Don’t Sell Berkshire Hathaway Stock Despite Recent Underperformance

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Berkshire Hathaway stock - Don’t Sell Berkshire Hathaway Stock Despite Recent Underperformance

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The critics are going after Berkshire Hathaway Inc. (NYSE:BRK.ANYSE:BRK.B) again. Over the past five-, ten- and, now, fifteen year periods, Berkshire Hathaway stock has underperformed or merely matched the S&P 500 in total return.

For the superstar investing legend of our time, it’s not a good record, right? Skeptics say much of Buffett’s recent performance came from sweetheart deals, such as bank investments during the financial crisis. Without those, they say, Berkshire Hathaway would be underperforming, since Buffett doesn’t understand tech stocks or the new economy.

But before we give up on Berkshire Hathaway stock, let’s give it a fairer hearing.

1999 All Over Again for Berkshire Hathaway Stock

Warren Buffett has been a superstar investor for so long now that every generation of new investors gets a chance to doubt him. The most recent crisis of faith with Berkshire Hathaway stock came in the late 1990s. At that time, dot-com stocks were all the rage. People that probably should have known better were quitting their careers to become full-time day traders. Mania was in the air.

Against that backdrop, Berkshire Hathaway stock performed badly. Very badly. In late 1999, investing magazine Barron’s infamously published its article “What’s Wrong, Warren?” following a year where the NASDAQ shot the moon, the S&P 500 rose more than 20%, and Berkshire Hathaway, by contrast, fell nearly 20%. The rest is history. Tech stocks plummeted, the S&P would soon top, and Berkshire Hathaway stock roared back.

At the 1999 annual meeting, Buffett stated the following to justify Berkshire’s avoidance of tech stocks in favor of slower-changing businesses such as The Coca-Cola Co (NYSE:KO):

We’re more comfortable in that kind of business. It means we miss a lot of very big winners. But we wouldn’t know how to pick them out anyway. It also means we have very few big losers — and that’s quite helpful over time. We’re perfectly willing to trade away a big payoff for a certain payoff.

Since 2000, Berkshire’s general avoidance of tech stocks paid off well. The NASDAQ underperformed the S&P 500 monumentally in subsequent years, as tech and biotech needed a long time to recover from 2000’s excessive investments. However, tech stocks are back to leading the pack in 2018 — and that has the Buffett critics back in action.

Berkshire Hathaway Stock Is Unpopular Again, FANG Now Dominates

Nowadays, instead of dot-com stocks, we have the FANG tech plays. Facebook, Inc. (NASDAQ:FB), Amazon.com, Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX) and Google, aka Alphabet Inc (NASDAQ:GOOGL), make up the so-called FANG bunch. And they’ve delivered tremendous returns for investors in recent years. But they are probably reaching a point of rapidly diminishing returns.

Historically, when stocks become the largest in the index, they tend to underperform. Witness the lousy performance of stocks like General Electric (NYSE:GE) and Exxon Mobil Corporation (NYSE:XOM) that have led the US in market cap since the turn of the century. While XOM stock hasn’t been a disaster, it’s lagged the S&P, and GE stock has been an atrocity. It’s hard for the world’s largest companies to keep competing and innovating in the way that made them so successful in the first place.

That sort of problem will hit the FANG companies sooner or later. And, as it is, investors are paying through the nose for them. Collectively, the FANG companies have a market cap of around $2.4 trillion. That weighs in at almost 5 times as much as Berkshire’s $500 billion market cap. Despite that, Berkshire earns more annual profits than all four FANG companies put together ($45 billion versus $31 billion respectively in 2017).

Sure, FANG stocks deserve a higher price-earnings ratio than Berkshire Hathaway stock due to the higher growth profile. And, admittedly, Amazon is currently under-earning due to its growth-at-any-cost strategy. Its real earnings could be significantly higher with a change in management focus. All that said, the disparity between FANG stocks at nearly 80x earnings as a group and Berkshire Hathaway stock at around 11x is hard to ignore.

Bullish on America

Berkshire Hathaway stock is one of the best ways to be bullish on the United States. The company is incredibly, unbelievably, diversified. In 2018, for example, it is expected to have five different divisions that all produce at least a billion dollars in profits. These include manufacturing and associated sales, financial services, Geico, the BNSF railroad and Berkshire’s energy division.

On top of its massive conglomerate business operation, it also holds tons of shares in America’s leading companies. Top holdings now include Wells Fargo & Co (NYSE:WFC), Bank of America Corp (NYSE:BAC), Apple, Inc. (NASDAQ:AAPL) and Coca-Cola, giving investors exposure to a broad cross-section of the economy.

In many ways, Berkshire Hathaway functions as a de facto index fund. But even better. A Berkshire Hathaway owner doesn’t have to pay ongoing management fees or deal with the tax inefficiencies that can arise from owning ETFs. Simply put, if you’re bullish on America, Berkshire Hathaway is every bit as good as — and quite possibly better than — buying the US market as a whole.

Don’t Worry About the Future

One big concern that investors have for Berkshire Hathaway stock is what happens when Warren Buffett can no longer run the business. Despite his famously carefree dietary habits, Buffett remains healthy at his advancing age. But someday Berkshire will have to move on to new leadership. There’s been some uncertainty as to whom the successor will be.

Regardless, it’s not a big deal who the next person ends up being. Berkshire is run with a subsidiary model. Each operating business has a wide deal of operational independence, and leaders of each business are judged on their performance. As it is, Buffett isn’t making all the hands-on decisions at each subsidiary anyway.

There’s also a big chance that Berkshire Hathaway will be broken up after Buffett passes. The company would almost certainly violate anti-trust laws should the government bring that case. Until now, Berkshire has been seen as benign and, thus, largely immune from criticism. But once the Buffett halo is gone, expect the government to feel more comfortable if Berkshire shrinks in size. That process is likely to lead to the company selling or spinning off many of its assets, resulting in a windfall for shareholders.

In the near-term, upside here probably isn’t huge. Berkshire Hathaway stock isn’t in favor at the moment; investors want growth. But on both an earnings and book value basis, Berkshire is worth at least $200 today, giving shares a fair margin of safety in one of America’s most dependable enterprises.

At the time of this writing, Ian Bezek owned BRK.B stock, FB stock, and XOM stock. He has no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2018/06/dont-sell-berkshire-hathaway-stock-despite-recent-underperformance/.

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