Berkshire Hathaway is of course very well known among (value) investors. It feels obvious and chewed out to talk about Berkshire Hathaway as a good investment. However, time and time again many people have failed to understand that integrity, immunity to hype and a simple focus on buying good companies actually is a timeless strategy for outperforming the SP500 index. With an index fund, Standard & Poor’s selects the stocks that go in the index and can make exceptions to their own inclusion rules, as we have seen in recent years with MRNA and TSLA. This thesis will mainly provide arguments why Berkshire Hathaway provides more value than the SP500 for a cheaper price. The quantitative argument should give a good sense of the margin of safety that you get by buying Berkshire as opposed to the SP500.
“You’re dealing with a lot of silly people in the marketplace; it’s like a great big casino and everyone else is boozing. If you can stick with Pepsi, you should be ok.” - Warren Buffett (1974)
By the numbers: Why Berkshire is looking cheap
Let’s get the numbers out the way first. At the time of writing, Berkshire can be bought at around 8.5 times earnings, while FAANG trades above 30 times earnings and makes up around 20% of the SP500 index. Its price to book value is around 1.5x, which seems fair compared to 4.6x for the SP500. You may say BRK is too large and therefore has limited opportunities to buy cheap assets and grow. I would say you are correct. Berkshire cannot pile into small caps and even plenty of large companies. However, there are plenty of cheap stocks that are overlooked. Value will always be available in good and bad times as long as human nature plays a role in markets. Apple is a good recent example of this. By eschewing SPACs, IPOs, pricey companies, speculation and gambling, Berkshire can of course miss the next big thing. However, if you are in the market to buy value and compound rather than thrills, Berkshire is still king in compounding money and waiting for a long time if needed.
“Sit on your ass. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.” - Charlie Munger
Nowadays the term “decentralization” is hip to use and is often misused for organizations and protocols that are centralized behind the scenes. Berkshire somehow has managed to make a culture of decentralization work and it has paid off big for them. I would be very surprised if Berkshire changes this culture and it would probably be foolish for then to do so. Buying businesses with excellent management doesn’t require a lot of control and therefore the strategy stays scalable.
“The Roman Empire worked so well for so long because it was decentralized.” - Charlie Munger (2021)
Key man risk
You often see people saying that the success of Berkshire depends on Warren Buffett and Charlie Munger. I don’t think the market outperformance of Berkshire will go away anytime soon, even if Warren and Charlie are no longer running the business in the future. While they of course have been instrumental to Berkshire’s success, I think people are discounting the amazing work and dispositions of Greg Abel and Ajit Jain. They have a long track record of managing Berkshire’s operations and making rational decisions, while still having a deep expertise in their respective fields (energy for Abel and insurance for Jain).
Furthermore, Berkshire explicitly selects companies that have great managements and that can be managed by idiots. This puts less dependency on Berkshire executives to run the individual business.
“I try to invest in businesses that are so wonderful an idiot can run them. Because sooner or later, on will.” - Warren Buffett
Cash will be king once again? (Macro)
Berkshire holds a lot of cash and short-term US Treasury Bills. Around 150 billion as of Q3 2021. It almost looks like the market is treating this as worthless. The notion that money is cheap and inflation is high does not mean we should all just pile into silly companies at high valuations. Berkshire is one of the few that is in a position to capitalize on illiquidity, market drawdowns and interest rate hikes. Even if the cash position becomes less significant due to high inflation, Berkshire holds a lot of consumer goods companies like Apple, Kraft Heinz, Coca Cola, Kroger, etc. that will raise their prices. I believe the large cash position adds to the margin of safety and robustness of the company, while the market seems to imply that holding cash is a great weakness in the current environment.
“Rule no. 1: Never lose money. Rule no. 2: Never forget rule no. 1” - Warren Buffett
Skin in the game
Around 43% of BRK-A shares outstanding are held by insiders at Berkshire. The only insider stock selling going on is Ajit Jain selling a few shares around twice a year. This is a big contrast to the insider sales we see at several modern tech companies. It is an indication of integrity and a vested interest of management to perform to the best of their ability. Since Berkshire has large free cash flow, it is also has additional incentives to do stock buybacks.
“In business and investing, you’ve got to have skin in the game, a stake in the company.” - Warren Buffett
In short, Berkshire has proven time and time again that it can outperform the index if you can afford to hold multiple years. Currently, we have come to a point where indices have actually become pretty risky instruments (with SP500 at 25.66 PE), whereas Berkshire provides a diversified portfolio at a low valuation and a large war chest that will be invested wisely in case of a recession.
“Risk comes from not knowing what you are doing.” - Warren Buffett.
Books that provide more insights into Berkshire Hathaway:
- Margin of Trust: The Berkshire Business Model by Lawrence A. Cunningham (Decentralization)
- Poor Charlie’s Almanack by Charlie Munger (Rationality)
- Uncommon Sense by Michael Kemp (Recognizing value and compounding)
1. 20-year BRK vs. SP500. John Rhodes (Seeking Alpha)
2. BRK vs. ARKK (Financial Times)
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Feb. 5, 2022, 4:22 p.m.,
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