Time to Turn Neutral on Berkshire Hathaway (BRK.B)

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Without argument or question, there is no single investor who can rival Warren Buffett, the “Oracle of Omaha.” There is also no doubt that Berkshire Hathaway (BRK.ABRK.B), in the long run, is a good stock to own.

Berkshire-Hathaway-brk-b-brk-aRegardless, it would be unwise to treat BRK.B stock any differently than you would any other you’re considering. Simply put, you must apply the same matrix, protocols and common sense when buying Berkshire Hathaway stock. When we apply common logic to BRK.B, the truth is that it might be best to wait for the stock to be cheaper.

Why are investors better off waiting for BRK.B to come down? Let’s delve into the reasons.

Berkshire Hathaway Pays High Premiums

Many prefer to argue that BRK.B stock should be judged on its intrinsic value. And in the long run, that’s true. But there are numerous things Berkshire Hathaway must do in order to ensure its intrinsic value is maintained. Primarily, Buffett and his managers must constantly use their cash flow to make investments in companies and business that could deliver long term value.

And those investments are massive. The latest financial reports suggest that Berkshire Hathaway invests between 50% and 100% of its cash flow in long-term investments. In the long run, this attitude works and creates a very healthy return on equity.

But the problem begins when Berkshire Hathaway is “forced” to pay rather high premiums for putting its cash to work. For example, the latest purchase of Precision Castparts cost roughly $32 billion, reflecting a trailing P/E multiple of about 23.

Before that, Berkshire Hathaway’s highest profile investment was its purchase of Heinz (HNZ) — which later merged with Kraft Foods — with help from its Brazilian counterpart, 3G Capital. According to Stephen Gandel from Fortune magazine, after Berkshire Hathaway had to forgo its preferred shares (which annually paid out 9% in dividends) the effective multiple that Berkshire Hathaway paid then was roughly 25.

Of course, all of Buffett’s purchases are well-run companies, but a multiple higher than 20 isn’t cheap by any stretch of the imagination. That’s especially true when you consider that some of Buffett’s latest purchases were companies that have had rather modest earnings growth.

Once again, Berkshire Hathaway’s high premium translates into lower returns in the near term. Thus its investments will take longer to yield positive returns on those multiples. For many investors, that long term could, in fact, be too long. Especially when we consider Berkshire Hathaway’s latest purchases and also think in terms of cash and dividends.

Bottom Line on BRK.B

BRK.B stock trades at 18 times its earnings and pays no dividend; granted, no cash outlay for dividends means more for reinvestment. But that’s no cash dividends at all while the DOW is trading at an aggregate P/E of 15 and yields a dividend of roughly 3.2%.

During periods of uncertainly (our current situation), investors want to focus on the now and not the later. They don’t want to wait for longer-term investments that will pay off, eventually. For now, they could focus on bargain hunting (my personal favorite) or on getting a fair dividend.

Berkshire Hathaway offers neither. Hence, Berkshire’s long-term strategy could cause BRK.B stock to temporarily lag during this time of uncertainty. Like many, many others, you may believe it’s prestigious to hold BRK.B stock. But compared to other higher-yielding investments, it might be wise to wait until BRK.B trades at a lower multiple and its premium becomes reasonable to pay.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/time-turn-neutral-berkshire-hathaway-brk-b/.

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