- Berkshire Hathaway is the largest position in my own portfolio, and my conviction about it begins with values, corporate culture, and focus on long term value.
- Berkshire is hard to analyze and different approaches produce varying results; its businesses and investments are very different and at the same time connected in ways that complicate valuation.
- Berkshire is synergistic - the sum worth more than the parts - but is usually priced reasonably in the markets, which Buffett prefers as fair to both buyers and sellers.
- Buffett's pivot from seeking huge acquisitions to making large buybacks enables holders to "create" a dividend while maintaining their share of the company; meanwhile, Berkshire's Return on Equity surges.
- Berkshire may serve as anchor and risk reducer in your portfolio, replacing the stabilizing power bonds served when they had reasonable returns.
Editor's note: This article has been corrected to reflect Berkshire Hathaway's most recently reported book value and the stock's valuation based on that metric.
Some who follow me on Seeking Alpha must think of me as "the Buffett guy" because I have written so frequently on Warren Buffett and Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B). They are right to the extent that I have been a student of Buffett and Berkshire for more than thirty years. Last year I counted the pages of my articles about Berkshire over seven years on this site and they added up to the equivalent of a book of 300-400 pages depending upon print size. I don't think I repeated myself much except for a few subjects which come up repeatedly.
Few stocks are as interesting as Berkshire Hathaway. Very few have made investors as much money over the years with such modest risk. I am one of them, as Berkshire Hathaway is by a wide margin the largest position in my own and household portfolios. I bought much of it many years ago and thus have a very low cost basis. Rather than selling any of it and paying a whopper amount of capital gains taxes I plan to leave it all to my children - in the distant future, I hope.
The above disclosures hint at my perspective on Berkshire Hathaway. With all that I have written on it, some of it quite recently, I look forward to doing this article under a new SA program responding to popular questions from all sorts of readers including those new to investing as well as experienced and very well informed investors. I will try to write in a way that makes it relevant to all readers, but especially in the hope that it will attract new readers and introduce them to some of the unique qualities of this excellent company and its stock.
How To Buy Berkshire Stock
For experienced investors the short answer is obvious. You can buy it any day the New York Stock Exchange is open. You simply place an order in your brokerage account. As always, check the bid and offer, and if it is wide, you may wish to place a limit order so as not to pay a higher price than you intend. Just to give you an idea, I just took a glance at the Vanguard site by putting in information for a trade which I did not execute. Vanguard gives you both the bid and offer prices along with the size of the bid and offer. On the Berkshire B shares you buy them on Vanguard brokerage under the symbol BRKB without the period inserted in the ticker symbols above. When I looked, Berkshire B shares were trading around $249 and the spread between bid and offer was 7 cents. That's the equivalent of one penny for a stock trading around $36 per share. So no worries there.
In Berkshire's case, however, there is a longer answer. Berkshire A shares were trading at a little under $376,000 per share. Their bid-to-offer spread was around $400 per share. You would certainly want to place a limit order if buying an A share. Most readers would not contemplate opening an initial position in Berkshire by purchasing an A share or shares.
Each A share is the equivalent of 1500 B shares in terms of percentage of ownership of Berkshire Hathaway. A shares may be converted into B shares, but B shares may not be converted into A shares. One reason is the difference in voting rights. A shares have a heavier weight when it comes to votes on Berkshire policies by a multiple of about 7. Over any significant period of time the two share classes track each other closely.
Why Is Berkshire Stock So Expensive?
Warren Buffett took control of Berkshire Hathaway in 1965. It was then a failing textile company which specialized in coat liners and he took control after building a majority of shares inside his investment Partnership. His initial intent was to fix the textile business, but when he saw that it could not be fixed, he used cash within Berkshire as a source of funds to buy other investments.
The Buffett Partnership resembled contemporary hedge funds but with terms somewhat more favorable to the Partners. Over 14 years it produced an annualized return of 31.6% (25.3% for his Partners) versus 9.1% for the Dow Jones Industrial Average, then the primary benchmark. It never had a down year and never failed to beat the Dow. The cumulative return for his investors was over 1400% versus 185% for the Dow. He closed the Partnership in 1969 when he saw the whole market as wildly overpriced and gave his Partners the option of receiving cash or their proportion of shares in Partnership holdings including Berkshire Hathaway.
