Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) was a detractor from performance during the quarter. We chalk up the stock’s pullback as nothing more than a much-deserved rest from the stocks significant outperformance since the end of 2015 versus the benchmark and the S&P 500 Index.
In spite of underperforming the market, the Company reported +18% growth in book value per share compared to last year and has compounded book value per share growth by about +13% during the past three years, which is well above our double-digit growth expectations.
More in line with some of the fastest growing large cap companies, Berkshire continues to plow back close to 100% of its capital into the business. Of course, close to $100 billion of the Company’s capital is tied up in cash or very short-term duration U.S. Treasuries. We think that this “dry powder” bodes well for the future growth profile of Berkshire Hathaway, particularly as the cost of capital rises across the globe – a byproduct of central banks halting and reversing a decade of QE. We believe the Company maintains a long-term competitive advantage in a below-average cost of capital insurance float, which should become more valuable in an environment of both heightened equity market volatility and/or higher cost of borrowing. We expect the cost of capital for Berkshire Hathaway targets to rise faster than Berkshire’s cost of capital, creating a more attractive spread for shareholders.
The growth profile of the Company continues to be underappreciated, but we are content to hold as management and the board have long stuck with a unique share buyback program that we think helps drive the stock to appreciate at least in-line with the attractive aforementioned book value growth. Specifically, the Company will look to buy back shares if the price to book value of the stock falls below 1.2X – which, at this level of margin of safety, would be both immediately and significantly accretive to earnings per share growth. The current valuation is an attractive 1.35X book. The Company has spent very little on buybacks over the past three years, despite a +45% increase in book value, so the market continues to reward the stock without much need for repurchase intervention.
It is impossible to know if the stock would have performed better or worse had the buyback authorization not been in place; however, we consider the telegraphing of this valuation target (combined with the Company’s large cash balance) to have been an incredibly shareholder-friendly way to execute a repurchase program, and we are surprised that few – if any – cash-rich companies have followed suit. We hope more do.
From David Rolfe (Trades, Portfolio)'s second quarter 2018 shareholder letter.
