Among the most widely anticipated and watched annual events for investors is the annual meeting of Berkshire Hathaway Inc. (BRK.A), held in its headquarters city of Omaha, Nebraska and presided over by Chairman and CEO Warren Buffett. This year's meeting is on Saturday May 4, 2019, and many of the more than 30,000 attendees will be less than thrilled that Berkshire's shares have risen by just 6.2% year-to-date through the close on April 30, badly lagging the 17.5% gain for the S&P 500 Index (SPX). While the S&P 500 has soared to new all-time highs this week, Berkshire is 3.2% below its own 52-week high.
Some believe that the best days for Buffett and Berkshire are far behind them, given that Berkshire also has underperformed the S&P 500 over the past 1, 5, 10, and 15 year periods, per Barron's. Others see an opportunity to grab a bargain.
“The stock is very cheaply valued, given the long-term growth opportunities in insurance, Burlington Northern, and its manufacturing, service, and retail businesses. There’s also the ability to create value through significant acquisitions and share repurchases,” according to Barclays analyst Jay Gelb, as quoted by Barron's. The table below summarizes five reasons why those bullish on Berkshire see a bargain.
5 Reasons Berkshire Is Undervalued
- Highly diversified business; 2019 profits should reach $26 billion
- Trades at only 1.4 times book value
- Book value likely to grow at 10% annual rate, propelling stock price
- Cash holdings of $112 billion can be used for buybacks or acquisitions
- Sum of its parts is worth at least 114% of its current market capitalization
Significance for Investors
Berkshire's cash hoard of $112 billion, as of the end of 2018, represents 21% of the company's $522 billion market capitalization, as reported by Barron's. With interest rates at historic lows, keeping such a large cash position has had a negative impact on earnings. However, Buffett prefers to pay for acquisitions in cash, and he may be biding his time to scoop up bargains should the market tumble.
Berkshire has stepped into the takeover fray surrounding Anadarko Petroleum Corp. (APC), offering to invest $10 billion in Occidental Petroleum Corp. (OXY) to help that company fend off rival bidder Chevron Corp. (CVX), per a press release from Occidental. Meanwhile, a variety of companies across a broad spectrum of industries may be in Berkshire's sights, according to analysis by Credit Suisse.
Berkshire's portfolio of equity investments in publicly-traded companies is currently worth about $210 billion, per CNBC, representing about 40% of its market cap. According to Generally Accepted Accounting Principles (GAAP), Berkshire's earnings include the dividends received on these investments, plus any gains or losses generated by fluctuations in their market values. The latter is a recent rule change and "neither Berkshire's Vice Chairman, Charlie Munger, nor I believe that rule to be sensible," Buffett wrote in his recent annual letter to Berkshire shareholders.
Meanwhile, Buffett has urged investors to consider the "look through earnings" related to Berkshire's equity portfolio. That is, to add a pro rata share of the earnings generated by those companies to Berkshire's own GAAP earnings, based on the percentage of those companies' stock that Berkshire owns. Analyst Jay Gelb at Barclays did the calculations and estimates that, on a "look through" basis, the forward P/E ratio for Berkshire would fall from about 20x estimated 2019 earnings to about 16x, Barron's indicates.
Additionally, the parts of Berkshire might be worth more than the whole. Based on comparisons to the valuations of publicly-traded competitors, Barron's estimates that just three key wholly-owned operating subsidiaries may be worth a combined $275 billion, or about 53% of Berkshire's market cap. These are railroad Burlington Northern, at $175 billion, insurer Geico, at $50 billion, and its utility operations, also at $50 billion. Add in the cash and the equity portfolio, and just these parts of Berkshire add up to at least 114% of its market value.
While Buffett has defended stock buybacks against politically-motivated critics and promised that "Berkshire will be a significant repurchaser of its own shares," per his latest annual letter, total repurchases in 2018 were only $1.3 billion, or roughly 0.25% of its market cap. By contrast, Barron's notes, many big banks are repurchasing 5% or more of their stock annually.
However, in a recent interview with the Financial Times cited by Bloomberg, Buffett stated that Berkshire may buy back up to $100 billion of its stock, but did not give a time frame. Making good on this promise may be the best propellant for the stock.