Those who opted to own Berkshire to the present moment hold their Berkshire A shares with a cost per share basis of $29. That's what happens when $29 compounds at an average 20% a year for 55 years. There are still many Berkshire multi-millionaires and a few billionaires from those early days, especially around Omaha. As of the 2020 Berkshire Annual Report, which was released on Saturday February 27, Berkshire Hathaway had indeed compounded value at a rate of 20% for 55 years versus half that rate (10.2%) for the S&P 500. It may well turn out that December 31, 2020, marked a generational low point in Berkshire's performance relative to the index.
Buffett has never seen any purpose in stock splits but by 1996 financial firms were threatening to buy up Berkshire shares then trading at about $30,000 per share and package fractional units for sale to investors. They planned to take a percentage for themselves, of course. To preempt this action, which Buffett saw as exploitative of small investors, Buffett created a new stock class, Berkshire B shares, priced at a ratio of 1/30 to the original Berkshire shares, now called A shares.
In 2009, in the course of Berkshire's acquisition of Burlington Northern Santa Fe Railroad, Buffett split the B shares on a ratio of 1/50 to accommodate BNSF shareholders who preferred Berkshire shares to cash. The B shares were then trading at about $3000 per share and the split provided the more convenient price of $60 per share. The new ratio of B shares to A shares became 1/1500. The present price for B shares is now around $250 per share, an all time high. At this moment, in other words, everyone who has ever purchased a Berkshire share is in the black. These things are transient, needless to say. As the great J.P Morgan once said, stocks fluctuate.
It should be noted that neither A nor B shares are expensive in the important sense. Both are based on assets and earnings which have grown in a way that warrants the current Berkshire share prices. In fact, as I suggest below, they are on the cheap side. They got to their current prices the right way - not by any faddish speculative fever but by a long history of success. That's the past, of course. The rest of this article will be about the future.
The Principles Behind Berkshire Hathaway
There are a number of ways to come at assessing a company, but often the most important element for long term success is pushed to the side - the principles which provide the framework for success. With Berkshire I will start with a list of underlying principles which shaped Berkshire Hathaway:
- Integrity. Warren Buffett has always been noted for his integrity and his actions have not disappointed. Occasionally he suffers from the "Aristides the Just" problem. Aristides was an Athenian leader who helped an illiterate citizen write the name Aristides on a pottery shard (ostrakon) supporting his banishment. When asked if Aristides had wronged him, the man replied no, but it irritated him to hear Aristides constantly referred to as "Aristides the Just." Remember that story when individuals take the occasional pot shot at Buffett.
- Corporate culture. Buffett is the only CEO Berkshire has had since 1965 and his principles have shaped its corporate culture. Among many such Buffett quotes he has reminded his employees that "it takes 20 years to build a reputation and five minutes to ruin it." In 2011 he dismissed a valued fixer of troubled subsidiaries and his presumed heir apparent, David Sokol, for front-running an acquisition he brought to Buffett. Sokol had used privileged information to make a $10 million purchase of shares in Lubrizol. Upholding standards of behavior is emphasized at Berkshire regardless of the cost. Buffett is a realist, however, and has said upon occasion that at any given moment someone somewhere in the company is probably doing something he would disapprove of if he knew about it.
- Berkshire has a deep bench. Buffett is 90 years old, but has repeatedly said that he has no intention of retiring. He apparently has a wonderful body which withstands McDonald's breakfasts, burgers, and five Cherry Cokes a day. He will eventually step down, of course, but Berkshire has a deep bench selected in his own image. Many Berkshire leaders could earn far more money elsewhere but remain at Berkshire because it's a great environment in which to work.
- A focus on the long term. For the past fifty years, with prompts from his friend and vice chairman Charlie Munger, his preferred investments have been "excellent businesses bought at a fair price" which have powerful brands or other competitive advantages (such as the fact that nobody builds another railroad or utility plant to compete with one that already exists). He prefers buying whole companies with good managements already in place.
- Indifference to stock price. Buffett doesn't try to pump up Berkshire's stock price. His preferred price for Berkshire stock is a band close to fair value which serves both buyers and sellers fairly. He has at times given his view that Berkshire shares are overpriced. An example was 1998 when the ratio of price to book value reached 200%. He was right as the stock price was cut in half despite continued operational success. It bottomed in March 2000 at the same time the NASDAQ bubble peaked.
