One of the most attractive value stocks on the market at the moment, in my opinion, is Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). As I explained in a previous article, I believe the Class B shares of the company could be worth between $250 and $350.
Anything below $250 would be cheap, and anything above $350 would be overvalued, by my estimates. At the time of writing, the stock is trading around $283, which looks fairly cheap based on this analysis.
However, this analysis is based on the corporation's financials for the first half of 2021. I think Warren Buffett (Trades, Portfolio) is likely to have been repurchasing shares over the past few months, which will have pushed up the value. Cash flow from operating businesses is also likely to have increased intrinsic value. As such, I think my valuation corridor of between $250 and $350 is conservative today.
Looking for the catalyst
Finding an undervalued equity is one thing. The hard part is waiting for the market to realize its true value. The market could realize the value relatively quickly, or it could never realize the value.
More often than not, it can be years before the market re-rates a stock to an appropriate valuation. In this situation, it can be challenging for one to continue to focus on the opportunity and not move on to find other investments.
One way of getting around these issues is to find value investments with an upcoming catalyst. The value investor Seth Klarman (Trades, Portfolio) believes that all value investors should try and reduce portfolio duration by "focusing on investments with catalysts for the realization of underline value." As he explained in his 2018 letter to investors, without these catalysts, a portfolio with "near indefinite duration" can trade "just about anywhere."
This is something I have been thinking about when reviewing Berkshire recently. Yes, the stock looks cheap, but like so many value investments, it can remain cheap for an extended period if there is no catalyst to unlock value.
Saying there is no catalyst is not strictly true. The Oracle of Omaha has been spending significant amounts of money repurchasing the corporation's stock over the past two to three years. These repurchases, coupled with an increase in the equity portfolio's value and underlying businesses, have acted as a catalyst. As noted above, I think it is likely share repurchases have continued, suggesting further catalysts on the horizon.
However, as much as Berkshire does have catalysts, it has anti-catalysts as well. I use this term because I believe these factors prevent the market from re-rating the stock to a higher multiple.
The most critical factor is Buffett's age. He is not getting any younger, and while he is making preparations for his departure, it is impossible to say what the future will hold for the group after he leaves. The market hates uncertainty, and this uncertain factor is only becoming more pressing.
Another anti-catalyst is Berkshire's cash pile. With $140+ billion sitting on the balance sheet earning almost nothing, this is a considerable drag on returns. Buffett wants to keep a large amount of cash on hand to protect the future of the company, which is understandable. It is the reason why I own the shares. Much of this cash pile is also necessary in order to maintain the market dominance of Berkshire's insurance business; without it, there's no way the company would be able to take on risks that no other insurer will take on. Nevertheless, I can understand why some market participants may view this as too cautious, driving them to find other opportunities elsewhere. This is another anti-catalyst.
The bottom line
There are always going to be pros and cons for owning any stock. Berkshire is no exception. The giant conglomerate may fit into some investors' portfolios (including this author's). Still, some value investors may be put off from investing in this enterprise due to the challenges outlined above.
I wanted to write this article to highlight some of the company's challenges and dissect the bear case for Buffett's conglomerate.
