Berkshire Hathaway Inc. (BRK.A, BRK.B) Is NOT Your Typical Trade

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On Friday of this week, Berkshire Hathaway Inc. (BRK.A, BRK.B) will release its full-year “earnings” report for 2015 … or a report that most looks like earnings results anyway. Being a hybrid of a mutual fund and a business development company and a private equity firm, its numbers don’t always look quite like those released by publicly traded entities.

Don't View Berkshire Hathaway as Your Typical Trade (BRK.B, BRK.A) Perhaps more important, along with the earnings figures, BRK.B and BRK.A owners — as well as the rest of the market — will be treated to a highly detailed and usually entertaining letter from the holding company’s founder, Warren Buffett. This is the proverbial keynote speech (outside of the annual shareholder meeting) for investors, detailing what worked and what didn’t in the prior year and what to expect in the current year.

It’s this much-anticipated letter, however, that may also raise a lot of questions for would-be buyers of Berkshire Hathaway stock. The biggest question of all? How would anyone know what BRK.B (or its bigger brother BRK.A) are actually supposed to be worth?

BRK.B, BRK.A Earnings Outlook

As of the latest look, analysts are collectively calling for earnings of $11,636.20 per share of Berkshire Hathaway for 2015. Don’t be too impressed by the big number, however, as that outlook is for BRK.A, which is presently priced at $198,650 per share.

The more “everyday man” version of the stock, which used the ticker BRK.B, is currently valued at about $131 per share. The pros are calling for a 2015 profit of $7.76 for this more affordable variant.

Either way, the outlook suggests Berkshire Hathaway is poised to report a rare decline in earnings, reflecting the broad market’s weakness and the economy’s general malaise.

Then again, perhaps more so for Berkshire Hathaway stock than any other equity out there, Berkshire’s earnings mean little in comparison to its more closely watched measures of book value and intrinsic value. Thing is, those are somewhat arbitrary measures, making it difficult for the average investor to value BRK.B and BRK.A shares.

Even so, based in actual earnings, Berkshire is more than reasonably priced. The current trailing price-to-earnings ratio of BRK.A and BRK.B is a palatable 14.3.

Investing in an Idea

Veteran owners of Berkshire Hathaway stock have grown accustomed to it, but newcomers may struggle with the idea that Warren Buffett built Berkshire Hathaway from the ground up to drive long-term cash flow — which isn’t necessarily the same as earnings — and pump up the book value and the intrinsic value of the privately and publicly held companies in the portfolio based on their cash-generation potential rather than their marketable value.

It’s a premise that sounds compelling, even if unusual, at first. It’s not easy to get a grip on the value of the portfolio, though, for two reasons … Berkshire holds a LOT of non-publicly-traded companies, and the value (book, and intrinsic) of those companies isn’t set by the market, but rather, by best-guesses.

Though the valuation model has never been detailed, this snippet from Warren Buffett’s 2010 letter to shareholders shows the surprisingly arbitrary philosophy when it comes to Berkshire’s assessment of its own value:

“There is a third, more subjective, element to an intrinsic value that can be either positive or negative; the efficacy with which retained earnings will be deployed in the future. We, as well as many other businesses, are likely to retain earnings over the next decade that will equal, or even exceed the capital we presently employ. Some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.

“This ‘what will they do with the money’ factor must always be evaluated along with the “what do we have now” calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value.”

In other words, Berkshire Hathaway is asking investors to trust their self-assessment. It’s unusual simply because the price of BRK.A and BRK.B are largely set by investors using this presumed value.

That being said, don’t be too scared — Berkshire/Buffett have been perpetually wise when it comes to managing the companies under its umbrella, and have been unquestionably reasonable with their valuations so far.

They’ve done very well too, as the arrangement allows for a great deal of necessary freedom most publicly traded companies could never enjoy. The 2014 letter offers just a glimpse of this upside:

“Sometimes pundits propose that Berkshire spin-off certain of its business. These suggestions make no sense. Our companies are worth more as part of Berkshire than as separate entities. One reason is our ability to move funds between businesses or into new ventures instantly, and without tax. In addition, certain costs duplicate themselves in full, or part, if operations are separated.”

Said in simpler terms, Berkshire Hathaway isn’t beholden to often-fickle shareholders, and is largely able to avoid the adverse impact of activist investors who will often recklessly force a company to make a change that’s not healthy for the long haul.

Bottom Line for BRK.B and BRK.A

Berkshire is frustratingly different than any other publicly traded company out there. It should be viewed as an actively managed fund, since in many regards, it is. It’s also viewed as an equity investment in a conglomerate though, and that point of view isn’t wrong either.

However an owner of BRK.A and BRK.B mentally categorizes their holding, one big breath of fresh air is the simple fact that trading in most other stocks has become a game of guessing as to how a particular stock — rather than the underlying company — will be valued by the market in the foreseeable future.

That’s in sharp contrast to Berkshire, which focuses solely on building the value of its businesses and trusting that the market will eventually appropriately price that value into shares. And it has, conservatively.

You know, what “investing” is supposed to be.

Just bear in mind Buffett and his protégés are calling all the shots. Fortunately they’ve proven plenty trustworthy and reliable.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2016/02/berkshire-hathaway-brkb-stock/.

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