One simple way to beat the market is to buy and hold Berkshire Hathaway stock at a good price. Buffett acknowledges that it is challenging to find intelligent ways to invest Berkshire’s massive and growing cash holdings. Nevertheless, he is clear that his goal is still to beat the S&P 500 which he believes he can do, albeit at a diminished level of outperformance vis-a-vis Berkshire’s earlier halcyon days. It is worth noting that Buffett is famously conservative in his missives about his ability to continue to outperform.
Berkshire’s recent performance compared to the S&P 500 is noteworthy. Berkshire has outperformed the S&P 500 in each of the ten most recent five-year periods by an average margin of just over 7%. For the record, Berkshire has never had a five-year period where it underperformed the market.
Buffett believes that Berkshire’s stock is undervalued at 1.1x book value (or approximately $109,000 per A share). He’s right. If you net out the equity investments ($67 billion as of Q3, 2011) and use Buffett’s estimate of normalized after-tax earnings ($12 billion), Berkshire has an earnings yield of about 10%. These earnings are being generated by a diversified portfolio of high-quality businesses that includes a number of bullet-proof, growing world-class franchises such as GEICO and BNSF.
Berkshire enjoys a number of advantages which should continue to increase its intrinsic value.
- Berkshire has outstanding veteran managers who are unencumbered by bureaucracy or quarterly earnings numbers. They focus solely on building long-term value.
- Berkshire can not only purchase operating businesses, but also marketable securities. This gives it a much higher likelihood of finding attractive investments compared to the typical S&P 500 corporation which is constrained to allocate capital within its own industry. Moreover, Berkshire has advantaged access to many deals based on Berkshire’s reputation, deep pockets, and ability to act quickly.
- Berkshire has a shareholder-oriented culture. Board members (excluding Buffett) own over $3 billion in stock, and compensation is completely aligned with shareholder interests. Moreover, Berkshire is imbued with a culture of frugality. This means that Berkshire’s wealth will increase the value of shares rather than line the pockets of management.
- Berkshire enjoys cheap leverage in the form of insurance float. Although it is impossible to predict with any amount of precision, it seems likely – based on Berkshire’s track record – that float will continue to grow. Berkshire can also borrow at low rates given its strength.
- Buffett is still at the top of his game and getting better. The IBM purchase shows his savvy and growing circle of competence and, in my humble opinion, has a reasonable likelihood of adding $10 billion in value over the next 10 to 15 years. Todd Combs and Ted Weschler are warming up in the bull-pen and were hand picked by the same guy who spotted Lou Simpson.
Of course, not losing money should be top of mind when considering an investment. Berkshire has a fortress balance sheet with massive cash holdings as a hedge against economic disruption that puts Buffett in a position of strength to take advantage of opportunities when others are scrambling. Also, Berkshire’s commitment to repurchase shares below 1.1x book puts a floor under the stock.