While much of the stock market has sold off hard due to tariffs and economic worries, one stock that has held up very well is Berkshire Hathaway (BRK.A 0.68%) (BRK.B 0.60%). As of this writing, the shares are up more than 14% year to date, compared with the 10% decline in the S&P 500 index.
The stock has been a ballast in the rough seas of the recent market turmoil. That makes Berkshire a great investment to hold in this environment. But can investors expect it to be a strong performer during the next few years?
NYSE: BRK.B
Key Data Points
The Oracle of Omaha
Berkshire's Chief Executive Officer Warren Buffett has lived up to his nickname, as the "Oracle of Omaha" smartly pared back the company's equities positions and accumulated a stockpile of cash in the process. Last year, he reduced the company's equity exposure, including top holdings Apple and Bank of America, as the market soared. In total, he sold $143 billion worth of stock while only purchasing $9 billion.
Beginning last May, Buffett also stopped buying back Berkshire stock, something he had done consistently over the prior six years. Together with the strong cash flow from its insurance operations and other operating businesses, Berkshire ended the year with an astonishing $334 billion in cash and short-term investments on its balance sheet.
While Buffett is not a market timer, his timing could not have been more perfect. He was able to reduce his company's equity exposure at attractive prices ahead of the recent stock-market pullback. While the market remains in flux and could continue to head lower, Berkshire is now armed with a boatload of cash it can put to work.
Even as he stockpiled cash, Buffett still extolled the virtues of holding stocks over the long term. However, he clearly saw an overvalued stock market that was not accounting for potential risks.
With $334 billion in cash, Buffett will have a lot of options at his disposal. Not only can he start accumulating positions in undervalued stocks, he'll also have plenty of money to buy companies outright. Given the uncertainty in the market with on-again, off-again tariffs, there could be private companies looking for an exit strategy. Berkshire has long been considered a desirable company to sell to, and Buffett an affable person with whom to deal.
He's also helped other companies finance acquisitions, including buying preferred equity and bonds in gum maker Wrigley to help candy maker Mars acquire it during the financial crisis. He also helped backstop Goldman Sachs during this period, through the purchase of preferred equity and warrants to buy Goldman stock. Within three years, Berkshire made $3.7 billion on its $5 billion preferred equity investment, while making a tidy profit on the warrants as well.
Buffett is at his best during tumultuous periods, so if the market and economy get even rockier, look for him to make some nice deals.
Image source: Getty Images.
Where will the stock be in three years?
Although Berkshire is in an enviable position with its cash hoard and Buffett at the wheel, the stock is not cheap by historical measures. This is one of the reasons Buffett has stopped buying back his own company's shares.
In the past, Buffett has used price-to-book (P/B) value as his preferred valuation metric. When the stock was trading below 1.1 times book value, he would look to repurchase shares. He later increased the threshold to 1.2 times book value, before eventually discarding it, in favor of repurchasing shares when he felt that Berkshire was trading below its intrinsic value.
Today, the stock trades at a P/B ratio of 1.7, which is well above the 1.1 and 1.2 figures where Buffett once considered the stock undervalued. This is also one of the highest valuations the stock has traded at over the past 10 years:
BRK.B Price to Book Value data by YCharts.
While well-positioned for the long term, given its valuation, I think Berkshire's stock over the next few years is likely to have only a modest upside. I have little doubt that Buffett will find good use for his cash eventually, but the value of Berkshire's equity portfolio has also declined, meaning its P/B valuation is even higher than currently reported.
Overall, I'd expect the new investments Buffett finds to help increase Berkshire's book value over the next three years, but for the stock to also see some decline in valuation. This should lead to solid but overall modest returns over the next few years.
