Berkshire Hathaway is currently sitting on $128B in cash/short-term securities. That’s more than the entire market capitalization of Nike, IBM, Starbucks, and 356 other companies in the S&P 500. But as Berkshire’s cash accumulates (at a pace of ~$2B per month), it’s stock price remains within just 2-3% of it’s December 2017 levels, despite an otherwise strong run by the U.S. equity markets and new investors like Pershing Square.
Is it’s current price, at around $222/share for its class B stock, an attractive investment?
I’ll argue that it represents a good value, especially in contrast to other high prices in the S&P 500.
What do you get for a share of Berkshire?
For ~$222 in December of 2019, your slice of the Berkshire pie represents $52 of cash/cash equivalents across the business and ~$112 in Berkshire’s investments, like those in Apple and Wells Fargo (calculated by dividing these figures from Berkshire’s most recent 10Q by the number of outstanding shares, noting that Class B shares are 1/1500th the value of Class A shares).
In addition to these combined $164 cash and investments per Class B share, you’ll also own a slice of their businesses, including BNSF railroad, BH Energy, Marmon, Lubrizol, Iscar and Precision Castparts. In Q3 2019, Berkshire’s insurance, railroad, utilities and energy businesses earned ~$6.4B in pretax profits (not including investment income from interest/dividends), or roughly $2.6 per class B share, ~$10.45 annualized.
How does Berkshire’s valuation compare to historical levels and the broader market?
Using a 21% corporate tax rate approximation for Berkshire, we can subtract the ~$164 cash and investments figure from the ~$222 share price to see we’re paying $58 for Berkshire’s earnings, or ~5.5x pretax profits and a ~7.0x P/E for these businesses, which have historically earned above average returns on equity and increasing earnings power. Now, recent falters in Kraft Heinz has demonstrated that not all of Berkshire’s portfolio is likely to compound at 15-20% perpetually in the future. Nevertheless, a seven times earnings valuation for these businesses compared to the current S&P average of 23.6 times is very attractive. As another proxy, the current price to book is hovering at roughly 1.36x, a bit higher than the 1.2x that Berkshire has historically sought to buy back its own shares, but still lower than its 5 year average of 1.4 and comparable companies in the S&P. Lastly, while it’s not feasible to predict the timing of the next correction in equity prices, it’s safe to say that Berkshire has developed itself into a machine ready to capitalize on such a downturn, and is well poised to do so with its cash-rich balance sheet and ability to execute deals on attractive terms quickly.
What kind of downside are we looking at?
Berkshire is among the safest investments of any such large, well documented and historic businesses in America. The best margin of safety is a discount to intrinsic value, the argument for which is outlined above. In addition, Berkshire’s massive cash pile, intention to buy back stock at 1.2x book value or higher (which effectively places a price floor at ~$195-$200, or ~10% below its current price, given its current book value), and strong diversified businesses in defensive sectors, suggests significant downside protection on the investment.