Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) is considered by many to be a foundation portfolio investment.
It is easy to understand why. The company provides exposure to a range of high-quality businesses managed by one of the world's best capital allocators, as well as a portfolio of high-quality equities.
The flexibility of the structure also allows Buffett to make strategic investments that have a unique structure and payoff schedule for the company's investors. I'm talking about preference share deals that offer 10% per annum returns, far in excess of the rate of return other investors may be able to achieve on the market.
However, Berkshire has some drawbacks, and I wanted to take an objective view of the company to analyze these drawbacks amid the group's attractive qualities.
Reasons to avoid Berkshire
I have outlined some of the reasons why investors might want to own the stock above. But why would investors want to avoid the company? It's clear that many are avoiding or even selling the stock, since it has been undervalued on paper for quite a while.
In my opinion, there are a couple of factors that are currently weighing on the stock. For a start, there's Buffett's age. At 91 years of age, Buffett is running out of time. Any investors owning the stock today need to consider the fact that he may not be around to run the business for much longer. Berkshire definitely suffers from "key man" risk; with Buffett's influence seemingly in decline, the market is discounting the stock accordingly.
Then there's the company's balance sheet. Berkshire is holding record amounts of cash. This is proving to be a drag on the group's earnings. Buffett did not get a chance to deploy his cash in the last crash. This is seen as a strategic mistake by many investors. Buffett has been struggling to find ideas for years due to record-high market valuations following the uncertain beginning of the Covid-19 situation, leading to speculation that he might be losing his edge.
The holding company structure is also something to consider. This has been an advantage in the past, but the market is now placing a discount on holding companies. This has pushed some corporations to break up in order to try and get a better stock valuation for shareholders. One doesn't have to do much work to see that the market is placing the same discount on Berkshire.
The group has around $150 billion of cash on hand. On top of this, its equity portfolio was worth nearly $300 billion at the end of September. That gives a value of $450 billion for these components alone. BNSF's annual revenues total around $23.2 billion. Peer Union Pacific (UNP, Financial) is trading at a price-sales ratio of 7.5. A similar multiple for BNSF would justify a market value of $174 billion. As such, these three components alone are worth $624 billion. Berkshire's current market capitalization is $636 billion.
These numbers suggest the market is valuing the rest of the conglomerate's companies, from Dairy Queen to GEICO and from Berkshire Hathaway Energy to Nebraska Furniture Mart, at $12 billion. Based on these numbers, I do not think it is unreasonable to say that the group would be worth more split up than together.
Buffett is using this gap between market value and intrinsic value to reduce the number of shares outstanding. However, the market reaction to this capital deployment has been disappointing. This suggests to me that the market is more worried about Buffett's prospects and prospects for Berkshire.
The problem is, the stock needs a catalyst to drive a re-rating. Unless there's a sudden market crash that is far deeper and more sustained than the 2020 slump, I don't think Buffett will get the opportunity to deploy significant amounts of capital. This suggests there is only one real catalyst for the stock on the horizon: Buffett's exit (which would not be likely to push the stock in the right direction).
This seems to explain why the market is not rushing to buy Berkshire, although personally, I believe the business has a future after Buffett. That's why I have been taking advantage of the recent weakness to build a position.
