The Value of Berkshire Hathaway

I attended my twelfth Berkshire Hathaway Annual Meeting this past weekend and found it to be as worthwhile as ever.  Chairman/CEO Warren Buffett, age 86, and Vice Chairman Charlie Munger, age 93, are still at the top of their game.  Their appreciative audience seemed to me larger than ever with approximately 40,000 stockholders in Omaha, NE for the meeting and related Berkshire Hathaway events.

Once again for five hours they responded to questions from financial journalists, research analysts and stockholders, many of which dealt with how the intrinsic value of Berkshire Hathaway is not reflected in its balance sheet and income statement.  Here are some of the stunning highlights:

  • Berkshire Hathaway’s security holdings of public companies now have unrealized gains of $90 billion not recorded in net earnings.
  • Berkshire Hathaway’s float, accumulated insurance premiums reserved for future claims, now exceeds $100 billion for the first time.  Carried as a liability on the balance sheet, Buffett regards these reserves as a revolving fund since premiums received for new insurance policies likely replenish insurance claims going forward.  Moreover, Berkshire Hathaway’s insurance operations, which have operated at an underwriting profit for the past fourteen years, are currently expected to continue that performance with the result that the investment earnings on its $100 billion float would fall to the bottom line.
  • Berkshire Hathaway has $15 billion of intangible assets, representing the cost of acquired businesses exceeding their book value, which must be amortized as expenses over many years.  In 2016, the amortization of intangible expense for Berkshire Hathaway was $1.5 billion.  Buffett believes this expense is unwarranted because the acquired companies would not have incurred such an enormous intangible expense had they remained independent.  It is only because of Berkshire Hathaway’s ownership that the intangible expense must be deducted from profit.

Buffet believes that the intrinsic value of Berkshire Hathaway’s stock far exceeds its book value.

Positive News for the Future

  • New Business in 2017
    • GEICO led by Tony Nicely has signed up 700,000 new policy holders.
    • Berkshire Reinsurance led by Ajit Jain received a $10 billion premium for a new reinsurance contract with AIG.
  • Stock Investments
    • Warrants from the purchase of Bank of America Preferred Stock are now worth $10 billion in addition to the $5 billion originally invested.
  • Tod Combs and Ted Weschler
    • Each of these investment managers brought into Berkshire Hathaway by Buffett are now managing $10 billion dollar portfolios and additionally have subsidiaries reporting to them.
  • Stock Repurchases and Dividends
    • Buffett explained that if the size of Berkshire Hathaway’s cash available for investment makes it increasingly difficult to employ, dividends and stock repurchases would be considered.
  • Taxes
    • Buffet said that reduction of corporate income taxes would increase profits of Berkshire Hathaway’s subsidiaries (with the exception of public utilities that have electric rate setting commissions which control profit levels).
  • Management Succession
    • Buffett explained that when he retires or otherwise can no longer be CEO, his successor will come from within Berkshire Hathaway.  While he is not prepared to disclose the name of his successor as long as he plans to continue as CEO, he said that there is ample talent within the company from which to choose.
  • Berkshire Hathaway Without Buffett
    • Buffett said of Berkshire Hathaway’s stock, “If I died tonight, I think the stock would go up tomorrow.”  He attributed the reason why to the market perception that the sum of Berkshire’s parts is worth more than their whole as a single company.  However, he has a loyal board and loyal managers who want his principles for Berkshire Hathaway to continue for the long term benefit of its shareholders.

Past performance is not indicative of future results. The information provided in this commentary should not be considered financial advice or a recommendation to buy or sell a particular security. You should not assume that any of the investment strategies or securities discussed herein are or will be profitable. The opinions expressed herein are those of Edgemoor Investment Advisers, Inc. (Edgemoor) and are subject to change without notice. You should always obtain current information and perform due diligence before investing.  All recommendations for the last 12 months are available upon request.

Edgemoor Investment Advisors, Inc. is a registered investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Edgemoor including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.

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A Good Start to 2017

In this latest installment of our quarterly report, my colleagues and I share some observations on the first quarter of 2017 and offer our outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • Continuing the rally that began last fall, the S&P 500 index returned 6.1%, including dividends, in the first quarter of 2017.  Foreign markets also surged amid fairly consistent global economic expansion, optimism about the potential for higher corporate earnings, and generally low inflation and interest rates.
  • We believe the backdrop for continued U.S. economic growth is currently favorable, with consumer and business confidence high, unemployment low, and inflation nearing the Federal Reserve’s target level of 2%.
  • Commodity prices have risen in response to global demand.  Oil prices have eased recently but remain near $50 per barrel, a price far above the $26 of last February.
  • The U.S. dollar has declined, partly due to concerns about potential policy changes that would restrict trade.  This pullback is good news for U.S. exporters, whose goods are more competitively priced when the dollar declines.
  • Tempering the outlook are ongoing political squabbles in the United States and concerns about the economic implications of protectionist and anti-immigration movements around the world.
  • Since the U.S. elections, investors have bid up stocks partly in anticipation of tax reform, regulatory easing, and infrastructure spending promoted by the White House.  More recently, investors have become warier of the timing and magnitude of the policy changes that will actually be enacted.
  • Analysts expect first quarter 2017 S&P 500 index earnings to increase about 9%, which would be the strongest result since 2011.  Robust profits would confirm the health of the economy and provide support for current stock prices.
  • We believe U.S. stock valuations are now a bit lofty overall, with the S&P 500 index trading at a multiple of earnings that is above its historical average.  Nevertheless, we remain confident regarding the long-term prospects for our holdings.
  • For income investments, we continue to favor other asset classes over most bonds, given low bond yields and our expectations of further rate increases, which would cause bond prices to drop.

