Berkshire Hathaway (NYSE : BRK.B) : Resilient Against the Market

Berkshire Hathaway

The Oracle of Omaha has faced immense scrutiny over the past few months, mostly painting him in a less than optimal light.

One of the events which have been repeated more than my mom has told me to do the dishes, include his reversal towards airline stocks. Market watchers estimate the losses to be in the vicinity of USD 4 billion from the failed campaign. Then there is the quarterly loss of USD 49.7 billion reported by Berkshire arising from dampened economic performance.

Figure 1: Berkshire has lagged the S&P 500 drastically in the past weeks

Looking through the fundamentals of Berkshire, I found cogent arguments backing the thesis that Berkshire is a low risk investment with returns which could outpace the markets in the long run.

Berkshire is low risk, even when the markets are riskier than ever

On May 8th, it was reported that Berkshire has amassed a record USD 137 billion cash pile. The following graph shows its steady climb over the past few years:

Figure 2: Berkshire’s cash pile has been steadily growing under Buffett’s financial prudence

It is undoubtedly a policy of financial prudence which drives Warren Buffett’s cash retention policy, financed by the large sums of dividends he receives from his holdings. These cash holdings are not just there to be eaten away by inflation, it serves as both a war chest and a safety net.

Liquidity is a condition for assured survival and allows investors to sleep well at night knowing that the invested companies will not be swarmed by creditors whom they can ill afford to repay.

Berkshire has traditionally been in a position of strength even in tough economic conditions. Think 2008, when AIG and Lehmann approached Buffett in desperate need of cash just days before they collapsed. That’s how influential the company was – it might have been able to prevent (or at the least, prolong) a cataclysmic collapse of the financial markets if Buffett had said yes.

Diving deeper, I believe it is clear that Buffett wants to position himself in a position to buy when the opportunity arises. He has personally stated that he is alright with staying away from the market for years if he sees no viable opportunity he likes.

It makes sense. Afterall if you wanted to lose money, why lose it to the markets when you can give it away to a charity?

Many investors have bemoaned the fact that Buffett has shied away from share buybacks even though he mentioned that he would do so if the price to book ratios drop below 1.2 (it is currently around 1.18).

Figure 3: Berkshire’s P/B ratio is current at recent lows <1.2

Buffett has always been an ardent supporter of value creation for Berkshire’s shareholders.

It seems to me that Buffett expects the markets to present better opportunities to reap greater returns on investments for Berkshire’s shareholders, as compared to share buybacks. Therefore the cash pile, as he deems, should not be employed through share buybacks but acquisitions of potentially undervalued companies.

The bottom-line is that investment boils down to two fundamental blocks – risk and reward. On the risk basis, Berkshire is an impregnable financial fortress, built on Buffett’s prudent financial ideologies.

Managing Berkshire’s growth expectations

When analysing Berkshire, investors must understand that this conglomerate is a highly mature company and will not be a 10 bagger.

Instead, they should manage expectations and expect this company to be a low risk holding delivering stable growth in the long run.

Berkshire’s portfolio consists mostly of mature companies (KO, AAPL, BAC etc) in their own right which has encountered exponential growth in the past and will remain as stalwarts going forward. These companies will range around 5-10% top line growth and their balance sheets have fortified as well, essentially reducing beta.

Figure 4: Top holdings of Berkshire are major companies in their own right

In the dot-com bubble, Berkshire was lucky to have little technological holdings and was well shielded from the downturn. The tables have turned however, and traditional industries have faced declines from ATHs since the onset of the pandemic.

At its core, Berkshire is cyclical in nature. Berkshire’s holdings require the investor to have faith in the US economy and if investors believe that demand will return to previous levels, then there is a strong case to be fought that Berkshire’s holdings will return to prior valuations after the crisis – though the time required is uncertain.

Figure 5: Berkshire’s equity book value has increased exponentially over time (adapted from Sven Carlin’s blog)

Buffett has been known to consolidate his holdings and accumulate during periods where the market has encountered sideways movement or downturns. This is essentially what investing is: accumulating holdings of companies which great fundamentals at reasonable prices, which is more apparent during periods of market stalemate or downturn. The compounding effect will then be evident during market upturns.

Berkshire’s mistake with the airlines is PERFECTLY NORMAL

Boy oh boy, this topic.

Buffett entered the airlines industry during in 2017, when airline stocks were relatively depressed. Last I calculated, the airline stocks were down around 52.7% since all time highs which states that Buffett made a loss of around USD 4 billion before he finally bailed.

In understanding the full context, we have to appreciate how Buffett has already understood the risks of investing in airlines even back in 2007.

Figure 6: Excerpt from 2007’s letter to shareholders

To save you some reading time, he states plainly that a durable competitive advantage is elusive for companies in the airlines industry even though its demand for capital is unyielding. Obviously, things have changed for Buffett and he eventually put his money into the 4 biggest US airlines.

That said, even the oracle makes mistakes sometimes.

Here’s an amazing video by Sven Carlin which states that up to 7.6 stocks in a 10 stock portfolio tends to underperform the market. However, the remaining 2.4 holdings more than make it for it. It is an intriguing watch and will definitely open your eyes to stock picking and its risks.

So one mistake for any investor, including Buffett, is perfectly normal. In relative terms, the amount he lost makes up only 2.9% of his cash pile (not even considering his equity holdings). Safe to say this failed venture was blown out of proportion by the media if you ask me.

For every poor investment Buffett makes, he has proven to be able to attain market beating returns through other acquisitions.

So what does this mean for the layman investor?

If you are looking for a high growth or high dividend stock, then Berkshire is not something you should be looking at. Berkshire’s upside is limited by its size and the size of its holdings.

This company should be viewed as a hedge against a recession. I think of Berkshire as a possible substitute to an S&P 500 ETF (SPY) in a portfolio on the basis that the company provides market pacing / beating returns and its going concern is not likely to be an issue.

For investors looking for a solid undervalued pickup during this period but do not want to face long term uncertainty, this stock is for you.

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