(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Berkshire Hathaway Inc. (BRK.A, BRK.B), one of the world's largest companies by market value at around $470 billion, has been punished by the market's steep sell-offs this year. Its shares have fallen 13%, compared to the 11% decline for the S&P 500, but less than financial peers in the Financial Select Sector SPDR (XLF), which has dropped nearly 19%, as of December 26th, 2018.
Major Challenges In 2019
That performance reflects the insurance, transportation and energy conglomerate built over several decades by legendary investor Warren Buffett. It also reflects the declining value of Berkshire's equity holdings which include big stakes in companies like Apple (AAPL), American Express (AXP) Coca-Cola (KO), and others. Now, the big question is whether Berkshire's earnings and revenue can grow fast enough in 2019 as the stock comes under intense pressure. Berkshire's price-to-book value, the most closely watched measure of the company, is the lowest since 2012.
The bright spot is that analysts forecast that Berkshire will deliver solid earnings and revenue growth in both 2019 and 2020 during a period when experts forecast a sharp slowdown in the U.S. economy.
Solid Earnings and Revenue Growth
According to Ycharts, analysts are looking for revenue to grow by 3.5% in 2019 to $266.5 billion, followed by a 4% gain the following year. Analysts have been increasing those estimates since the beginning of the year. Berkshire is a complex company with revenue coming from many sources. In the third quarter it reported revenue of $63.5 billion, with 77% coming from the insurance business, while 18% came from railroads, utilities, and energy.
Analysts expect earnings to rise 5% in 2019 to $10.48 per share, followed by growth of 8% in 2020. Since February, analysts have increased their estimates by 9% for next year and by 5% for 2020.
Despite Berkshire's solid outlook for earnings growth in 2019, investors are clearly worried about the industries it operates in. The SPDR Insurance ETF (KIE) is down 14% from its September highs. Meanwhile, transportation stocks, as measured by the Dow Jones Transportation Average, are about 21% off their highs.
Trading at a Low Valuation
Nervousness about the economy has reduced the stock's valuation significantly. It trades at 1.8 times book value, placing it at the lower end of its historical range since 2012. Additionally, the stock is trading at the lower end of its price to tangible book value at just 1.3. The current valuation is at a trough level which historically has coincided with lows in the stock.
The options market has a neutral view on Berkshire and sees the shares rising or falling by as much as 18%, using the long-straddle options strategy from the $195 strike price for expiration on Jan. 17, 2020. However, the number of puts to call at the $195 strike are fairly even at approximately 1,500 contracts each. It would suggest there is no bias in the stock rising or falling.
Weak Technical Chart
The technical chart tells a different story and suggests Berkshire's Class B stock, for example, may face steeper losses. It failed at technical resistance three separate times around $220, which is a bearish technical pattern known as a triple top. The stock is currently trending downward toward technical support at $189. Additionally, the stock is approaching a long-term uptrend which dates back to 2016, which may also indicate that there is trouble ahead. Should the shares fall below technical support and also below the long-term uptrend, they may drop further.
With the stock market currently in a heightened state of volatility, Berkshire's exposure to insurance and transportation may make its shares vulnerable if the economy deteriorates over the next two years. Similarly, Berkshire has suffered losses in its equity holdings as some of its top positions, including Apple and Wells Fargo, have lost 12% and 27% respectively. Still, Buffett and Berkshire are legendary for outperforming over the long term, making many investors millionaires in the process. That track record may mitigate the severity of a decline in the stock.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.