Very well written summary of how Warren Buffett and Charlie Munger grow this 'GIANT' (by Yahoo Finance)
Berkshire Hathaway (BRK-A) (BRK-B) was a struggling textile company when
Warren Buffett first invested in it in 1962.
Today, it’s a $400
billion behemoth. In Buffett’s own words, it’s a “sprawling conglomerate,
constantly trying to sprawl further.”
The companies in
Berkshire’s portfolio vary greatly. But one thing ties them all together:
Buffett says they’re about “maximizing long-term capital growth.”
Here’s a brief
introduction to Berkshire Hathaway.
The insurance business is the backbone of the
company
After it acquired
National Indemnity in 1967, Berkshire relied on its insurance businesses to
power much of its expansion.
As Berkshire has
gotten bigger and diversified its businesses, its insurance operations have
become a smaller contributor to earnings than in the past, currently making up
26% of total company earnings. But they remain an important part of the
company’s access to a permanent capital base by generating what’s known as
“float.”
“Float” is money
collected up front that is not paid out until later. In Berkshire’s property
& casualty (P&C) insurance businesses, premiums are collected up front,
but claims are paid out often years or decades later, allowing the float to be
used for investments.
Today, Berkshire’s
insurance group consists of four segments: GEICO (auto insurance), General Re
(reinsurance), BH Reinsurance Group (retroactive reinsurance through subsidiaries),
and BH Primary (focused on commercial markets, led by National Indemnity Co).
The property and
casualty insurance business has faced headwinds—including deteriorating
pricing and margin compression. But 2016 posted solid performance, with GEICO
in particular making a comeback. Last year, GEICO suffered from higher
personal auto claims (as a result of more low gas prices and more driving), and
this year it accelerated new business efforts.
Berkshire’s insurance
float was only $1.6 billion in 1990, and sat at $91.6 billion as of 2016. It is
now over $100 billion, including the $10 billion reinsurance deal with
AIG (AIG).
Equity portfolio
Berkshire’s investment
portfolio represents Buffett’s long-term conviction ideas.
At the end of 2016, about
60% of his equity portfolio was invested in five companies—Wells Fargo (WFC), Coca-Cola (KO), IBM (IBM), American Express (AXP) and Apple (AAPL), a position he
initiated last year and built up even more recently
Buffett also made a big bet on airlines last
year, diverging from his position in the past. He significantly increased
his positions in Delta (DAL), United
Airlines (UAL) and American
Airlines (AAL) while adding a
big stake in Southwest Air (LUV).
Shift to non-insurance businesses
Berkshire has evolved
from its early years, when it was an insurance-driven company driven by
outperformance on investments. It is now a large conglomerate that
includes many non-insurance businesses.
The railroad business
now comprises 22% of Berkshire earnings. Burlington Northern Santa Fe Railroad
(BNSF), which Berkshire acquired
in 2009 for $44 billion, is one of seven major railroads in North
America and carries 17% of all inter-city freight. Berkshire has been investing
heavily in this business.
Utilities businesses
comprise 10% of Berkshire earnings. BH Energy owns four utilities
servicing customers in 11 Western/Midwestern states, two electricity
distribution companies in England, two interstate pipelines, a renewable energy
business, and a residential real estate brokerage firm.
Berkshire’s
manufacturing, service and retailing (MSR) operations, 35% of total earnings,
include everything from candy to jets. Companies include food supply chain
company McLane, manufacturing businesses (like specialty chemicals company
Lubrizol, industrial components company Marmon, flooring company Shaw
Industries, and paint and coatings company Benjamin Moore), service and
retailing businesses (including NetJets, See’s Candies, Borsheim Jewelry
Company, the Pampered Chef, and Oriental Trading Company), recently acquired
battery maker Duracell, and aerospace components manufacturer Precision
Castparts, which Berkshire
bought in 2015 for $37 billion.
Its finance
businesses, 8% of earnings, focus largely on the manufacturing and financing of
homes and the leasing of transportation equipment. They include Clayton Homes,
UTLX, XTRA, and other leasing and financing activities.
Acquisitions accounted
for about 60% of Berkshire’s earnings growth in the past 20 years,
according to Morgan Stanley.
As Morgan Stanley’s
Kai Pan points out, Berkshire has a “managers as owners,” mentality, a
decentralization that allows each unit to focus on long-term goals.
Additionally, Pan highlights, each unit maintains an economic “moat” in its
respective industry, separating it from competition to some degree.
More acquisitions are
likely on the horizon for Berkshire, which has an estimated $60 billion in
excess capital.
Valuation
Buffett’s preferred
method for evaluating the attractiveness of investments and businesses is
intrinsic value, which represents the sum of all of discounted cash flows that
can be taken out of a business during its remaining life. The investor
Whitney Tilson sees the current intrinsic value at $300,000 per share,
significantly above the recent share price of $247,520.
Book value is another
approach used to value Berkshire. However, Buffett has noted that the metric
has underrepresented Berkshire’s intrinsic value because of the number of
operating businesses Berkshire has acquired, which are held on the books at
cost.
A book value
calculation does, however, provide a floor for investors. Berkshire has an
open-ended share repurchase program that authorizes management to repurchase
shares if the stock price drops below a price-to-book ratio of 1.2x.
Beneficiary of stimulus
As Morgan Stanley’s
Kai Pan points out, Berkshire has large exposure to Industrials and Financials
and thus will be a major beneficiary of the administration’s “pro-growth”
policies and tax reform, if they pan out.
“Given Berkshire’s
outsized exposure in Industrials and Financials, it is not surprising that BRK
shares have rallied +22% post-election vs. +14% for the S&P 500,” Pan wrote
on March 20. “A potentially lower US corporate tax rate would also aid
earnings. A 20% tax rate could boost BRK earnings by ~14% vs. its current ~30%
consolidated tax rate,” he added.
The
bottom line: Berkshire’s business
has transformed over the years, but remains focused on long-term return and the
efficient use of capital.
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