It's not often that Warren Buffett's holding company, Berkshire Hathaway, is able to secretly invest billions of dollars in a single company. But that's exactly what happened roughly one year ago when Berkshire received a disclosure exemption from the Securities and Exchange Commission (SEC). Typically, the company invests enough money to warrant a public disclosure, letting the rest of the market know what Berkshire is doing with its portfolio. This time, Berkshire got to accumulate its stake out of public view.
Earlier this year, however, Berkshire was forced to reveal its position. And I think there's a strong chance Berkshire will continue to buy more of this stock over time. In fact, it's possible that Buffett will eventually buy the entire business outright.
This is Berkshire's secret new holding
Buffett's mystery stock is none other than insurer Chubb (CB +0.23%). We won't ever know the full details behind the disclosure exemption, including why Berkshire wanted to hide its stock purchases of the company. But there's an obvious potential reason: Chubb and Berkshire compete directly in the insurance markets.
NYSE: CB
Key Data Points
While most people know that Berkshire has a giant investment portfolio operated by Buffett and his lieutenants, many are unaware that at the core of Berkshire's operations sits a large portfolio of insurance businesses, offering everything from health insurance and property insurance to commercial insurance and even reinsurance -- insurance for insurers. Berkshire generates billions of dollars per year in reliable premiums that are minimally affected by economic or market volatility. It uses that regular cash flow to finance its investments in other areas, creating a sort of "permanent" capital pool it can tap at any time, especially when asset prices are cheap.
Chubb isn't a diversified insurance conglomerate like Berkshire. Instead, it operates almost exclusively within the property and casualty category. This is definitely not the flashiest business model -- but don't let the staid nature of the insurance industry distract you from a profitable investment opportunity. Over the long term, Chubb has trounced the S&P 500. And while its outperformance has slowed in recent years -- Chubb stock, for example, has only matched the S&P 500's return during the past five years -- that has more to do with the extreme performances of certain index components like Nvidia than any fundamental weakness on the part of Chubb.
When analyzing insurance businesses, the first thing you want to do is check the company's combined ratio. This ratio essentially measures how much profit the insurer makes from collecting premiums and paying on claims and other expenses. During the past decade, rising competition has pushed industry combined ratios close to 100%, meaning that for every dollar an insurer collects, they expect to pay a dollar out in claims. The only profits, therefore, would come from investing those premiums in the meantime.
Chubb, however, has maintained one of the strictest underwriting policies in the industry, and its combined ratio last quarter was less than 90%, meaning it only needed to pay out $0.90 in claims for every $1 of premiums it collected. This underwriting strategy -- not to mention Chubb's willingness to stay conservative even when the competition turns aggressive -- is likely one of the top things that caught Buffett's eye. And it's resulted in a durable competitive advantage for Chubb over the long term.
Will Buffett acquire 100% of Chubb's stock?
I think Buffett will continue to buy more and more Chubb stock over time. Why? First of all, he's already done that. Nearly every quarter since acquiring its original stake, Berkshire has purchased even more stock. Last quarter, for instance, it boosted its stake from 5.8 million shares to 6.9 million. Buffett undoubtedly believes Chubb is a good company, powered by its proven underwriting strategy. But it's also a reflection of Berkshire's growing cash balance, which currently tops $200 billion -- an all-time record.
Buffett stated this year that cash looks "quite attractive" relative to richly priced equities and given "what's going on in the world" from a geopolitical standpoint. Investing in Chubb gives him an ability to earn returns greater than cash in an industry he knows very well. And if he likes Chubb enough, why not acquire the company outright and integrate it with the rest of Berkshire's insurance arm? With a market cap of $110 billion, Chubb could provide Buffett with an outlet for much of Berkshire's $200 billion cash hoard, all without leveraging the company to an economically sensitive industry should market volatility arrive.
