This article is part of our Rising Star Portfolios series.
Cash might be king, but that doesn't make Warren Buffett some court jester. Today, the Young Gun Portfolio is showing its reverence for his majesty and plunking 12% of the portfolio in Berkshire Hathaway (NYSE: BRK-B ) .
In the quick couple of months since we launched the Young Gun Portfolio, we've made two trades, in hotel-buying jockey play Pebblebrook Hotel Trust and in banana champ Chiquita Brands. We took what was intended to be an initial bite in each -- 3% in Pebblebrook and 2% in Chiquita. The market, beneficent all around lately, has been especially generous to these two, and they are up about 12% and 14%, respectively, outperforming the market. Lovely as that may be, the rising tide has floated each of these stocks away from where I'd happily add to our positions. Incremental investment in either or both may yet become warranted, but right now I'm keeping these two at their current allocations.
That means that a nice chunk of cash I had mentally earmarked for further investment in Pebblebrook and Chiquita is no longer set aside for those opportunities. Taking into account the additional $1,000 added to the portfolio every month, our look-through cash balance is now more than 90% of the portfolio. Especially in such frothy markets, I am a patient investor, but that level of cash is excessive. I have more ideas today than at any time over the previous two months, but while I flesh them out, I am going to invest a nice chunk of our change in Berkshire Hathaway.
Berkshire needs no introduction, and I am not going to reinvent the wheel with a novel take on Warren Buffett's investment vehicle. This is mostly a placeholder trade, so don't be surprised if I trim our position to invest in more opportunistic places as I uncover them.
I said this was "mostly" a placeholder trade because, cash balance considerations aside, Berkshire is looking cheap these days. By reverse engineering a discounted cash flow model for Berkshire, we learn that the market is expecting a mere 4.5% average sales growth for the next 20 years before declining to a 3% terminal rate. Sure, it gets harder and harder to grow as a company gets bigger, but for Berkshire, which has grown revenue at an average clip of more than 25% annually since 1991, 4.5% is a pretty darn low hurdle.
Berkshire is also cheap relative to its book value. Over the past 10 years, Berkshire has traded at an average of about 1.6 times book value, and peers (or, as close to "peers" as it gets for Berkshire) Markel (NYSE: MKL ) and Leucadia National (NYSE: LUK ) have likewise average price-to-book value multiples of 1.7 and 1.6 over the same time frame. Today, Berkshire is selling at just 1.3 time book value, or about 25% below its -- and its peers -- historical average.
My own discounted cash flow model, which assumes overall sales growth of about 8% gradually declining to about 5.5% over the next 20 years before going to a terminal rate, gives us a base case valuation of about $101 per B-share, or about 24% above today's $81 price.
Patience is key in investing, and the Young Gun Portfolio will not chase valuations. I remain wary of these frothy markets, but having more than 90% of the portfolio in cash is not something with which I am currently comfortable. Believe me, I'm all for having dry powder ready, and this trade will leave us with a still-hefty cash balance -- and besides, there are other ways to make sure you have dry powder in case of a market correction (keep your eyes peeled for more on that). In the meantime, Berkshire Hathaway offers us a great place to store some cash while we continue to hunt for other opportunities. I'm always happy to put my extra dollars to work under the supervision of the world's greatest investor, and at today's valuation, this move is a no-brainer.
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