We are going to go out on a limb here and say that things have been going pretty well for Berkshire Hathaway (NYSE:BRK.A). Sure that old textile mile sputtered pretty badly for a few years back in the 1960s but overall shareholders are likely pretty satisfied.
Even over the past decade Berkshire's share price has moved along at a very brisk pace along with earnings and book value despite the sheer size of the company making it very hard to grow.
We would argue that the success of the past decade has been accomplished despite having a Central Banker created wind blowing in Berkshire's face.
We believe that the historically low interest rates that we have experienced in recent years works against many of Berkshire's strengths.
With that in mind we would like to consider four reasons why Berkshire shareholders should cheer for higher interest rates.
1) A Significant Increase In Interest Income
As you are likely aware Berkshire is a massive player in the insurance and reinsurance game. Geico, General Re and Berkshire Hathaway Reinsurance group are three of the operations that Berkshire has in this sector that are easily recognizable.
All of these insurance businesses have two key components to them.
One is underwriting insurance policies where the insurers try and make sure they are properly compensated for the risks they are taking.
The other is the investment side of the business. This is where the insurer tries to generate investment income off of the cash that the company holds as a result of the insurance premiums it has collected.
Because the insurance companies must always be ready to pay out a significant amount of cash relating to some sort of event, a significant portion of that cash (which is called the float) must be kept in liquid interest bearing deposits.
Those interest bearing deposits today earn almost nothing.
At the end of last year (Berkshire's 10k) the company had $60 billion sitting in cash or near cash deposits.
Today all of that cash is earning very little. On top of that Berkshire has another $25 million of fixed maturity securities that also as a group are earning far less than they would have if interest rates were at historical normal levels.
As a rough guess, if we assumed that interest rates were closer to what used to be considered normal Berkshire could easily by earning another 3% on that $85 billion of cash, near cash and fixed maturity assets. Even for Berkshire that is real money.
2) Get Rid Of Some Competition For Potential Acquisitions
Where Berkshire would prefer interest rates to move higher there is whole other group of investors and companies who are having a ball with interest rates near zero.
For Private Equity firms and corporations that are acquisitive by nature these ultra-low rates allow them access to incredibly low cost debt. It also encourages them to pay higher prices for the businesses and assets they buy.
That hurts Berkshire which is always looking to buy entire businesses but will only do so when the price is right. With all of this competition armed with huge amounts of low cost debt trying to buy things Berkshire is interested in prices get pushed beyond what Berkshire is willing to pay.
Berkshire's CEO Warren Buffett actually was quoted this week (link) saying that low interest rates were creating "irrational competition" for the companies and assets he was interested in buying.
3) Create A Buying Opportunity In The Stock Market
Berkshire's favorite thing to do with its cash is acquire 100% control of entire businesses. Buffett loves this approach because it gives him full control of the free cash flows that these companies generate which he can then reinvest as he pleases.
When you are arguably the greatest investor ever having control over the cash that your investments generate is something that you should try and have.
Option two for Berkshire's investing is buying pieces of great businesses in the stock market. While Buffett thinks he is facing irrational competition for companies he is trying to buy 100% of there is little doubt that low interest rates have pushed up prices of publicly traded stocks as well (see the declining earning yield on the S&P 500 below).
We all saw how much cash Buffett was able to deploy in a hurry during the 2008 financial panic and market crash. A beaten down stock market would be much better for Berkshire's long term prospects since it is a buyer of stocks today.
4) Provide All Of Its Business Units With A Larger Competitive Advantage
Every company that operates under the Berkshire umbrella has one huge advantage over all of its competitors. It has the backing of the Berkshire balance sheet which is the financial world's equivalent to Fort Knox.
This Berkshire financial backing lets the individual business units take advantage of acquisition opportunities, it helps them skate through cyclical lows, it allows them to get better credit terms and who knows what else.
When interest rates rise many of the competitors of these business units are bogged down by increased interest payments. Berkshire's business units are not going to have those same problems.
Rising interest rates are going to put all of the Berkshire subsidiaries into a stronger competitive position relative to their competition.
The Problem Is Who Knows When Interest Rates Will Rise
High interest rates, low interest rates or medium interest rates. Berkshire Hathaway is going to do just fine through all of them. It would be a rise in interest rates that could open up the greatest opportunities for the company however.
Today it seems hard to imagine interest rates going anywhere fast. While the interest rate increase cycle stalled at the starting gate in the U.S. it is still much closer here than the rest of the world where easy money policy just keeps getting easier.
Some day interest rates will rise. The reality is that it could be a long way down the road. Then again, these things do change when you least expect them.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.