I often recommend Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) as an excellent "core" stock for any portfolio, and for good reason. Not only does Berkshire have a diverse portfolio of excellent businesses and stocks, but the company also has a strong history of shareholder-friendly management and smart financial discipline.
However, the most common question I get is "Warren Buffett won't be running Berkshire forever -- what happens then? Will it still be a great investment?" The answer, I believe, is a resounding "yes."
Berkshire is prepared for anything
Buffett has said that the chance of Berkshire running into financial problems is virtually zero, thanks to these three characteristics:
- Berkshire has a large and reliable stream of earnings. The company makes its money from a diverse portfolio of subsidiary businesses as well as from its massive investment portfolio. All of Berkshire's revenue generators were hand-picked for their durable competitive advantages, so even if the market has tough times, Berkshire will be in a strong position to make it through.
- The company has lots of liquid assets. Berkshire will always keep at least $20 billion in cash or equivalents, which is the best type of asset to have if times get tough. As Buffett says, "Cash ... is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent."
- The company has no significant near-term cash requirements. Berkshire will never take on significant short-term debt maturities or other arrangements that could require a sudden demand for lots of cash.
As a result of these three things, Berkshire will be in a position not only to make it through the tough times, but also to get even stronger. The company was in the position to profit tremendously from the financial crisis of 2008-2009 and will be able to do the same the next time the market panics.
Buffett believes that Berkshire will be able to increase its earning power every single year. Actual earnings will go up and down, but the potential to profit will only go up, because of this smart business model.
Always a great long-term investment
In the most recent letter to shareholders, Buffett emphasized that Berkshire will always be a good choice for long-term investors, but did offer some words of caution.
Specifically, Buffett advised against buying shares to hold for short periods of time (defined as less than five years), as well as to keep an eye on Berkshire's valuation before jumping in. He said that as the share price approaches twice the stock's book value; it may take many years for the investor to profit. As Buffet put it, "A sound investment can morph into a rash speculation if it is bought at an elevated price." Even so, it's important to point out that he doesn't necessarily discourage people from buying Berkshire stock at high valuations -- as long as they're prepared to hold the stock for years to come.
However, Buffett did say that the best time to buy Berkshire would be at valuations close to where the company would begin to repurchase shares -- which he has said is at 1.2 times book value.
What about management? Who will be running the company?
Warren Buffett has made it clear that the board of directors already knows who Berkshire's next CEO will be. And while the identity of that person remains a secret, we do have a couple of clues:
- Berkshire's directors believe that future CEOs should come from internal candidates.
- The new CEO will be relatively young -- Buffett wants the next CEO to stay on the job for decades and says that the company will operate best if its CEOs stay for 10 years or more.
Regardless of who is named CEO, Buffett believes they will be successful thanks to Berkshire's lack of bureaucracy. The subsidiaries are, for the most part, free to operate without much interference, and the company has no legal office, human relations department, or many other departments that serve to complicate other companies' structure. Buffett has said that he loves Coca-Cola because a "ham sandwich" could run the business. The same could be said about Berkshire itself (other than its stock portfolio).
Just as a safeguard, Buffett has requested that his son Howard be named non-executive Chairman in order to make it easier to change the CEO if the need should ever arise. In Buffett's experience, this is much more difficult to do when the chairman and CEO are the same person, and would have to see Berkshire stuck in such a situation.
Investments will be handled by several specialists who will report to the CEO, but with lots of freedom to operate, and Berkshire has two great ones in Todd Combs and Ted Weschler, both of whom have already make Berkshire plenty of money that the company otherwise would not have made, according to Buffett himself.
The beauty of Berkshire's business
What many investors don't fully understand is how small Warren Buffett's day-to-day role is, in terms of Berkshire's businesses. Buffett is a hands-off manager -- that is, he allows the heads of each individual business almost complete freedom to operate.
In other words, if Warren Buffett were to leave Berkshire tomorrow, GEICO would still sell insurance in the exact same manner as today, Fruit of the Loom will still produce the same clothing, and all of the other subsidiary companies would also keep going in the exact same way.
The tools are in place for Berkshire to succeed for decades to come, no matter who is in charge or what the economy is doing.