As always, feel free to contact us if you have any questions or comments.  For more information, visit our website.

Jordan Smyth and the Edgemoor Investment Advisors Team

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What a Year – Highlights from Edgemoor’s January 2017 Newsletter

In this latest installment of our quarterly report, my colleagues and I share some observations on 2016, discuss the potential impact of upcoming policy changes under the new administration and Congress, and also offer our broader outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • Stocks rallied through the end of 2016, as investors appeared to express greater optimism about the U.S. economy and improving corporate earnings.  Value stocks outperformed growth stocks after several years of lagging.
  • Anticipation of the new administration’s planned changes in tax and regulatory policy to support business activity and investment helped to boost the market.  In addition, a return to earnings growth in the third quarter, after six quarters of declines, likely played an important part in the rally.
  • Oil prices also surged in 2016 from their February low to about $53 per barrel at year end, providing a needed boost to the energy sector.
  • One event that surprised nobody was the U.S. Federal Reserve’s decision to increase the federal funds rate by another 0.25% in December, a full year after the last hike.  Stocks plowed ahead, but bonds fell as interest rates increased.
  • We enter 2017 believing the U.S. economy is healthy and expect it to continue its slow but steady expansion.  Consumer confidence is at a 16-year high, and the most recent jobs report showed increases in wages.  Inflation remains low, and business optimism should improve with the expected policy changes.
  • Beyond the United States, the European economy continues to expand, though more slowly than the U.S. economy, and the European Central Bank remains committed to low interest rates, bond purchases, and other monetary support.  Chinese and Japanese exporters could benefit from a strengthening U.S. economy, and Japan’s economy showed relatively strong growth in the third quarter of 2016, a positive sign after many years of stagnation.
  • Overall, we are currently optimistic regarding stock market returns for the coming year.  We believe valuations remain reasonable, even after the recent surge, and we are encouraged by the outperformance of value stocks over growth in 2016 and so far in 2017.
  • For income investments, we continue to favor other asset classes over most bonds, given low bond yields and our expectations of further rate increases, which would cause bond prices to drop.

As always, feel free to contact us if you have any questions or comments.  For more information, visit our website.

Jordan Smyth and the Edgemoor Investment Advisors Team

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Buckle Up! – Highlights from Edgemoor’s October 2016 Newsletter

In this latest installment of our quarterly report, my colleagues and I share some observations on the third quarter, discuss the potential impact of the upcoming election, and also offer our broader outlook for the economy and markets.  Click here to go to the full report on our website.  Following are a few highlights:

  • We are watching the Presidential race closely but do not believe the upcoming election will have a significant long-term impact on the markets.  Other factors more directly and fundamentally influence investment returns, and markets have done well through many different political environments.
  • We agree with the market consensus that the Fed will probably raise rates in December, unless economic data changes significantly.  Any increase would likely be 1/4%, enough to signal the Fed’s willingness to act to control inflation but not enough, in our opinion, to derail economic growth.  Though it should not surprise anyone, this change could temporarily rattle markets.
  • U.S. economic growth rose to 1.4% in the second quarter, and it appears that growth should pick up further in the second half of 2016.  GDP is increasing more slowly than last year, but we believe the near-term odds of a U.S. recession are still slight.  Elsewhere in the world, the economic picture is mixed but, in our view, positive overall, and central bankers are currently maintaining their stimulative policies.
  • The third quarter saw a reversal of many trends from the first half of the year.  For example, technology and financial stocks went from lagging in the first half to outperforming in the third quarter.  Meanwhile, several defensive asset classes that performed well in the first half reversed course due to more positive economic data and increased odds of an interest rate hike by the Fed.  Also, U.S. stocks outperformed in the first half but lagged foreign stocks in the third quarter.  Since it is nearly impossible to predict all of these short-term changes in sentiment, we believe these shifts emphasize the importance of a well-diversified, global portfolio.
  • Corporate earnings for the third quarter will likely be flat or down slightly, so they will not provide much lift to the broad market until they pick up meaningfully from current levels.
  • Particularly encouraging is the recent performance of value stocks, which are beating growth stocks for the first time in several years.
  • With a rate hike likely in December and interest rates still at historically low levels, we continue to favor other income classes over most bonds.

As always, feel free to contact us if you have any questions or comments.  For more information, visit our website.

Jordan Smyth and the Edgemoor Investment Advisors Team

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Presidential Elections and the Stock Market

When it comes to long-term stock market returns, does it matter who occupies the White House?  According to a recent analysis by Dimensional Fund Advisors, which you can read by clicking on this link, the answer is, “No.”  While this conclusion may seem counterintuitive, particularly in the midst of this year’s contentious campaign, we agree that trying to invest according to the person or party in the White House is likely to be less fruitful than a sound, steady, long-term strategy.

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