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Berkshire Hathaway is a great way to tap into the best companies in the US
We believe Warren Buffett-run Berkshire Hathaway is a great vehicle for achieving a ready-made exposure to a diverse group of some of the best companies in the US and increasingly, elsewhere in the world.
Influence from Berkshire portfolio managers Ted Weschler and Tod Combs has increased the company’s exposure to some fast-growing technology companies, such as cloud data platform provider Snowflake and Brazilian payments group StoneCo.
Former hedge fund manager Weschler is often cited as a potential future chief investment officer of Berkshire Hathaway.
Berkshire has used its growing cash pile to repurchase over $51 billion worth of its own shares since 2018, giving a boost to earnings per share growth on top of underlying organic growth.
Despite the share repurchases, the wholly owned businesses continue to throw off cash, and Berkshire has around $70 billion of cash which could be used to buy public companies on the cheap if stock markets stumble, providing a defensive and opportunistic angle to the story.
NOT YOUR AVERAGE CONGLOMERATE
Investors often label Berkshire Hathaway as a conglomerate which is seen as derogatory, implying it is a collection of sprawling, unrelated businesses.
But there are two big differences between traditional conglomerates and Berkshire. Firstly, Berkshire takes both controlling stakes and minority stakes in companies.
Secondly, the businesses targeted are required to have sustainable economic advantages and competent managements.
Buffett said it best in his 2020 shareholder letter: ‘It took me a while to wise up. But Charlie – and also my 20-year struggle with the textile operation I inherited at Berkshire – finally convinced me that owning a non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100% of a marginal enterprise.’
A key characteristic of great businesses is their ability to retain earnings (the portion of profit not paid as dividends) and reinvest them for future growth, creating a virtuous cycle.
THE FAMILY JEWELS
Berkshire is a big operation by any yardstick and employs around 360,000 people across nearly 100 subsidiaries, covering all sectors of the economy including railroads, confectionery, home furnishings, house building, insurance and energy.
But the most valuable assets are three wholly owned operating businesses and one partially owned one, Apple, where Berkshire holds a 5.4% stake, currently valued at $109 billion.
The property and casualty insurance businesses have been the bedrock of the Berkshire empire for 55 years. They are run very prudently and operate with far more capital than any of their competitors.
Key to the business is the concept of float, which simply represents the cash received up front from insurance premiums paid by customers.
If Berkshire writes the same level of business every year, the amount of annual float remains the same or grows in line with the business growth. Over the years the float has grown from a few million to $145 billion at the end of the third quarter 2021.
Even though Berkshire’s insurance companies don’t legally own the float, they can deploy the cash in whatever way they want, and this has been a good ‘cheap’ source of funds for the company over many years. Berkshire has used this cash to purchase many of its businesses.
Buffett claims that cumulatively over the years the cost of the float has been zero. That is, the premiums paid, less the costs of claims and expenses has averaged out at close to zero.
The second jewel is the railroad business BNSF (Burlington and Sante Fe railway), the largest railroad in the US measured by freight carried, representing around a 15% market share.
The third jewel is energy company BHE (Berkshire Hathaway Energy) which has grown earnings under Berkshire’s ownership by a compound annual growth rate of 17% a year over the last 21 years.
In other words, earnings have grown from $122 million to $3.4 billion. In the third quarter of 2021 BNSF and BHE contributed pre-tax earnings of $2 billion and $1.4 billion respectively.
Berkshire ended the third quarter with shareholders’ equity of $472.5 billion, up 6.6% from 31 December 2020, putting the shares on a price to book ratio of 1.5 times.
SUCCESSION AND OTHER RISKS
Buffett turned 91 years of age last year and his long-term business partner Charlie Munger is 99 years old which adds risk to the investment proposition despite decades of succession planning.
The pair have always highlighted the challenge of growth as the company gets larger and that challenge has not receded. Berkshire also has one of the world’s largest catastrophe insurance operations which could be impacted by extreme events.