The recent excitement about artificial intelligence and its world-changing potential reminds me of the internet's earliest days almost 30 years ago. Go back to the late 1990s when investor euphoria over the internet caused a technology stock bubble.
While it eventually popped, many of today's largest companies, such as Amazon, rose from those ashes and created mind-blowing investment returns over the years, eventually carrying the S&P 500 index to new heights.
Ironically, Warren Buffett, who has traditionally avoided technology during his years of leading Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%), has outperformed the S&P 500 over these past several decades. Had you invested $10,000 in Berkshire in 1997, you would have $117,000 today, compared to $84,000 with the S&P 500 -- including dividends, which Berkshire doesn't pay.
Can Buffett and Berkshire keep delivering market-beating returns? The answer is more straightforward than you might guess...
Buffett's strategy is still effective
Berkshire's success boils down to some simple observations. Sure, the company buys and sells stocks quarterly, but the meat of Berkshire rarely changes. For its portfolio, Buffett keeps 70% of Berkshire's portfolio in four stocks -- Apple, Bank of America, American Express, and Coca-Cola. He bought stock in these high-quality businesses opportunistically.
For example, Berkshire began buying Apple in 2016 when the stock traded at a price-to-earnings ratio (P/E) of around 10 to 12.
He backed Bank of America during the debt ceiling crisis in 2011. Buffett bought American Express in 1964 when the company was embroiled in a scandal. These contrarian investments paid off, and Buffett has held instead of booking profits and moving on.
Additionally, Berkshire's nonpublic businesses include a combination of insurance, railroads, and energy infrastructure, companies with primarily physical competitive advantages that aren't as susceptible to disruption from innovation and technology. The underlying theme is that Buffett identifies durable businesses, invests opportunistically, and holds his winners. As long as Berkshire sticks with this philosophy, shareholders appear in good hands for the future.
The war chest keeps growing larger
Berkshire doesn't pay a dividend, instead retaining all of the profits Berkshire owns. The result is a massive balance sheet that steadily grows over time as profits and investment income stack up. Today, Berkshire's $130 billion cash pile is one of Wall Street's most significant financial war chests.
Buffett is deliberate in holding a lot of cash because it gives Berkshire a lot of flexibility to be opportunistic. Some of those funds have been used for share repurchases in recent years, increasing the value of every Berkshire share.
BRK.B Cash and Short Term Investments (Quarterly) data by YCharts
Increasing interest rates have made it easier to generate investment income, as Berkshire can hold treasury bonds yielding 3% to 5% while Buffett and the team plot Berkshire's next big move. Investors can own Berkshire confidently due to the balance sheet that gives it both opportunity and safety during hard times.
Berkshire is a great business; is the price fair?
Since Berkshire has so many different parts within it, looking at the company's book value can show you how much value the business is creating over time. You can see below that its book value, the collective value of Berkshire's tangible assets (like stocks and real estate) minus its liabilities has steadily grown over time.
Buffett's reputation and Berkshire's market-beating results have created a demand for the stock, which means it rarely goes on sale. Shares typically trade at a 20% to 50% premium to book value, shown as the price-to-book value (P/B) below.
BRK.B Book Value (Quarterly) data by YCharts
The stock has risen to near the upper end of its typical valuation range, which could mean it is a little expensive today. Investors with long time horizons can dollar-cost average, buying slowly over time, or one could wait for a pullback. Either way, Berkshire Hathaway is a proven compounder that should be on any long-term investor's watch list. There's no reason Berkshire can't keep its market-beating ways going.
