Sunday, March 16

Week 141 - An Update on Berkshire Hathaway

Situation: In a past blog (see Week 125), we characterized Berkshire Hathaway’s B shares (BRK-B, priced around $120/sh) as a “hedge fund for the masses” and we’re sticking to it. The reason we could make this designation is because there are two parts to the company that act to counterbalance each other in a way that maximizes returns and minimizes risks. Almost 2/3rds of the company is made up of more than 80 wholly-owned subsidiaries that are, for the most part, “low risk” enterprises. These include electric utilities, a railroad, a car insurer, a restaurant chain, and a trucking company. The remainder of Berkshire Hathaway is an investment portfolio holding stock in 42 companies that are, for the most part, “high risk” enterprises. 

Many investors like to have the latest information on what Warren Buffett is up to, so we have summarized the major current holdings of Berkshire’s investment portfolio for you in the Table. Red highlights denote higher risk or lower performance vs. the benchmark we like to use, VBINX, which is a low-cost hedged S&P 500 Index fund. 

How are the two parts of Berkshire Hathaway performing? For 2013, Berkshire Hathaway as a whole was up 27.4% in value vs. 28.9% for the lowest-cost S&P 500 Index fund, VFINX (see Column G in the Table), whereas, the average stock in the Berkshire Hathaway’s investment portfolio was up 31.7%. These results are as expected, given the overall robust performance of the stock market and the relative risk of Berkshire’s wholly-owned subsidiaries vs. its investment portfolio. 

As of Dec 31, 2013, the value for all of Berkshire Hathaway was $294 Billion, with the investment portfolio representing $105 Billion. In other words, 36% of the company’s value is in marketable common stocks. Berkshire Hathaway is in the financial services industry, so it is not surprising that stock in such companies represents 43% of its investment portfolio. Wells Fargo (WFC) alone accounts for 20% of that portfolio and American Express (AXP) 13%. Every quarter, the Securities and Exchange Commission (SEC) requires large companies to submit an update of their investment holdings. We’ve perused Berkshire’s recently issued “13-F filing” for the 4th quarter of 2013, and summarized the results for company holdings that are larger than $0.5 Billion (in Table). Two companies were excluded because their stock was issued only recently: General Motors (GM) holdings worth $1.6 Billion, and Liberty Media (LMCA) holdings worth $0.78 Billion. When this filing is compared with the previous quarter’s, we see that Berkshire Hathaway has exited from positions in Dish Network and GlaxoSmithKline plc but has added a position in Liberty Global plc valued at $0.26 Billion. Warrants that Berkshire had been holding in Goldman Sachs (GS) have been converted to shares worth $2.2 Billion.

Taking a closer look at the investment portfolio (Table), we see only 3 financial services companies (WFC, AXP, USB) among the largest 10 holdings (denoted in the Table with green stock tickers in Column B). Not surprisingly, given Warren Buffett’s prowess as a stock picker, all 7 non-financial companies have finance values (Column E) higher than our benchmark’s (VBINX). Costco Wholesale (COST) is the only one in that high value group that isn’t in the Top 10 holdings, so it stands to reason that COST is a candidate for further accumulation.

BRK-B shares are priced around $120/Share, making those easy to accumulate by using a low-cost online brokerage such as TD-Ameritrade. And, it is a hedge stock by our definition (i.e., a stock that a hedge fund trader would be unlikely to bet against). Why? Because of characteristics that minimize its volatility enough to temper a hedge fund trader’s enthusiasm: a) it has outperformed the hedged S&P 500 Index (VBINX) since the market peak on 9/1/00 and over the most recent 5 yrs, as well as the past year; b) its losses during the Lehman Panic were limited (28.8%) while the S&P 500 Index fund lost 46.5% (see Column D in the Table); c) it has a 5-yr Beta of 0.29 (Column J) that is much less than the hedge fund industry average ranging from 0.6 to 0.7; d) it has a trailing P/E much less than the market’s (Column K); e) it has an AA S&P bond rating. Berkshire Hathaway falls down on only one criterion for discouraging a hedge fund trader. It doesn’t pay a dividend. Remember, traders bet against a stock by entering into a “short sale.” That involves borrowing and immediately selling a stock in the hope that it will fall in value, at which point it is bought back cheap and the shares returned to the original owner, pocketing the difference between what was earned on the sale and the cost for re-purchase. However, when the stock pays a dividend the trader (or the boss) has to reimburse the original owner in an amount equal to the value of each quarterly dividend over the holding period. That’s a nuisance, and a significant expense. Berkshire Hathaway doesn’t pay a dividend so its shares can be shorted without incurring that expense. 

To summarize, it is very unlikely that the price of Berkshire Hathaway’s stock would ever be driven down more than 5% because of “short” sales. And, because it is so well managed, Berkshire doesn’t need to pay a dividend in order to gain the investors trust. That means all of its Free Cash Flow is being used to grow the company instead of some being diverted to pay dividends. There is also a tax advantage to waiving dividends: Shareholders are already being taxed at the 35% “corporate” rate, so why would they be happy being taxed again at the 15-20% “individual” rate on the same earnings in the form of dividends? 

Bottom Line: The reader should feel comfortable buying BRK-B shares, knowing that her investment will have unusually low volatility while being representative of a broad swath of the market.

Risk Rating for BRK-B: 4

Full disclosure: I have stock in Berkshire Hathaway, and make monthly additions to dividend reinvestment plans for WMT, IBM, KO, XOM, and PG.

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