- Service to all constituencies. Buffett wrote in his recent Shareholder Letter that Berkshire's mission includes the following: "to delight its customers, to develop and reward the talents of its 360,000 associates, to behave honorably with lenders and to be regarded as a good citizen of the many cities and states in which we operate." Berkshire's electric utilities, an early leader in renewable energy, have not returned dividends to headquarters while building renewable infrastructure with a targeted completion date of 2030. GEICO returned more than $2 billion in premiums in 2020 because the pandemic reduced average miles driven - thus fewer accidents.
- Acknowledging mistakes. Buffett admitted straightforwardly in this year's Shareholder Letter that he overpaid for Berkshire's acquisition of Precision Cash Parts. He also admits mistakes of omission, including failure to act on his awareness of the genius of Jeff Bezos and buy Amazon (AMZN) or to recognize that the amount of money Berkshire spent on ads in Alphabet (GOOG)(GOOGL) was a signal to buy the stock.
In sum, Warren Buffett's Berkshire Hathaway is a unique phenomenon in American business and we are unlikely to see anything quite like it in the future. It's a model of how capitalism ought to work.
Berkshire Hathaway is a conglomerate made up of around 80 operating businesses from many different industries as well as a portfolio of publicly traded stocks. It is a notoriously difficult company to analyze, and to prepare this article I skimmed the many articles published here on Seeking Alpha in the last eight months. No two of them used quite the same approach. Very few brokerage analysts even follow Berkshire.
The most important clustering of Berkshire's businesses includes, in descending order, (1) Insurance Companies which range from property and casualty insurance and reinsurance to GEICO, (2) Burlington Northern Santa Fe Railroad, (3) Berkshire Hathaway Energy, including electric and gas utilities, (4) Manufacturing, and (5) Service and Retail. In addition to its operating companies, Berkshire has that publicly traded stock portfolio worth $281 billion, with Apple (AAPL) being the largest position at around $140 billion. Buffett himself says that the four "jewels" of Berkshire are the insurance companies, followed by Burlington Northern and Apple in a virtual tie, and Berkshire Hathaway Energy.
Oddly enough, some analysts on this site do not attempt separate the business value of the insurance companies, making the argument that their value is fully reflected in the use of insurance "float" - the premiums paid and held against future claims. This argument fails to fully reflect the value the market places on other, similar insurance companies including a couple which I own - Chubb (CB) and Travelers (TRV). No other insurance company is seen as consisting of nothing but its "float." It is to Berkshire's tremendous advantage, I should add, that in an era when bonds pay very little, Berkshire's strong balance sheet enables it to meet capital requirements set aside against future claims by owning stocks and operating businesses rather than bonds.
The issue of "float" itself presents an interesting valuation problem in that Berkshire's consistent ability to earn around 2% on underwriting suggests that it effectively owns the float in perpetuity. In the larger picture, the connection between the insurance companies and Berkshire's operating companies and stock portfolio illustrates the fact that Berkshire's various pieces function in a way which provides not only diversification but synergy. In short, the whole is worth more than the sum of the parts.
The stock portfolio also presents valuation issues. The necessity of including fluctuations in the market value of the portfolio under a GAAP rule change made in 2018 has caused reported earnings to fluctuate wildly and meaninglessly. Buffett himself prefers to "look through" to the operational results of his share in the companies owned. As for Berkshire's earnings, he prefers operating earnings, which were down 9% to $21.9 billion this year because of the pandemic but in the future they should resume compounding starting at an amount above $2 billion per month.
When trying to place an accurate overall value on Berkshire Hathaway there are certain numbers which one should understand but then disregard. One is GAAP earnings which are distorted by those wild swings in portfolio value. Reported revenues are helpful, however. Over the past nine years they have doubled, growing at a rate of about 8% a year. Expenses have done almost exactly the same, as has the entry for "property, plant, and equipment." This means that there is a comfortable consistency in revenues, expenses, and capital expenditures. Free cash has actually increased at a slightly higher rate, 9%.
Here's an effort at a very broad estimate of overall Berkshire value:
- Using $24 billion for annual operating earnings, the value of Berkshire's operating businesses at 15 times earnings is about $360 billion. In the present market this is a very cheap valuation. A multiple of 20 times earnings may be more consistent with the valuation of similar businesses. That would lift the valuation of operating businesses to $480 billion.
