Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) Class B shares hit $167 last week, finishing below its most recent book value per share number. This has happened only twice in the last 20 years (in 2009 and 2011) and both were a great time to buy the stock.
Warren Buffett (Trades, Portfolio) recently abandoned the practice of reporting changes of the book value of Berkshire as a proxy for changes in intrinsic value, arguing that the company is increasingly focusing on operating businesses rather than just marketable securities (i.e., shares of companies). Of course, with the recent downturn, the share of marketable securities has suffered a downturn. However, given the quality of Berkshire's portfolio of high-quality businesses as well as portfolio companies, its unlikely that intrinsic value is much affected by the Covid-19 crisis.
Berkshire stock has performed well over the last two bear markets as compared to the S&P 500. For example, in the three years following the start of the 2000 bear market, its Class B stock outperformed the S&P 500 handily.
The same was true (to a lesser extent) in the great financial crisis of 2007 to 2009.
The relationship between Berkshire's stock price and the S&P 500 can be clearly seen when the former (BRK.B, Financial) is plotted against the latter (S&P 500) in the following chart. Over the last 20 years, Berkshire's Class B shares have steadily advanced, shrugging off and indeed thriving in bear markets and recessions. Berkshire's relative outperformance can be clearly seen in the two major bear markets we have seen in the last two decades.
Berkshire's fortress Balance Sheet Gives optionality in a recession when other businesses are on sale. In the 2008-09 time frame, Berkshire was able to make lucrative investments in businesses like Goldman-Sachs (GS, Financial), Bank of America (BAC, Financial) and General Electric (GE, Financial) when they were on the ropes. It's likely the same could happen this time around.
Great cash position gives it options
The company held $125 billion in cash and equivalents at its insurance and other key businesses at the end of 2019. Some $100 billion, or 80%, of that $125 billion was in U.S. Treasury bills. Berkshire has another $3 billion of cash and equivalents elsewhere. The cash and equivalents account for about 25% of its market cap.
Buffett’s decision to hold Berkshire’s cash in the most conservative way underscores the company’s financial strength and helps make it one of the most defensive big stocks in this wobbly market.
In spite of the large cash position, Berkshire has been generating a median return on equity of 8% for the last 10 years. This is quite good for such a large company, trading close to book value, given the low-interest rates from treasury bonds. Given that Berkshire retains 100% of its earnings, all of it compounds at the ROE. Basically we can expect a doubling of the market capitalization of the company in the next decade. This is consistent with what has happened in the last decade. As Buffett observed in his most recent annual report:
"Nevertheless, when business ownership was sliced into small pieces – 'stocks' – buyers in the pre-Smith years usually thought of their shares as a short-term gamble on market movements. Even at their best, stocks were considered speculations. Gentlemen preferred bonds. Though investors were slow to wise up, the math of retaining and reinvesting earnings is now well understood. Today, school children learn what Keynes termed 'novel': combining savings with compound interest works wonders."
In any event, Berkshire is now in a great position to deploy a good portion of this excess cash and boost ROE in the coming years.
Disclosure: The author has a long position in Berkshire via options.
Read more here:
- Investment Note: MGP Ingredients
- Gold as a Hedge in a Bear Market
- The Coronavirus Bear Market Is Here, and a Recession Will Likely Follow
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