Shares of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) have been under pressure this year, though not as much as the general market. The company's Class B shares have declined by 12% year to date, compared to around 25% for the S&P 500 as a whole.
While this stock price performance is better than the rest of the market, the performance is far less impressive over the past five years. Indeed, over the past five years, the stock has roughly matched the performance of the S&P 500, excluding dividends. When we include dividends, the S&P 500 has outperformed Berkshire because the latter does not pay a dividend to Investors.
So, what’s going on here? Why has the stock underperformed over the past five years? More importantly, why has it registered a double-digit decline this year even though Berkshire is one of the best-placed businesses in the S&P 500 to deal with current economic uncertainty and inflationary pressures?
Investor skepticism on growth
One of the reasons why Berkshire has underperformed over the past five years compared to the rest of the market is the company's relative lack of exposure to technology. Sure, it has its Apple (AAPL, Financial) investment and several smaller tech equity holdings, but few of its operating businesses have exposure to high-growth tech sectors.
It also has quite a significant cash position on its balance sheet, which has been earning negligible rates of return over the past couple of years as interest rates have remained near zero.
While returns on this cash pile should begin to increase as the cost of borrowing rises, the sell-off in technology stocks has narrowed the gap between the S&P 500’s overall performance and Berkshire, but the company underperformed when the market was going up, and it is going to take time to recover from this lag.
Berkshire has achieved such impressive long-term returns because the stock has outperformed during market selloffs. We are seeing that today, but due to the gap that had emerged in the years before, the company’s five-year performance is now worse than the S&P 500 (including dividends).
Berkshire has three main business divisions: insurance, energy infrastructure and railroads. These three business divisions are incredibly well placed to deal with rising prices. As a market leader, the company can quite easily pass higher prices on to insurance customers. Energy bills tend to rise with inflation, and so do contracts with railroad customers.
With this being the case, I think Berkshire’s double-digit loss this year is surprising. Not only is the company well-positioned to deal with rising prices, but it should also be able to increase earnings on its cash pile as interest rates rise. And there’s lots of scope for share buybacks as well as select deals on favorable terms in a hostile economic environment.
Uncertain outlook
If I were to hazard a guess at what else is causing the market to approach the business with more caution than it has in the past, I would say there are a couple of reasons.
For a start, Warren Buffett (Trades, Portfolio) is not getting any younger. At 92 years of age, if this economic downturn lasts for more than a couple of years, he might be too old to make any significant investment decisions. That adds a layer of uncertainty into the equation. Buffett has built Berkshire in his image, but this may no longer be acceptable to the market. This is a prime example of "key man risk."
The business also doesn’t provide much information on its operating performance. We have to trust the Oracle of Omaha. That’s been fine for the past five or six decades, but there’s no denying the situation is going to change after Buffett is no longer with the company, and asking investors to continue to trust the business and its managers is a big ask, especially in such an uncertain economic environment.
Considering this uncertainty, trying to figure out if Berkshire will be a good investment over the next 10 years is becoming harder. With interest rates rising, investors have more opportunities. From the viewpoint of some, even Treasury bonds yielding 4% might be a better investment than Berkshire with an uncertain outlook.
