The last year marked the end of a period in which Warren Buffett's Berkshire Hathaway ( BRK.A -0.29% ) ( BRK.B -0.61% ) underperformed the S&P 500 over the past one-, three-, five-, and 10-year periods.
But could that change in 2021?
There is some reason to think it could. After all, the underperformance at Berkshire doesn't seem to be driven by fundamentals. Rather, it appears Berkshire's size, Buffett's advancing age, and Berkshire's relative lack of technology holdings have caused investors to chase newer and shinier growth stocks.
Still, the stock is quite cheap, Buffett is buying back more of Berkshire's stock than he ever has before, and Berkshire's industrial and manufacturing businesses should rebound with the economy once vaccines are distributed. Here are several key things for Berkshire shareholders to look forward to 2021.
No. 1: An industrial earnings recovery
2020's COVID-19 outbreak obviously affected a wide swathe of businesses, and Berkshire's diversified holdings weren't spared. The pain was felt especially acutely at Berkshire's Precision Castparts subsidiary, which makes custom airline parts for the major airplane assemblers. Precision's revenues were down 41.4% last quarter, and its operating earnings were down 80%. This year, Precision Castparts also laid off about 40% of its workforce and took an asset impairment writedown of $300 million.
While Precision was perhaps the most-affected, Berkshire's other industrial and manufacturing businesses were also down, though not as much. These subsidiaries include Lubrizol, which makes specialty chemicals for transportation and industrial fluids, Marmon, a highly diversified industrial machine and parts producer, and International Metalworking Co., which is huge metalworking conglomerate.
Yet while the pandemic caused the entire group's revenue to decrease 20% and earnings to decline 35.6% last quarter, the rollout of vaccines and economic stimulus should allow this key group to bounce back in 2021.
No. 2: Growth at Berkshire Hathaway Energy, and clean growth at that
One of the brighter spots in Berkshire's 2020 results has been the resilience and continued growth of Berkshire Hathaway Energy, the segment that includes a number of electric utilities, and for some reason, BHE also includes the Berkshire Hathaway real estate brokerage business.
At any rate, BHE has showed revenue and profit growth last quarter, with revenue up 8.8% and pre-tax earnings up 5.7%, in spite of the recession that has dampened energy consumption at large. In last year's letter to shareholders, Buffett praised the accomplishments of the MidAmerican Energy segment, which is completely wind self-sufficient in Iowa. That focus on renewables allows MidAmerican to sell power to consumers significantly cheaper than the other competing utility, which only has less than 10% of its power coming from renewables.
In that same letter, Buffett also outlined $100 billion in investment opportunities for Berkshire Hathaway Energy, and this will probably come over time, because of the slow nature of regulatory approvals for large utility projects. Still, with the costs of wind and solar power continuing to plummet, and with BHE unburdened by dividend payments of most utility companies, look for Berkshire to greatly expand its electric utility business in 2021 and beyond. Additionally, Berkshire's largest purchase this year, a $9.7 billion acquisition of natural gas pipelines, storage, and export terminals from Dominion Energy ( D -0.49% ), will add even more fee-earnings assets to the mix this year.
No. 3: More share repurchases likely if the price stays here
Through its earnings were down, during the first three quarters of 2020, Berkshire still managed to produce just under $20 billion in free cash flow, swelling its hefty cash pile has swelled to $142 billion as of September.
Yet Berkshire's stock remained depressed, increasing only 2.4%, versus the S&P 500's return of 18.4%. Furthermore, Berkshire only eked out a positive gain thanks to a last-minute surge following a COVID-19 vaccine announcement.
Some investors scoffed at Buffett's reluctance to buy stocks in a big way during the March swoon; however, Buffett did make a rather sizable stock buy this year -- Berkshire Hathaway itself.
Through the first nine months of 2020, Buffett repurchased $15.7 billion of Berkshire's stock, good for about 3% of shares outstanding. Buffett had relaxed the buyback rules he used to adhere to in 2018, saying at the time that Berkshire would repurchase shares, "at prices below Berkshire's intrinsic value, as conservatively determined by Warren Buffett, Berkshire's chairman of the board and chief executive officer, and Charlie Munger, vice chairman of the board."
This year's share repurchases were significantly higher than the $5 billion in repurchases made in all of 2019, and probably continued into the fourth quarter. That probably means Buffett thought Berkshire's own collection of businesses and investments were among the best deals in the market. And even though Berkshire's share price is up compared with the third quarter, it's still far behind the market and Berkshire's likely book value growth for the year. With a still-cheap stock and loads of cash, look for more repurchases in 2021, barring a sudden spike in Berkshire's share price.
No. 4: Expect the unexpected
While Berkshire didn't execute many large, consequential buys in 2020, Berkshire did make several smaller but unique investments, with some even the kind Buffett himself had said he'd never make.
High up on the "unexpected Berkshire buys" list was Barrick Gold ( GOLD -3.16% ) a gold miner that Berkshire purchased in the second quarter. This was very surprising since Buffett had long been opposed to investing in gold versus productive businesses -- though arguably Barrick is a business, albeit one whose earnings is tied to the price of gold.
Buffett didn't shed light on the purchase, but as its size was only about half a billion dollars, it was probably the work of Buffett's lieutenants Ted Wechsler or Todd Combs. We still don't know the exact reason for the gold-oriented purchase, but it could be due to fears of inflation and instability. Interestingly, the Barrick Gold position was slashed by 42% in the third quarter, so the purchase may have been a short-term hedge against the considerable uncertainty in the immediate aftermath of the pandemic.
Berkshire then surprised again with the purchase of over six million shares of Snowflake ( SNOW -8.57% ) at its IPO price of $120 per share. Snowflake was a high-flying technology name at the time of the IPO, and since then it's gone to the stratosphere, more than doubling to around $280 per share as of this writing, and trading at an astronomical 163 price-to-sales ratio.
The purchase is a huge outlier for the stingy Buffett, the world's best-known value investor. However, it's highly likely the purchase was spearheaded by Todd Combs, one of Buffett's younger lieutenants and a user of Snowflake's big data platform at Berkshire's GEICO insurance subsidiary.
Finally, Buffett himself made what is in many ways a typical Berkshire value investment, but in an atypical geography of Japan. During the summer, Berkshire purchased 5% stakes in five different Japanese trading companies, which have large and diversified businesses across energy, food, textiles, and other import/exports. All five companies sported low valuations and high dividend yields that Berkshire typically seeks, but were not easily found in the U.S. markets this year.
Not many would have predicted Buffett and his team would buy into gold, high-flying tech IPOs, or Japanese stocks last year, and I'd expect more shrewd and surprising moves from Buffett and his team in this strange economic time.
At a valuation of just 1.3 times book value as the of the end of Q3 -- though probably even cheaper today after a book value increase in Q4 -- Berkshire remains one of the best value stocks in the market heading into 2021.