- Subtract about $130 billion for insurance float and $35 billion for deferred capital gains taxes. As you do so, however, remember that both are in a sense phantom numbers because insurance float is unlikely to have to be paid out any time soon if ever and the largest stock positions are unlikely to be sold.
- Add the portfolio value of publicly traded stocks, $281 billion as of December 31, 2020. Also add cash and short term securities on hand at that time, $147 billion.
Valuing Berkshire as a whole by the above method yields a total of $623 billion using a 15 PE for operating businesses (about 7.4% above the current market cap of $580 billion) while a 20 PE on operating businesses - not at all out of line - produces a value of $743 billion, which is more than 28.4% above the present market cap at the moment I type this line. That value, of course, is sensitive to fluctuations in the stock portfolio, and would go down sharply in a general bear market.
Except for Apple, which has quadrupled its purchase price since early 2018, Berkshire Hathaway is largely an "old economy" company. This is not necessarily a bad thing, as its businesses are stable but nevertheless able to compound value annually at a Return on Equity Capital of about 9%, but likely to rise. This is nothing like the ultra-rapid growth of the other half dozen largest stocks in the S&P 500, but it comes with a rugged durability and consistency in industries which aren't going away any time soon.
Berkshire Hathaway does not pay a dividend. Many analysts criticize this policy, but most shareholders strongly support it - as evidenced by the vote on a proposal put forward in 2014 in which 98% of shares voted were in opposition to establishing a dividend.
One major argument for a dividend has been that the difficulty of finding a large acquisition in the current expensive market argues that Buffett should employ his large cash position to institute dividends. Another pro-dividend argument - a spurious comparison, in my view - is that Buffett likes dividends when they are paid into Berkshire but dislikes the idea of Berkshire having to pay them out. The two cases are an apples to oranges comparison because, within a corporation, dividends are taxed at a rate as low as 10% while for individuals in relatively high brackets dividends are taxed at more than twice that. Buffett has also noted that individual investors may have very different preferences - some wanting a dividend that is 30% of earnings, some preferring 50%, and some preferring no dividend at all.
Fortunately, there is a solution, and it has important positive internal impact on Berkshire's value as well as serving all Berk shareholders. Buffett appears to have gradually let go of hopes for a major acquisition under present market conditions, at the same time realizing Berkshire can itself provide the equivalent of an excellent acquisition. Buying back shares of Berkshire Hathaway in a large dollar volume would equal or beat any other use of cash while having essentially the same effect as a large acquisition.
In 2020 Buffett bought back almost $25 billion of Berkshire shares - about 5% of the share float. For continuing shareholders who did nothing, it meant that for each share they owned they now owned 5.2% more of Berkshire. Those who wanted a dividend could sell 5% of their shares for cash - their own manufactured "dividend" - and still own the same percentage of Berkshire that they had owned before the buybacks. It was win-win, Buffett at his best.
There was additionally a very helpful internal calculation. Removing that 5% of Berkshire from cash and short term Treasury Bills reduced the book value by that amount while using unproductive cash with a claim on Berkshire operating results. Shrinking both the market cap and the book value by 5% while keeping the same absolute return served to increase the return on equity by that same 5.2%. Doing it every year would quickly drive the Return on Equity to more than 10%, and eventually into the teens.
If you track this argument, you might want to take a look at the numbers on McDonald's (MCD), which has driven its equity capital below zero, as have several similar companies. The negative aspect of this for McDonald's is that it has accomplished this by massively increasing debt, which has become its entire capital structure. This leaves McDonald's at increased risk if interest rates rise. For Berkshire Hathaway it has not been necessary to add debt because it already holds surplus cash.
The next time somebody tells you Berkshire needs to pay a dividend, you'll know what to tell them. Buybacks have the effect of right-sizing Berkshire Hathaway, turning an unproductive asset - cash - into the fuel to concentrate the powerful impact of its growing operational businesses. At the same time it gives you the opportunity to create your own dividend without losing your share in its operational success.
Is Berkshire Hathaway A Good Investment Right Now? And If So For How Long?
