Berkshire Hathaway (BRK.A)(BRK.B)'s holdings are finally on the upswing with the rest of the mega caps of the Dow and S&P 500. It’s finally starting to look like previous decisions by Berkshire management were prescient. For those who have not been initiated into the philosophy of Berkshire Hathaway, I would like to provide a simple introduction.
CEO Warren Buffett invests in a conglomeration of private holdings that are based on value, economic moat and patience. Berkshire is listed as an insurance company on the surface, but it is so much more. The insurance portion of the company contains several private holdings including Geico and other reinsurance operations. The insurance operations are believed by many Berkshire investors and Buffett himself to provide a “hidden premium” in the book value, possibly indicating that a price-book ratio average of 1.25 to 1 is the true net asset value.
The reason for the hidden value is insurance premiums must be recorded as liabilities on the balance sheet even though the “float” (the amount of premiums paid in by customers being insured), is investable by the Berkshire managers for short durations. Buffett constantly gloats in his annual letters that his managers handle the float better than the majority of other insurance institutions in the U.S.
The recent upswings in the market have also increased short- and long-term bond yields, investment instruments that are likely to be a target for short-term managers using the float of insurance premiums. This combined with possible loosening of insurance regulations in the near future should be a good thing for this portion of Berkshire.
Then you have the large-cap public holdings managed by Buffett, Ted Weschler and Todd Combs, with several financials at the top of the list that include Wells Fargo (WFC, Financial), US Bancorp (USB, Financial) and convertible preferred shares of Bank of America (BAC) that will eventually allow Berkshire to become one of its largest shareholders as its warrant option strike price will almost certainly be several times below market value at the time of exercise. There has already been a change in the tone of Janet Yellen’s minutes; net interest margins should rise as the federal funds rate does.
Industrial earthmovers like Deere (DE), oil refiners in Phillips 66 (PSX, Financial) and domestic food giants round out the list of companies that will all benefit from the encouragement of increases in gross domestic production. The refining bet is an easy and logical one. Even if OPEC cuts production, the encouragement of domestic operations to start back up again should keep the cost of the input product for oil refiners at reasonable prices for the foreseeable future. This thought process is also evident in the Berkshire mindset by the large new purchases of airlines post-presidential election. Airlines function in the same way an oil refiner does, with fuel being their primary cost that controls margins.
Finally you have the private holdings. These contain airplane part makers like Precision Castparts, the electric utility company NV Energy (that keeps all the neon lights glowing in Vegas and Reno), MidAmerican Energy (one of the largest midwest utility companies), BNSF railway and the aforementioned Geico. These are all very profitable large companies that were once publicly listed, but we do not have access to them any longer unless it is through Berkshire.
Almost all of these companies are largely American based and will be increasing their margins even more if corporate tax breaks can actually make it out of congress. Berkshire is, in a sense, the index fund that should perform best when the U.S. chooses to stimulate its GDP.
Additionally, for the index fund investors out there, the logic has always been to go with one of the low-cost S&P 500 index funds and leave it alone. However, there have been some years where the DOW wins the battle, and this could be one of those interesting periods of history. State Street’s ETF labeled Diamonds (DIA, Financial), is one of the larger Dow Jones Industrial index funds on the market. It produces an almost 3% dividend yield even though it’ net asset value fee is slightly higher than Vanguard’s S&P 500 ETF (VOO, Financial) or State Street’s (SPY, Financial).
Berkshire and mega-cap U.S.-based companies could be experiencing an upcoming boon, but it will be highly dependent upon which assumed promises of the new U.S. administration come to fruition.
The author is long Berkshire, Bank of America, DIA, SPY, VOO and Phillips 66.
The author has no position in Deere, US Bank or Wells Fargo.
