 2024, Berkshire Hathaway's stock slightly outperformed the market: its total annual return was 25.5%, compared to the S&P 500's 25.0%. Over the past 10 and 15 years, Berkshire Hathaway has slightly lagged behind the S&P 500, but over the past 20 and 30 years, it has slightly outperformed. During these periods, the gap between the company's performance and the stock market has been minimal.

To understand why these probabilities do not give us confidence that Berkshire Hathaway will outperform the market in the future, consider how many years it would take to convince a strict statistician that the company's past performance was due to genuine skill rather than luck. To illustrate this, I will use the company's performance over the past 30 years—the latter half of its 60-year history under Buffett's management.

In the first thirty years of Buffett's management, the company was smaller and could invest in undervalued small companies. Today, Berkshire Hathaway is so large that, as Buffett has said in past annual meetings, only large companies can have a material impact on Berkshire's financial statements, so it is only interested in large companies.

Given that the company's annualized excess return over the market (alpha) over the past 30 years is 1.5%, and the standard deviation of its annual returns during this period is 39.2%, it would take over 100 years of such performance to achieve 95% confidence that the company's alpha is not purely due to luck.

In other words, nobody can statistically conclude that Berkshire Hathaway's market-beating performance over the past 30 years was due to factors other than luck. Therefore, the most reasonable assumption is that the company's future performance will be close to that of the overall market.

(It's worth noting that statisticians would have reached the opposite conclusion during the first 30 years of Buffett's management of Berkshire Hathaway. At that time, its alpha was larger, so that period was sufficient to achieve 95% confidence that the company's performance was not just luck. However, as mentioned earlier, those early years are of little relevance in predicting Berkshire Hathaway's future performance.)

This statistical review of Berkshire Hathaway's performance provides the necessary context for considering any topics Buffett might discuss in the upcoming annual report. If our best guess is that the company's future performance will be close to that of the market, we may need to view some of his perspectives differently.

One of the most closely watched data points in the report will undoubtedly be Berkshire Hathaway's cash reserves. As of the third quarter of 2024, the company's cash reserves had reached $325 billion. Will this cash reserve be even higher by the end of the year? Does this mean Buffett is pessimistic about the stock market? Regardless, how much attention should we pay to this issue?

This is not a critique of Buffett's exceptional track record. For almost all other managers, the statistician's conclusions would likely be even harsher. Buffett has far surpassed nearly everyone, defying the law of gravity. But as Berkshire Hathaway continues to grow, outperforming the market becomes increasingly difficult, and eventually, it too will succumb to this law.