The S&P 500 index is up 178% over the last decade, which has made it more difficult to find value investments within its ranks. There are good deals out there if you know where to look. While investors have chased momentum in technology, some gems in other sectors have been overlooked.
One of the most underappreciated large-cap stocks right now is Warren Buffett's Berkshire Hathaway (BRK.A 0.59%) (BRK.B 0.43%). The legendary investor has built a fortress of outstanding businesses across various industries, and these companies are sending more cash back to Omaha, Nebraska, than Buffett knows what to do with.
Here are three great reasons you should consider partnering up with the greatest investor of all time.
1. Berkshire's operating businesses are undervalued
Over the last decade, Berkshire Hathaway has become a certified cash cow of the first order. Here's a snapshot of how Berkshire's cash position and operating cash flow have changed over the last 10 years:
|Metric||2009||Through Q2 2019 (TTM)|
|Revenue||$112.5 billion||$261 billion|
|Cash from operating activities||$15.8 billion||$38.1 billion|
|Total cash and investments||$146.0 billion||$339.6 billion|
|Shareholders' equity (book value)||$131.1 billion||$382.5 billion|
There is no doubt Berkshire is worth a lot more today than a decade ago. But the gap between the stock price and the long-term value of the company has been widening lately.
The following chart shows the stock's price-to-book-value ratio, which has historically been investors' favorite metric to value Berkshire. Note that the stock has been this cheap just a few times over the last 20 years or so:
In the past, Buffett has cited the growth in book value as a proxy for the year-to-year change in Berkshire's intrinsic value. However, Buffett explained in his 2018 shareholder letter that book value is no longer as meaningful: Berkshire's value is increasingly coming from its non-insurance operations, which book value doesn't adequately reflect.
Berkshire's non-insurance operating businesses generated $16.8 billion in earnings last year. If these businesses were publicly traded as stand-alone companies and traded at the average trailing price-to-earnings ratio of the S&P 500 index, they'd be worth, in aggregate, $357 billion. If we apply a more conservative P/E ratio of 15, that would put the value at $252 billion.
Equally important is the company's $200 billion stock portfolio. Buffett looks at the ownership of stocks the same way he thinks of ownership of whole businesses. Plus, Berkshire has over $100 billion of cash sitting on the balance sheet waiting to be put to work.
Berkshire's equity investments and non-insurance operating businesses, combined, are worth almost as much as the company's current market capitalization (stock price times shares outstanding) of $489 billion. And we haven't even considered the value of Berkshire's insurance operations.
All told, there are plenty of clues to suggest that Berkshire's stock is currently undervalued.
2. Buffett sees a bargain
As early as 2011, Buffett recognized the market wasn't giving Berkshire stock its due. To help alleviate the problem, the Oracle of Omaha went against his long-standing policy of avoiding share repurchases.
In recent years, Buffett has been willing to buy back Berkshire's stock at up to 1.2 times book value, a level that he said in his 2016 shareholder letter represents "a significant discount to Berkshire's intrinsic value."
With the stock hovering just above that valuation level, Berkshire's repurchase activity is picking up. In 2018, Berkshire bought back $1.346 billion worth of its shares, and so far in 2019, it has bought back $2.133 billion. The stock hasn't moved much over the last two years, so Buffett clearly sees it as a bargain at current prices.
3. An all-weather stock
His conglomerate has more than 60 subsidiaries, each run by a manager who's focused on long-term value creation. This impressive collection of assets, including Burlington Northern Santa Fe Railway and energy investments spanning solar and natural gas, should be pumping out a growing stream of earnings for a long time.
Berkshire offers a combination of a relatively cheap stock, a group of wonderful businesses working to build long-term value, and a mountain of cash it can put to work if the markets pull back in the short term. All these factors make this a great time to consider buying shares of Berkshire Hathaway.