Nothing lasts forever. When I was a boy, market old timers used to say that there had been just three true empires: the Roman Empire, the British Empire, and the Standard Oil Company of New Jersey. Jersey Standard (J) as it was called then is now Exxon (XOM). The Roman and British Empires are long gone, and we know what has happened to Exxon over the years since the 1950s. It was overtaken over the years by the increasing difficulty of finding cheap oil, a changing view of the need to protect the environment, and its own failure to recognize changes and move to address them in a timely manner.
Will Berkshire Hathaway - another empire of a sort - eventually succumb to the forces of time? The answer is, inevitably, yes. All things shall pass, me, you, empires, and outstanding businesses. probably in that order. However, the above pattern of events is unlikely to occur at Berkshire Hathaway for a very long time. Its underlying strengths will sustain it. This includes strong and deep leadership, a corporate culture built on the principle of integrity, a sense of duty to the commonweal as well as shareholders and employees, and the ability to admit mistakes. No corporate leader I can think of has invested as much focus on succession and planning for the future as Warren Buffett, or has worked with such determination to preserve core principles by implanting them in the minds of all who work there.
This is the primary reason that Berkshire is almost always a good buy and is a strong candidate to occupy a large and very special role in your portfolio (as it does in mine). I won't quite go so far as to say Berkshire is always a buy. Buffett himself pointed this out in 1998 when its market price stood at 200% of its book value. That isn't the case at the present moment. As of December 31,2020, Berkshire's book value was $443 billion, so that at the current price it is trading at about 1.31 times book value. That level seems reasonable, and in comparison to most parts of the market, cheap.
Bear in mind that since Buffett began buying whole companies on a large scale (around 1998), the accounting rules make book value a less helpful estimate of value. The reason is that a subsidiary purchased in its entirety remains on the books at its purchase price unless written down because of an impairment (Buffett did that this year with Precision Cast Parts). The accounting rule is not symmetrical. An acquisition price is never written up in value. BNSF Railroad was purchased in 2009 for about $44 billion and remains on the books at that number although it is now worth something like three times as much.
In summary I think Berkshire is still a buy with a good margin of safety up to at least $396,000 for an A share and $264 for the B shares. At those prices you can expect to compound the value of your investment at 9-10% and can expect to regularly create your own dividends at 5%, if you wish, without having your percentage of ownership decrease. You can make an argument for higher numbers, but with an eye to margin of safety I'll leave it there.
Berkshire serves very well as a portfolio anchor, offsetting and providing ballast for risker positions. In fact, it may provide much of the non-correlated diversification and stability that bonds used to provide. This idea is not as radical as it sounds. Cash - the zero duration fixed asset - gets you nothing but an assured regular leakage of value at the inflation rate. Treasury bonds have yields so low that their leakage of purchasing power is only a little less than that of cash. Berkshire, on the other hand, promises to plug away compounding money internally at 9-10% even as the price fluctuates, and has a high probability of offering you a chance to pay yourself a 5% annual dividend without loss of a percentage of your ownership.
Berkshire, with its pricing power and assured return and likely upward valuation of property, plant, and equipment in an inflationary environment may be the best present option for playing defense. Its history suggests that it is often negatively correlated to the flashier and riskier parts of the market - giving it a place in the "efficient frontier" portfolio (Google Harry Markovitz) which bonds used to provide. It often zigs when the rest of the market zags.
It is often pointed out that Berkshire has trailed the S&P 500 over 1, 5, and 10 year periods, but Berkshire has actually beaten the S&P over the past 20 years. The fact that Berkshire trailed over the past decade hasn't resulted from poor operational performance, although Buffett himself has long said that it would beat the index by a smaller amount in the future. The 1, 5, and 10 year underperformance has resulted from the fact that overall market valuation has gone up 67% over the past ten years while Berkshire's valuation has remained about the same. When Berkshire's recent performance lags, it often prefigures the turning point in a cycle.
The major risks to Berkshire are pretty much in the area of outlier events which would take down everything and are thus not worth worrying about. Aside from such risks as a nuclear event - in which insurance liabilities would be the least of anyone's worries - Berkshire Hathaway seems solid, safe and likely to provide steady compounding of your capital. I acquired my own large Berkshire position in stages, as each successive purchase came with the confirmation that all prior estimates about Berkshire Hathaway had been fully validated. That's an approach that new investors might apply at this time.
This article was written by
Analyst’s Disclosure: I am/we are long BRK, B, CB, TRV, GOOG. 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.
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