- Chairman Warren Buffett seeks to acquire businesses with capital efficiency.
- Berkshire Hathaway looks for businesses that sell needed products.
- Berkshire Hathaway’s sizable cash balance will enable the company to add to its vast collection of businesses.
Under the guidance of Chairman Warren Buffett, shareholders of Berkshire Hathaway-A (NYSE:BRK.A) enjoyed a 20.8% annual compound return over the past 50 years. A mere $50 investment in the company’s Class A stock five decades ago would be worth $634,332.14 as of the end of last year, according to Berkshire Hathaway’s 2015 annual report. Not everyone can afford the $210,000 + price for one share of Berkshire Hathaway’s Class A stock. However, Berkshire Hathaway's Class B (NYSE:BRK.B) stock, which traded at a much more affordable price of $140 per share as of this writing, lies within the reach of most individual investors. Long-term investors may want to consider Berkshire Hathaway for their portfolios. Let’s examine why.
Business of collecting other businesses
Successful long-term investors understand that staying invested in stocks for the long-term represents the best chance of success. They understand that superior price gains and dividend increases stem from the thriving enterprise represented by the stock. In fact, Warren Buffett sits in a position of thought leadership in this regard. On behalf of his shareholders, he strives to find companies with a superior return on capital and isn’t afraid to look across multiple industries to find them.
In his annual letter to shareholders, Warren Buffett touted Berkshire Hathaway’s diverse portfolio of businesses as providing a distinct advantage over “one-industry companies”. Multiple businesses provide different sources of cash flow that can be deployed in other efficient (and cheap) enterprises. The business world, notorious for dynamism and change, could cause one or even a few of Berkshire Hathaway’s subsidiaries to go out of business and the company could conceivably have many more sources of cash to fill the void.
Large influence in the economy
Warren Buffett spent a great deal of media time as well as space in Berkshire Hathaway’s annual report on optimistic discussions about the American economy and its future. These discussions aren’t at all irrelevant to Berkshire Hathaway and its shareholders. Optimism fuels hope and good feelings, which can lead to consumer spending, which helps increase the revenues of the company’s subsidiaries.
Berkshire Hathaway owns many businesses that represent part of the backbone of the American economy. For example, Berkshire Hathaway’s railroad, BNSF Railway, hauls 17% of U.S. Inner City Freight. Buffett pointed out that this calculation represents a percentage of all modes of transportation including rail, air, truck and pipeline. Berkshire Hathaway also operates in power generation, petroleum and chemicals. Berkshire Hathaway sells 45% of manufactured housing in the United States via its Clayton Homes subsidiary. Moreover, National Indemnity represents the largest property-casualty insurer in the world based on net worth, according to Buffett.
The huge scale indicated above provides advantages in the form of bargaining power and economies of scale for Berkshire Hathaway’s subsidiaries. This gives Berkshire Hathaway the ability to provide cheaper products for customers and clients in the company’s various industries. Lower cost can prove especially helpful in some of Berkshire Hathaway’s commoditized businesses such as insurance and electric power.
Importantly, Warren Buffett and his management team strive to look for businesses that sell needed products and sit behind wide barriers to entry, which is what all investors, large and small, should be doing. This approach has led to the purchase of businesses such as BNSF railroad, Precision Castparts, which sells parts to the aerospace industry, and Lubrizol, which operates in the chemical business. Moreover, Berkshire Hathaway looks for companies with other cost advantages. GEICO, one of Berkshire Hathaway’s most prominent examples of cost efficiency, keeps costs low by not utilizing agents in the selling of car insurance.
Conservatism reigns supreme
Warren Buffett does not like losing money and, as a result, takes no unnecessary risks. While he likes businesses with superior returns on capital, he still doesn’t want to pay any more than necessary for ownership. As an example of conservatism, Clayton Homes demonstrates a knack for loaning to customers with the ability to pay regularly. Warren Buffett highlighted Clayton Homes’ better than average customer payment pattern during the Great Recession. In 2015, foreclosure rates amounted to 3% at Clayton Homes and 95% of homeowners were current on their payments. Moreover, Berkshire Hathaway likes to keep its utilities running at above average efficiency, adding to the cost moats highlighted above.
Forward thinking with a bridge to the past
Berkshire Hathaway likes to invest in the future while simultaneously sticking to the tried and true. For instance, the decline in the coal industry, as well as supply and demand imbalances in the oil industry proved detrimental to railroads such as BNSF. Eventual supply rebalances would prove especially beneficial to the railroad. Berkshire Hathaway energy also owns 7% of America’s wind generation and 6% of its solar generation, giving the company a leg up on any future trends towards renewable energy.
Plenty of cash
Berkshire Hathaway brings in plenty of cash and holds plenty of cash on its balance sheet to fund operations and make acquisitions to generate other income streams. Last year, Berkshire Hathaway’s free cash flow amounted to $15.4 billion with more than $71 billion in cash and equivalents on its balance sheet, which would enable the company to buy any small to mid-cap, publicly traded company without any problems. One of the more difficult problems for Berkshire Hathaway is finding uses for the huge amounts of cash it carries.
Berkshire Hathaway certainly offers everything a conservative investor wants, underlying portfolio diversity, size and scale, plenty of cash and excellent management stewardship. Long-term investors should definitely consider owning shares of its Class B stock or even its Class A stock if they can afford it. The only downside here is the company’s sheer size and complexity may make it difficult for the company to achieve share price appreciation much beyond the S&P 500 in the future. It would definitely pay to buy Berkshire Hathaway stock during a market downturn, if possible.