At the largest ever Berkshire Hathaway Annual Meeting on May 3, with approximately 40,000 stockholders in attendance, Warren Buffett and Charlie Munger rose to the occasion and were at the top of their game. Buy good companies, let their managers run them, and invest the capital they generate has been their mantra from the outset, and it is still working.
Net income of $19 billion for Berkshire Hathaway in 2013 was an all-time record. But net income is not a good measure of Berkshire Hathaway’s real value, whether it be the 31% increase in 2013 over the prior year or the 4% decrease in the first quarter of 2014 from the same period a year earlier (due to a drop in insurance underwriting profits which were unusually high a year earlier).
To comprehend the intrinsic or true value of Berkshire Hathaway, it is necessary to understand its three components. First is the ownership of 68 non-insurance operating companies led by railroad BNSF and public utility Berkshire Hathaway Energy. These operating subsidiaries now account for more than two-thirds of Berkshire’s annual net profit.
Second is Berkshire’s insurance company business and its rapidly growing $77 billion of reserve “float” invested in stocks, the largest four of which are Wells Fargo, Coca-Cola, American Express and IBM. Profits from Berkshire’s stock portfolio are vastly understated since only dividends received by Berkshire are reported as net income, not the share in earnings these stock holdings represent nor their gain in market value. The unrealized gain in Berkshire’s stock portfolio increased $11 billion in 2013, but none of it reported as income.
The third component is the value of future earnings which Berkshire will make from investment of its growing retained earnings. Berkshire retains all its earnings for reinvestment with enormous stockholder approval. Ninety-seven percent of Berkshire’s shareholders rejected a proposal that the company pay a dividend.
For the past 49 years, Berkshire has compared the book value of its shares to the S&P 500 Index. During that period of time, Berkshire’s book value per common share has compounded at an annual gain of 19.7% compared to 9.8% for the S&P including dividends. The recent criticism of Berkshire for the underperformance of its book value per share compared to the S&P over the last five years represents a misunderstanding of what the company is all about. Berkshire is a value oriented investor which outperforms the S&P in years when the market is down or marginally up, underperforms the S&P when the market is unusually strong, but outperforms the S&P over the course of full business cycles. Going back to 2007 before the Great Recession began, Berkshire’s increase in book value has outperformed the S&P.
It should be noted that Berkshire’s book value significantly understates the intrinsic value of the company. Taking all aspects of Berkshire’s intrinsic value into account, Warren and Charlie make a strong case that Berkshire’s shares are worth much, much more. Warren is so confident of this that Berkshire is committed to aggressively repurchase its shares if they ever fall below 120% of book value. At just 139% of current book value today, investment in Berkshire’s stock looks very attractive.
Here are some other interesting take–aways from Berkshire’s Annual Meeting.
- Warren’s $1 million bet with New York asset manager Protégé Partners that the performance of a low cost S&P 500 Index fund would beat that of five Protégé selected hedge funds over ten years is working overwhelming in his favor. Six years into the bet, the total return of the S&P fund is up 43.8% compared to 12.5% for the hedge funds.
- Both Warren and Charlie think that Federal Reserve Chairman Ben Bernanke did a heroic job during and after the market crash of 2008-2009, and they like what his successor, Janet Yellen, is doing now. On a cautionary note, they point out that we are in uncharted waters with the Fed holding short term interest rates near zero and purchasing billions upon billions of US government debt securities for over five years. Warren describes it as a movie we have not seen before and don’t know how it ends.
- Both think that the federal government should continue to provide guarantees of properly underwritten home mortgages to keep their interest rates low, but not through any form of public/private vehicle such as Fannie Mae or Freddie Mac.
- Both concur that the Canadian oil tar sands are a significant long term energy asset for the future, but neither has an opinion as to whether they are a good investment opportunity at this present time.
- Both feel that after they are no longer around, the management of Berkshire will remain excellent. Warren has recommended a successor CEO to the board; Warren’s investment protégées Todd Combs and Ted Weschler are each managing portfolios in excess of $7 billion which are outperforming the S&P 500 Index; and Warren’s son, Howard Buffett, has been designated future non-executive chairman to preside over a future CEO change should it become necessary.
At Edgemoor Investment Advisors, Berkshire’s stock is still on our buy list, for many good reasons.
