Why Berkshire Hathaway Is A Smart Long-Term Pick
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Berkshire Hathaway (NYSE: BRK-A) traditionally releases its first quarter earnings at the same time as its annual party, err, meeting. So it was this year, and while earnings were certainly solid, they did come in short of analysts' expectations. For this article, unless otherwise stated, I will be discussing numbers for the “A” series shares. The ratio of “A” to “B” shares is now 1500 / 1.
Before getting into the nitty gritty, let me note as an aside that everyone should at one time or another buy at least one “B” share, so as to be a shareholder of record and attend a three day Berkshire annual meeting. Part pep rally, part intense question and answer session, and with much of Nebraska in attendance, it is a unique spectacle among public companies. Iit is worth spending $80 plus commission to get your “ticket” for one of these before Warren Buffett passes on.
Berkshire is a holding company with a mix of wholly owned companies, in industries including insurance, homebuilding, and rail, along with large, partial equity stakes in some of America's best known companies. Buffett, along with right hand man Charlie Munger, have built an enviable long term record. Recent years have not been so kind, as Berkshire stock has trailed the S&P average for three years in a row. Buffett's health, and he has been diagnosed with prostate cancer, is always on the minds of Berkshire investors and probably weighs on the stock. A clear succession plan would make a great deal of sense here, and Buffett has made recent steps in that direction.
Most of Berkshire's portfolio is still based on financials and consumer non durables. As such, the portfolio is relatively recession proof. The exception is of course, the insurance companies, which by most tokens is the heart and soul of the company. Geico, with its enormous advertising budget, has become a top tier personal lines insurer, now the third leading auto insurance underwriter after State Farm and Allstate. Geico too is quite stable as it has no designs outside the United States. The BIG variable for Berkshire is its large, reinsurance units, Berkshire Hathaway Reinsurance and General Reinsurance, combined the fourth largest reinsurer in the world. Any reinsurance company is inherently volatile, not due to economic cyclicity, but rather due to the nature of large risks in light of man-made and natural disasters.
Berkshire posted first quarter profits of $3.245 billion, or $1,966 per class “A” share. This was up more than twofold from the first quarter of last year, when earning were $1.511 billion, or $917 per share. The big difference was the reinsurance business. In 2011 the reinsurance business worldwide was weighed down from international disasters ranging from the earthquake and tsunami in Japan, to Australian flooding and beyond. The total catastrophic disaster claims paid were $1.1 billion in the year ago quarter. Berkshire's overall insurance losses from claims declined a total $1.24 billion from the first quarter of 2011, which accounted for a large bulk of the company's overall profit improvement.
But the insurance division was still far from healthy. Underwriting gains at Geico fell over $200 million to just $124 million, and the reinsurance units, while managing a vast improvement over a huge underwriting loss in the first quarter of 2011 of $1.67 billion, only managed to improve to an underwriting loss of $110 million. This slump in the overall insurance group led to Berkshire's missing, by a substantial amount, the near $2,300 in earnings per share that had been expected.
Many of Berkshire's recent bets have been paying off well. Lubrizol, the specialty chemicals company, Marmon, which was also acquired in 2011, and Burlington Northern railroad are all benefiting from the uptick in domestic economic conditions. Core equity holdings in businesses such as U.S. Bancorp, Wells Fargo, Coca-Cola and IBM also continue to increase in value and to pay dividends.
The price of the “A” stock has traded between $110,000 and $123,000 per share since early 2010. All the while, book value has been increasing, and even though the stock price is at the cusp of its all-time high, the stock trades to only a modest 14% premium to the book value.
There is no other company quite like Berkshire, and its quirkiness along with the integrity of how it is run appeal to me. I recommend it to long-term, conservative holders.
Perhaps General Electric (NYSE: GE), with its transportation, energy, health care, and finance divisions, is of the same ilk as Berkshire. GE made a great stroke in purchasing most of MetLife’s banking operations in the first quarter. Growing the capital arm of GE is essential, and growing the retail bank will help to offset the potential volatility of GE Capital's historical role of financing what it sells. GE's core, industrial businesses are growing at double digit rates, and a bump from GE Capital in terms of dividends to the corporate parent would be most helpful. GE's 3.5% yield is also an attraction.
Another big, diversified company I like a lot is United Technology (NYSE: UTX), the maker of everything from Otis Elevators to Sikorsky Helicopters to Carrier HVAC systems. It beat analysts' estimates by 9% in the first quarter of the year, posting earnings of $1.31 per share. Assuming continued lifting of the U.S. Economy, and some stabilization in Europe, I see United on a strong earnings growth curve over the next three to five years. Analysts generally agree, seeing earnings growing from $5.30 per share in 2011, to $6.73 in 2013. The stock itself has languished of late, as since hitting over $90 per share in July, 2011, it has not even been close to that level since. The good news is it is trading for less than twelve times 2013 earnings. I think United is a winner, so enjoy the 2.4% yield and watch United outperform the market.
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