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Rupert Hargreaves
Rupert Hargreaves
Articles (1077)  | Author's Website |

Berkshire Hathaway: Considering the Stock's Underperformance in 2019

After last year's performance, Berkshire looks severely undervalued

February 11, 2020 | About:

Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is slated to report its fourth-quarter and full-year earnings results later this month.

The result is going to be fascinating, as we will finally find out how the empire performed in 2019.

The figures should be impressive. U.S. GDP growth ranged between 3.2% and 2.1% throughout the year, which likely helped the group's operating businesses. We are still waiting for the final figures for the fourth quarter.

Meanwhile, the S&P 500 rose by more than 30% in 2019. This suggests Buffett's $215 billion investment portfolio jumped substantially last year.

Initial figures from the group tell us what sort of gains to expect.

Booming portfolio returns

According to the conglomerate's fourth-quarter figures, operating profit jumped 14% to a record high thanks to an increase in its equity portfolio and rising profits in its railroad business.

The results pushed Buffett's cash pile to a record $128 billion. The results showed $8 billion of profits from the group's equity portfolio in the third quarter, compared to a gain of $10.2 billion in the same period a year earlier.

Buffett has had some big winners in his portfolio over the past 12 months. For example, Berkshire's most significant public stock position at the end of September 2019, Apple (NASDAQ:AAPL), which made up around 26% of the $215 billion stock portfolio, is up 90% over the past 12 months.

Even for a business like Berkshire, these sorts of profits are tremendous. The position was worth $56 billion at the end of September 2019. The stock has since gained a further 44%.

Other big winners in the portfolio include Bank of America (BOA). This stock has only matched the performance of the S&P 500 over the past 12-months. However, when you take into account the fact that this is the second-largest holding in the portfolio, these gains become significant. It would appear that Berkshire has earned a capital gain of around $7 billion on its investment in Bank of America in 2019.

Meanwhile, the third-largest holding in the portfolio at the end of September 2019, Coca-Cola (NYSE:KO), added 18% (excluding dividends) in 2019. That suggests a total profit of around $4 billion.

These are only back of the envelope calculations and, for the most part, exclude dividend income. Nevertheless, they make it clear just how profitable Berkshire's portfolio was for the company's shareholders in 2019.

Valuation gap

While the portfolio of equities produced tens of billions of dollars of profits for the conglomerate's shareholders last year, it would appear that Berkshire's own stock price didn't match this performance. Indeed, the B Shares gained just 12.6% in 2019.

Considering the fact that the conglomerate has a market capitalization of around $550 billion, that suggests a total value added of nearly $70 billion in 2019.

Once again, these are only back of the envelope calculations, and they are not designed to be accurate forecasts of value creation. Still, because Apple alone returned 33% in the fourth quarter of 2019, it seems that Berkshire's stock price is massively undervaluing the conglomerate's underlying equity portfolio.

Considering Apple was worth $55 billion at the end of Q3 2019, a 33% increase implies the position is now worth $73.2 billion. That suggests that in one quarter this position accounted for nearly 25% of Berkshire's total value added in 2019. That's without including any other value creation from any other position or division throughout the rest of the year.

These numbers imply that Berkshire is severely undervalued at the current level, as the market has failed to reward the business for its value creation in 2019.

Of course, we won't know the truth until the company publishes its fourth-quarter numbers, but the indications are extremely positive.

Disclosure: The author owns shares in Berkshire Hathaway.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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