3 Reasons to Buy Berkshire Hathaway Post-Buffett
At a cost of more than $127,000 each, Berkshire Hathaway’s Class-A (NYSE: BRK.A) shares are easily the priciest investment on the American exchanges, in part because the company has never had a stock split or paid a dividend to its shareholders. With Warren Buffett at the helm for nearly a half-century, Berkshire, a diverse holding company with its core in insurance, has grown into the world’s eighth largest publicly-traded entity. It’s no doubt that Buffett is quite the investor (here’s our Top 10), but he also has more in common with action hero Chuck Norris than you might think; read here for more.
Now, over the past decade, BRK.A has achieved an average annual return of 9.3 percent, easily outpacing the broader markets, and the insurance industry as a whole. In order to prevent the formation of “copycat” unit trusts, Buffett oversaw the creation of Berkshire Hathaway’s Class-B (NYSE: BRK.B) shares, which now trade for close to 1/1,500 of their classier peers. These offer a similar return at a much lower minimum level of investment. Presently, both BRK.A and BRK.B are priced near their 52-week highs, which has brought plenty of bears out of the woodwork claiming overvaluation, or that Buffett’s eventual retirement will doom the company to mediocrity. Here are three reasons why those naysayers are wrong.
1. Succession worries are overblown. By the end of next month, Buffett will turn 82 years old, making him the fourth oldest CEO in America. In early April, he announced that he would receive treatment for stage 1 prostate cancer, but that it isn’t expected to interfere with his executive duties. When Buffett does choose to retire from Berkshire, he will be replaced by a new governing structure, made up of a CEO and multiple investment managers. Surprisingly, a direct successor has not been named publicly, though Buffett has chosen one internally.
While many claim that a post-Oracle Berkshire will no longer be worthy of a “Buffett premium,” so to speak, it is notable that he has had the ability to mentor his eventual successor; this minimizes the risk of any strategic misstep. Moreover, new blood may actually help Berkshire access new markets, as Buffett has never owned Google (NASDAQ: GOOG), Apple (NASDAQ: AAPL), or any tech company besides IBM (NYSE: IBM). Holding true to this mantra, Buffett has avoided investing in companies he hasn’t understood, and has missed out on some truly astounding returns. By definition, having a larger investment management team could give the company additional expertise in high-yielding industries like technology.
In fact, one such manager is Todd Comes, who’s Castle Point Capital returned 34 percent a year under his watch between 2005 and 2010; 13F forms show that he has tended to favor tech giants, in addition to media outlets. Buffett has also announced Ted Weschler, founder of Peninsula Capital Advisors, would be aiding Comes with the enviable task of managing Berkshire’s $100 billion portfolio. Weschler has focused on media stocks in the past, most notably Liberty Media (NASDAQ: LCMA), which Berkshire coincidentally took a position in earlier this spring.
The point is this: we trust Buffett’s successors because, like companies, they are investments as well. With the Oracle’s remarkable track record, it would be foolish doubt his ability to assess human capital.
2. Buffett has amassed a solid portfolio for the long haul. Out of the companies Buffett has acquired or taken positions in, almost all are rock-solid. GEICO, which Berkshire acquired over three decades ago, generated close to $900 million in investable “float” funds in 2011, allowing Buffett & Co. to reinvest this cash in other operations. On the whole, the company’s insurance “float” has risen by more than 300 percent since 2000. A few other companies held by Berkshire, in order of stake percentage, are Wells Fargo (NYSE: WFC) at 19.0%, American Express (NYSE: AXP) at 12.6%, Moody’s (NYSE: MCO) at 12.5%, and The Coca-Cola Company (NYSE: KO) at 8.6%. Since the recession, each has returned an average of 18.7 percent per year, and more importantly, reached a dominant position in their respective markets.
Wells Fargo has seen extraordinary revenue (73.8%) and earnings (177.3%) growth over the past three years, while positioning itself to be the bank that makes the most from a housing rebound; it currently holds nearly $2 trillion in mortgage loans. WFC reported impressive earnings last week, and estimates that it now originates one out of every three mortgages in the U.S. With housing forecasts like this, its prosperous position is apt to grow even stronger in the coming years. Likewise, American Express has a throttlehold on the closed-loop credit card industry, as its control over the card issuing process gives it an advantage over competitors like Visa (NYSE: V) and Mastercard (NYSE: MA). AXP sports a particularly high return on equity of 26.8 percent while trading at undervalued price multiples; both of these indicators point to a bright future for its shareholders, particularly for Berkshire.
In a similar manner, Moody’s has also been extremely profitable in recent years, as it sports operating (38.6%) and net (25.1%) margins way above industry averages. More importantly, though, the company is more efficient than its primary peer, McGraw-Hill (NYSE: MHP), which owns Standard & Poor’s. MCO trades at lower P/E (14.3X) and Forward P/E (11.2X) rations than MHP, despite the fact that it has grown EPS (30.0%) at a much quicker rate than MHP (9.3%) post-recession. Soft drink maker Coca-Cola has also proven its worth to Buffett & Co., as it holds the distinction of being the largest non-alcoholic beverage producer in the world. Earlier this week, the company reported earnings above the Street’s estimates, citing better than expected sales in the emerging markets, indicating strong growth in Africa (+12%), Eurasia (+12%), the Pacific (+8%), and Latin America (+3%).
3. Shares of Berkshire are very cheap at the moment. Last but not least, we wouldn’t be very good Buffetologists if we advised buying Berkshire Hathaway at an unreasonable price. While most analysis of Berkshire uses traditional price ratios like the P/E, P/B, and P/S, there are more thorough ways to determine this stock’s value. One such method we can use is to determine the company’s price-to-net asset value, an approach loved by Buffett himself. Currently, BRK.A and BRK.B are trading at an average premium of 23.8 percentage points above net value, which is far below the company’s historical range (60%-150%) in the decade leading up to the recession. Assuming that shares regain just the lower bound of this valuation, BRK.A has upside of $160,000 while BRK.B should flirt with $110 a share over the next two to three years.
Another Buffett-specific metric is earnings yield, which indicates the earnings of a company as a percentage of its share price. Typically, an earnings yield above the 30-year Treasury yield (2.58%) signals that a good investment can be had. Currently, the earnings yield of BRK.A (5.7%) and BRK.B (6.0%) are more than double the yield of a T-bond, and what the both classes of the stock were offering just three years ago. Now, WealthLift’s Sentiment Index rates both BRK.A and BRK.B as strong buys, with the majority of the community’s users placing an “overperform” rating on each stock. Unless you’re interested in emptying out your kid’s college education fund, though, it may be better to stick with BRK.B.
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Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours. He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.