From struggling local textile company to world-renowned outperforming investment vehicle, Berkshire Hathaway Inc. (NYSE:BRK.B) has come a long way, growing earnings at an astonishing rate all the while. For current buyers, don’t worry — BRK.B stock isn’t done yet.
Many investors still see risk with Warren Buffett now 86 years old and and Charlie Munger 93. In his trademark wry humor, Charlie Munger joked during this year’s annual shareholder meeting with faux wistfulness about how nice it would be to be 90 again
Just as with Apple Inc. (NASDAQ:AAPL), there is undoubtedly key man risk.
But there are mitigating factors here, ones that leave me with more confidence in BRK’s future. Based on the business Buffett has built, the future remains bright — and valuations remain attractive (though admittedly a little less so than when this year began).
Deep-pocketed investors could always shell out $260,000 for the high-priced A shares, though BRK.B shares — still bougie at nearly $170 per share — are much more accessible, even if you’re OK with the difference in voting rights.
Berkshire’s Secret Sauce
No, it’s not Heinz ketchup (more on that later). Berkshire’s “secret sauce” is the float; that is, the float from its insurance business. That’s the cash the insurance arm of the business spins off, and it’s crucial to the Company’s intrinsic value growth.
Insurance is the dry powder generator that allows Buffett to scoop up bargains in sizable quantity when he sees fit. Profitable insurance underwriting creates inherent financial leverage. BRK gets paid, in the form of premiums, to hold and invest that money.
From Berkshire’s 2016 annual report:
“If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money — and, better yet, get paid for holding it.”
In 2015, that float figure in millions was $87,722, so growth continues at a mid-single-digit clip. Over time and especially in recent years, performance has been strong.
Ajit Jain is the man behind the cash-flowing insurance business. Though he was once seen as a top contender for the top job at Berkshire, it looks like he’ll be sticking to his expertise heading insurance.
But as float continues to increase alongside a profitable insurance outfit, there will be plenty of fuel to power BRK stock going forward.
Berkshire’s Earnings
A lot of press surrounding Berkshire involves Buffett and Munger, and rightly so — it is under their tutelage that BRK has grown and thrived. The media focuses on their big wins and the calculated investment decisions that they make at the top. Again, rightly so, for there is much to learn.
But all the emphasis on the Buffett can overshadow just how strong the underlying business is on its own. Earnings per A share in 2016 were $14,646, up from $6,125 in 2011. Most of these net earnings have been attributable to business earnings (inclusive of underwriting profits). Overall, investment, dividend and interest income is actually a relatively small part.
They’ve essentially built an earnings compounding machine, that will continue to compound at least in the medium-term, lessening that key man risk.
Other Investments
Berkshire’s stakes in Bank of America Corp (NYSE:BAC) and Kraft Heinz Co (NASDAQ:KHC) are worth mentioning, too. Berkshire owns warrants to purchase 700 million shares exercisable in 2021. Value will not be more than a rough number on paper under that time, but it’s something I would consider material.
BRK also owns both common stock and preferred stock in KHC, which holds numerous consumer brands including Heinz. Given accounting methodologies, the amount is not marked to market at the end of every quarter, so it may in fact be underreported.
Conclusion
Berkshire’s key figures might be advanced in age, but the table is set for any successor.
BRK stock is a strong long-term buy — the strongest of the strong, some might say. Whether it’s A shares or B shares, your portfolio will be better off with the wisdom of Buffett and Munger.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.
