If you don't want to own Berkshire Hathaway
Berkshire's dominance is fueled by the funds generated via its insurance business. Every insurance company has float, the premiums it collects before claims are made. When its underwriting proves profitable, the insurer not only gets those funds for free, but also gets paid just to hold the money. It's good work ... if you can get it.
But not every insurance company has the pricing discipline of Berkshire's array of insurers, and few have its "managerial mindset." Rather than price properly (or wisely), many insurers often small-f foolishly underprice their business to maintain market share.
Berkshire Hathaway also dominates the worldwide reinsurance market, not unlike Secretariat's supremacy at the racetrack in 1973. Of Berkshire's $3.8 billion underwriting profit in 2006, more than half came from reinsurance alone. Berkshire Hathaway may pay dearly when major catastrophes strike, but in turn, it's repaid dearly for bearing that burden. If its reinsurance business gets nailed in a bad hurricane season, it can pass along these costs immediately in the form of higher premiums, because no one else can provide the necessary capital to fund such demands for reinsurance.
In 2006, Berkshire Hathaway closed a huge deal to provide a type of reinsurance for the venerable Lloyd's of London. Berkshire's float at the end of 2006 was $50.9 billion; this transaction will add another $7 billion. The Deferred Charges for Reinsurance Assumed (DCRA) will be amortized over a 50-year period. If that's not long-term planning, Mona Lisa was a man.
Berkshire Hathaway has another advantage: It keeps its insurance eggs in more than one basket. In 2005, investors made much ado about nothing because Berkshire Hathaway's reinsurance business lost money. But those investors didn't notice that GEICO and other primary insurers more than offset Berkshire's catastrophe losses. (If I were really smart, that would have been a good time to add to my Berkshire holdings.)
Berkshire dominates specialty insurance markets. Half-court shots at basketball games, hole-in-one contests, workers' compensation for plumbers, carpenters or electricians, and community bank bonds are the obscure, but highly profitable, markets served by insurance companies under the Berkshire banner.
A mutual fund with a twist
The major reason to not own individual stocks is their abundance of uncompensated company risk. At Berkshire, though, that's hardly a problem. In addition to its diversified insurance business, Berkshire owns more than 60 operating companies, which contributed more than one-third of Berkshire's pre-tax earnings in fiscal 2006. Earnings from areas independent of the reinsurance market help Berkshire weather financial storms.
Many private equity firms seek acquisitions solely "flip" them for the quickest profit possible. In contrast, Berkshire insists that its acquisitions' executive staff stay in place, with the freedom to operate independently. The consortium of companies held by Berkshire primarily asked to join the party. Also, as Mr. Buffett notes, "many of the businesses we control are worth much more than their carrying value." That's a recipe for long-term success.
Some people liken Berkshire to a well-diversified, balanced mutual fund. But owning Berkshire has advantages such funds can't offer. It charges no annual expenses to reduce your return. It doesn't have to distribute all dividends and capital gains directly to shareholders, sparing them the drag of additional taxes. And though Berkshire owns positions in dozens of publicly traded companies, it doesn't undertake the frenetic trading that afflicts most funds. In short, Berkshire offers all the benefits of a top-flight mutual fund, with none of the drawbacks.
Why Berkshire's the best
Cherry Cokes and hamburgers might not keep Warren Buffett young forever, though hope springs eternal. However, the company has a plan for his succession, which should go more smoothly than choosing a pope. The company is tapping younger people to join its board of directors, and when the Oracle of Omaha finally bows out of the market for good, Berkshire plans to divide his job into two positions, letting one successor cover operations while another supervises investments.
No other publicly traded company provides an owner's manual, as Berkshire does. Its 2006 annual report updates the one Buffett and Charlie Munger first presented in 1996. They succinctly describe what ownership of Berkshire Hathaway involves, and provide investors a much better idea of the benefits of owning their stock.
While analysts love crunching numbers and comparing results, this exercise is like relying entirely on your rear-view mirror when driving your car. It's more important to know whether your investments have a system in place, as Berkshire does, to generate shareholder value in the future.
Besides, you'll probably never hear Jim Cramer screaming to buy Berkshire. In my opinion, that's a great reason to own it.
Fool contributor Buz Livingston, CFP, owns Berkshire Hathaway Class B shares. He believes most investors will benefit from professional advice, and he appreciates your feedback. The Fool has a disclosure policy.