In my third post in the “Why I Wish I Invested in…” series, I wanted to cover Berkshire Hathaway. A diversified conglomerate based in Omaha, Berkshire is the child of legendary value investor Warren Buffett.
Anyone who’s been following my blog for awhile knows I’m a serious Buffett fan. I admire him not only for his investing acumen, but also for his writing skills. He has this fantastic skill for simplifying complicated concepts and making them understandable for readers with no business background. For someone that spends a lot of time writing, this is inspiring.
Enough about Buffett – let’s dig in to all the reason why I wish I invested in Berkshire Hathaway.
Building the Behemoth
A history of Berkshire Hathaway is not complete without a history of Warren Buffett. As the CEO of Berkshire Hathaway since 1970, he has had an enormous influence on the company’s success. He is also an individual that has taught me many lessons and I’ve made a point to study his life in an attempt to learn. Case in point: I’ve recently finished reading a fantastic biography titled The Snowball: Warren Buffett and the Business of Life.
This book receives a 10/10 from me. Stay tuned for a future post reviewing it!
The Snowball does a fantastic job of outlining Buffett’s career before Berkshire Hathaway. His career in business started at a very young age – Buffett purchased his first stock at age 11. When not at school, he could be found working odd jobs like delivering newspapers or washing cars, and using these proceeds to reinvest in other business ideas. A notable example was purchasing pinballs machines and placing them in local buildings to earn a profit.
Buffett attended college mostly due to his father’s insistence, studying business at the University of Pennsylvania and the University of Nebraska. Afterwards, he enrolled at Columbia Business School after being rejected by it’s Harvard equivalent. It was at Columbia where Buffett met Ben Graham, often considered the father of value investing. Graham (along with his colleague David Dodd) is the author of Security Analysis, one of the books featured in my earlier post Three Books That Have Shaped My Investment Philosophy.
Benjamin Graham had an incredible influence on Buffett, and has been quoted as the second most influential person in Buffett’s life (behind his father). Buffett took classes from Graham at Columbia, and eventually worked for him as a securities analyst.
After university, Buffett knew he wanted to become a professional investor. His medium for doing this was to create investment partnerships, which he created after brief stints at Buffett-Falk & Co. (his father’s investment business) and the Graham-Newman Corporation (run by Ben Graham). By seeding $100 himself and raising $105,000 from external investors, his partnership had some serious capital to work with. He also had a very interesting fee structure that was beneficial both for himself as the fund manager and for his investors.
Essentially, the partners were paid 4% interest regardless of how the partnership’s assets performed. If the fund performed above that 4% watermark, Buffett earned 50% in fees and the other 50% was paid to the partners as additional interest. This “interest” never actually left the partnership – instead, Buffett’s investors reinvested all profits, which led to compound growth of the partnership’s assets over time.
When Buffett was 38 years old, the partnership’s assets had grown to more than $100 million and his personal stake was around $25 million. Given that this was in 1968, the power of inflation means that this would be much more in today’s dollars.
It was 1963 when Buffett’s Partnership began purchasing shares of Berkshire Hathaway, and Buffett’s involvement with this company began in earnest. Berkshire had working capital (which is the difference between current assets and current liabilities) of about $19 per share, while Buffett was paying under $15 per share, leading to a margin of safety above 25%. A typical Ben Graham investment – it could have been a case study from Securities Analysis.
In the Snowball, the author describes how Buffett’s relentless accumulation of Berkshire Hathaway stock started as an innocent investment, but grew out of control when the then-CEO of Berkshire (Seabury Stanton) tried to con Buffett out of some money on a tender offer for the stock. Buffett then began purchasing out of retaliation, rather than pure investment.
At the time of Buffett’s initial purchase, Berkshire was an ailing textile mill. Buffett made the wise decision to diversify the company’s operations away from the textile industry, and began using the earnings from Berkshire to enter new industries. Most notably was his entrance into the insurance sector by purchasing the National Indemnity Company.
Berkshire began purchasing common stock with the proceeds from the insurance businesses, and the complexity of the ownership structure began to grow out of hand. In the Snowball, the author details how Buffett owned stock in Berkshire Hathaway, Diversified Retailing Company, and Blue Chip Stamps. In turn, each of these companies owned stock of the other two. This complexity eventually instigated an investigation from the SEC, which uncovered nothing criminal – but this inspired Buffett to simplify his ownership structure and use Berkshire as an overall holding company.
Interestingly, Buffett has recently claimed that his biggest investment mistake was purchasing his company’s insurance subsidiaries through Berkshire Hathaway and not through his investment partnership. By purchasing the insurance company under the Berkshire umbrella, Buffett and his partners had to share profits with the public shareholders of Berkshire Hathaway instead of having claim on all of the profits themselves.
Decades later, Warren Buffett still sits at the helm of Berkshire Hathaway and his annual reports contain more investment advice than your typical business school textbook. I’ve personally learned a lot from them myself and highly recommend that you read them if you want to get serious about investing. That’s why I was delighted to see that someone had collected them to form a handy anthology:
Berkshire’s performance is as good as ever.
Enough history – let’s get on to the reasons why I wish I invested in Berkshire Hathaway.
Why I Wish I Invested In Berkshire Hathaway
When I think about why I wish I invested in Berkshire Hathaway, three main reasons come to mind.
