Few stocks can match the long-term performance of Berkshire Hathaway (BRK.A 0.74%) (BRK.B 0.61%). From the moment that CEO Warren Buffett took over the company, Berkshire started to deliver the amazing returns that have turned so many of its original investors into millionaires.
Yet with Buffett now well into his 80s, some investors wonder whether Berkshire's magic will be able to outlive its leader and deliver market-beating performance for future generations. Buffett himself would urge investors to look at the company's fundamentals before deciding whether to buy the stock. No article this length could claim to do anything close to a complete review of Berkshire Hathaway, but it can at least offer a simple opinion about whether Berkshire stock is a buy right now -- as well as serving as a starting point for further research.
Consumer-insurance giant GEICO is a key part of Berkshire. Image source: Berkshire Hathaway.
How to look at valuation
Buffett believes in investing in strong stocks at reasonable prices, and that standard has traditionally applied to Berkshire's own stock, as well. Unlike the bulk of other American companies its size, Berkshire hasn't made massive buybacks of its own stock, choosing instead to do only targeted repurchases when valuations fell to attractive levels.
Because Berkshire's earnings are now subject to mark-to-market requirements for its investments, its bottom line is prone to wild fluctuations depending on how the overall stock market has fared. However, Buffett often has looked at the ratio of price-to-book value in evaluating Berkshire's valuation. That figure is right around 1.5 currently.
That's above the price-to-book ratios of 1.1 and 1.2 at which Berkshire has been comfortable doing buybacks in the past, but a recent change to the company's policies suggests that Buffett believes fair value for the stock could be higher now than it was previously. After a rise of nearly 20% in the past year, Berkshire doesn't look extraordinarily cheap right now, but it's also not overly expensive compared to past valuation levels.
The search for growth
One massive problem that Berkshire has right now is that it has more cash than it knows what to do with. As of the end of the second quarter, the conglomerate sported a cash balance of $111 billion. Buffett's quite uncomfortable with the amount of cash Berkshire has, as it sees having $20 billion as adequate to take advantage of any unexpected investment opportunities that pop up from time to time.
Berkshire prefers complete acquisitions over partial stakes in companies, but the challenge lately has been that most stocks are overvalued in Buffett's eyes. Without the ability to negotiate a price that Berkshire can be comfortable with, deals simply can't get done.
That's leaving many investors thinking that Buffett will have no choice but to turn to buying back Berkshire shares -- and while that might be beneficial for the stock price in the short run, it also offers the troubling conclusion that adverse market conditions could reduce Buffett's ability to make money in the best way possible: finding great new businesses to add to the Berkshire Hathaway family.
Insurance could soar
At the core of Berkshire Hathaway's success has been its insurance business. Insurance is what gives Berkshire much of the investing capital it uses to invest, and its competitive advantage in putting its collected premiums to work is a major source of its outperformance over time.
Berkshire has always done a good job of handling underwriting at its insurance businesses successfully, with an eye toward taking on reasonable risks at fair prices. When major events like Hurricane Florence happen, it can result in short-term losses that lead many investors to panic about the insurance sector. But for Berkshire Hathaway, even catastrophic losses are easily handled, and the long-term benefit is that such events typically knock out weaker competitors and allow Berkshire to raise premiums.
Hedge your bets
I've owned shares of Berkshire Hathaway longer than any other stock, and I'm comfortable recommending the stock at its current prices. But I also think that come next quarter, losses from Florence could lead to results that prompt some investors who are less confident about Berkshire to sell. Taking a half-sized position in Berkshire now in the hopes of buying more toward the end of the year might seem like market timing, but it's really more about maximizing your chances of building a long-term position that has the best chance of delivering the returns that Berkshire investors have gotten used to seeing over the decades.
