Setting the facts straight about Berkshire Hathaway
We posit the following:
- Berkshire's public market holdings represent the least attractive component of its investment portfolio.
- Berkshire's 5-year underperformance versus the S&P is based on an unfair comparison.
- Berkshire has a number of other characteristics which make it more attractive than a mutual fund.
1. Public Holdings Vs. Reinsurance & Private Portfolio
We believe that Berkshire's public market holdings represent the least attractive component of the investment portfolio:
Berkshire owns some high-quality, wide-moat stocks... but I certainly don't need to pay Warren Buffett to buy Coca-Cola and re-invest the dividends for me.
As of the 2013 10-k released 2 days ago, Berkshire's Big 4 public equity portfolio comprises 55% of the fair value of its equity holdings. This includes Coca-Cola (NYSE:KO), Wells Fargo (NYSE:WFC), IBM (NYSE:IBM), and American Express (NYSE:AXP).
It is the private portfolio that allows Berkshire to generate enduring alpha. These are investments that the public lacks access to. Certainly, once they are bought and taken private under the Berkshire holding company, the only way the public can access their earning potential is by owning BRK.
These companies are all stable cash flow generators, and through prudent reinvestment, they have produced a portfolio that will stand the test of time.
The fact that Berkshire invests in public companies comes as the result of having too much capital to invest: We suspect that Berkshire would prefer to acquire more companies outright. Only when a company is too large or impractical to acquire, will a fractional ownership be taken.
Berkshire's chief selling point is that it steadily builds book value. If anything, the fact that it has exposure to the public equity portfolio, which is subject to the gyrations of the equity market (and is thus marked-to-market) is a detriment. Berkshire's book value can decline if IBM takes a tumble in the market. The public market portfolio is the weakest and most volatile component of Berkshire.
If you really like a company, why not buy the whole thing? This seems to be the prevailing strategy employed by Berkshire.
2. Berkshire's 5-year underperformance versus the S&P is based on an unfair comparison
That Berkshire has underperformed the S&P for the last 5 years is also something of an artifact, and arguably an unfair comparison; the low beta of BRK means that it also declined less than the rest of the market during 2008/2009, so it was insulated against the crash and had less recovery required just to re-attain its pre-crash level. In fact, its book value declined by only 9.6% in 2008 (see Page 1, Berkshire 2013 shareholder letter).
Over almost any longer period, it has outperformed the S&P (with dividends reinvested) handily.
For those disputing this, please consult page 1 of Berkshire's 2013 shareholder letter. It is fairly clear.
Berkshire's comparison compares the increase in the book value of a Berkshire share to the performance of the equity ("stock") market; it does not look at the market constituents' aggregate ROE. It just looks at the S&P's market cap/share price performance, which is subject to the gyrations of the equity market.
The market was oversold in 2009, but as a result, it has outperformed Berkshire over the last 5 years. If Berkshire continues to steadily build book value, this is not likely to occur for more than any 7-year period.
3. Other Benefits
In addition to the fact that Berkshire's performance has handily outperformed the S&P total return index:
- It has done so with lower Beta than the index
- Has re-invested dividends profitably
Moreover, by never paying a dividend and re-investing the capital, Berkshire reduces headaches for investors by ensuring that investors never encounter problems, as they often do when they DRIP shares in a brokerage account. Little nuisances like cheques issued from your broker for returns of fractional share dividend amounts are eliminated by owning Berkshire. You know your capital is being re-invested well. This may seem like a trivial point, but it counts.
In this regard, BRK functions like a mutual fund (although, I suspect, with a far lower MER).
Berkshire does have some properties similar to a mutual fund, but it permits investors to gain access to high quality private companies that mutual funds cannot get exposure to. These private cash flow generators are the most attractive elements of the portfolio.
Berkshire's 5-year underperformance versus the S&P 500 has been an artifact and accusations that Berkshire has underperformed total return indexes appear to be without merit.