First of all, to generate returns. The main reason we invest is obviously to make some money, and Berkshire Hathaway has had fantastic investment performance when compared to the S&P 500. Take a look:
I’m presenting data since March 17, 1980, since this is the earliest data for Berkshire available on Yahoo! Finance. The outperformance is dramatic, and this is only on $100. Imagine a $10,000 or $100,000 investment!
The second reason why I wish I invested in Berkshire Hathaway is that they have a profound impact on the entire American economy. By being the parent company for household names like GEICO, Dairy Queen, Berkshire Hathaway Energy, Burlington Northern Santa Fe Corp., Duracell, and many others, Berkshire Hathaway is literally everywhere. And owning a piece of that would be really cool – whether you’re chowing down on a Blizzard or buying car insurance from GEICO, you feel like you’re a part of the process.
The third reason is to attend the annual meetings. Berkshire Hathaway is known for having some of the most fascinating annual meeting in the world. This is partially due to the wide array of subsidiaries they own – there are displays from each of the companies I mentioned in the previous paragraph. Management has done of fantastic job of capitalizing on the business opportunity presented by these annual meetings, as Berkshire often sets record sales on the days the meetings are held. Buffett also openly advertises for the meetings in his annual reports to shareholders.
Reasons to Invest Now
As I did in my previous posts about Apple and Google, I’m now going to present a few reasons that suggest that Berkshire Hathaway is still a worthwhile investment, and some other reasons to state the contrary.
First, what makes Berkshire Hathaway a good investment right now? Well, there are a few things.
Proven track record. As investors, we are often given the whole “Past performance is no indicator or future returns,” speech. Regardless, the earlier chart of the growth of a $100 investment indicates that Berkshire has a proven ability to grow investors’ money over time. If that wasn’t enough to convince you, here’s a bit more data on Berkshire Hathaway’s recent performance:
If Buffett & Co. can keep this up, then Berkshire still makes for a great place to invest your money.
Instant diversification. Similar to Fairfax Financial Holdings Ltd., a company that is a part of my current investment philosophy, Berkshire Hathaway has subsidiaries in a wide variety of industries. These industries include:
- Insurance (National Indemnity, GEICO, General Re, and others)
- Auto Sales (Berkshire Hathaway Automotive, formerly the Van Tuyl Group)
- Railroads (Burlington Northern Santa Fe Corporation)
- Utilities (Berkshire Hathaway Energy and subsidiaries)
- Materials and Construction (Clayton Homes)
- Aerospace (Precision Castaparts Corporation)
- Food and Food Products (Dairy Queen, See’s Candies, The Pampered Chef)
- Furniture (Nebraska Furniture Mart)
And the list goes on. For more information on Berkshire Hathaway subsidiaries, feel free to peruse these two links:
- Wikipedia List of Berkshire Hathaway Subsidiaries
- Berkshire Hathaway’s Website Links to Subsidiaries
Berkshire Hathaway’s wholly-owned subsidiaries aren’t the only way that the company provides diversification.They also have a common stock portfolio that makes them a minority owner of a wide variety of companies. Take a look at their common stock portfolio at the end of last calendar year:
As you can see, Berkshire’s common stock portfolio has been tremendously successful due to Buffett’s value investing techniques he picked up from Benjamin Graham and his seminal work Security Analysis, as I’ve mentioned previously. The common stocks held by Berkshire provide diversification for the individual investor.
Diversification is important to the success to any investment portfolio. That’s why it’s one of my Ten Guiding Principles of Personal Finance. Berkshire provides plenty of it.
Why to Doubt the Future of Berkshire Hathaway
Warren Buffett’s tenure is coming to an end. Whether through retirement or an unfortunate death, the end of Buffett’s involvement with Berkshire is an inevitability, not a possibility.
As such, succession planning is on the radar of both the investors and the management of Berkshire Hathaway. Going forward, Buffett plans to segregate the portfolio management role from the CEO role for his company. That’s why he’s hired two portfolio managers to assist him: Ted Weschler and Todd Combs. Both were money managers in the past with satisfactory performance records.
The question of who will fill the CEO role is much more mysterious. Most “experts” believe the role will be filled by one of two current Berkshire Hathaway insiders. The first is Greg Abel, who leads Berkshire’s energy operations. The second is Ajit Jain, who leads Berkshire’s reinsurance businesses. Both have strong track records, and will likely be a suitable successor to Warren Buffett.
If you’re considering initiating (or adding to) a position in Berkshire Hathaway in the near-to-mid future, keep in mind that Buffett’s departure from the company will lead to a disappearance of the Buffett premium.
Large size means growth will be slower going forwards. As successful as Berkshire has been to date, it’s reasonable to assume that their growth will be slower in the future than it has been in the past. Small companies tend to grow more quickly than large companies (the “size premium”), so expect Berkshire growth to be slower moving forward.
All in all, Berkshire Hathaway is a tremendous company with a fascinating man at their helm.
There are plenty of days when I think about how cool it would be to own a portion of Dairy Queen, Duracell, BNSF, & others, I just don’t have the capital to buy their common stock (currently trading above $200,000).
Readers, what are your opinions on the future prospects of Berkshire Hathaway? Do you think the stock will experience extreme amounts of volatility when Buffett cuts his involvement (whenever that may be)? Let me know in the comments section!