As Berkshire Hathaway's (BRK.B) portfolio of investments widens, it looks more and more like an index fund. In addition, it often underperforms the S&P 500. By CEO Warren Buffett's own admission, it would be difficult to beat the S&P 500 by a huge margin going forward. However, purchasing Berkshire's stock is still likely to be more profitable than purchasing the S&P 500. Some of the reasons for that analysis are listed below:
Berkshire invests more during downturns:
The biggest difference between Berkshire and the S&P 500 is in the way Berkshire behaves during deep economic downturns. As witnessed during the recession in 2008, Berkshire continued to invest in the stock market while the stocks were very cheap. Conversely, in 2008, most companies that made up the S&P 500 were downsizing and deleveraging. Since most components of the index were unprepared ( as they usually are) for a reduction in earnings, they started to hoard cash. Had these companies been better prepared, they could have used their reserves to make acquisitions and give themselves a better competitive position post-recession.
Since Berkshire manages its cash very well, it is always in a position to invest, regardless of the state of the market. In addition, Berkshire benefits from Warren Buffett's wisdom. Buffett is a long term investor and always has a long term view of the businesses he purchases. He is usually happier if the stocks fall, so he can buy more. The above attribute of Berkshire's seems to be the biggest and the most important difference between the company and any other ordinary index or business.
Better portfolio of companies at Berkshire Hathaway than in the S&P500:
Berkshire's stocks are selected based on whether a company offers a durable competitive advantage, good management, and relatively cheap stock. The S&P 500 stocks are selected by a committee on the basis of the following characteristics: market capitalization, liquidity, domicile, public float, sector classification, financial viability, length of time publicly traded, and listing exchange.
Clearly, the quality of companies chosen by Berkshire is superior, since they are chosen based on whether the business model is good enough. On the other hand, the S&P 500 looks at attributes such as sector, liquidity, and market cap. These factors may hold importance in the short term, but not in the long term. Berkshire's portfolio is clearly superior to that of S&P 500 in terms of the quality of companies.
No need to reinvest dividends:
Berkshire does not pay dividends, but rather reinvests the cash in other good businesses. This saves investors the burden of reinvesting the dividends and even paying tax on the dividends. With the good business model of BRK, an investor knows that the earnings would be better used at Berkshire than in most investment opportunities that the individual investor can think of.
Good Risk/Reward Ratio:
Let us suppose that Berkshire, despite investing well, is unable to beat the S&P 500 regularly, and is sometimes a point or two behind. For most investors, this is a not nightmare scenario. Here's what happened: They picked a stock which had the potential to beat the S&P 500 by several points each year, but ended up underperforming by a small margin. Most people could live with this.
The risk/reward ratio is tilted in favor of the BRK investors. They will have had savings in dividend taxes, cheaper investments during recessions, and a better portfolio. This is enough of reward potential for the risk of losing to the S&P 500 by a small margin.
Berkshire does look like an index. As years go by, the company will become even more diversified. However, due to the quality of companies within Berkshire, reinvestment of dividends, and the discounted purchase of companies during downturns, it is likely that it would beat the S&P 500 in more years than the other way around.