When the stock market is rocky, Berkshire Hathaway —with more than $100 billion in cash and a master investor at the helm—is an appealing play.
Warren Buffett, the company’s CEO, likes these periods of turmoil because they can provide a flush Berkshire (BRK.B) with opportunities that don’t arise in good times. Buffett capitalized during the financial crisis with well-timed investments in Goldman Sachs (GS), General Electric (GE), and other companies.
So far, the 88-year-old Buffett has made no public deals, but that could change if the current market correction turns into a rout. He has been looking unsuccessfully for many years for what he calls an “elephant”-sized acquisition that could total $50 billion or more. “Be fearful when others are greedy and greedy when others are fearful” is one of Buffett’s maxims.
“As a long-term Berkshire holder, this is the kind of environment that you hope for given all the cash,” says David Rolfe, the chief investment officer of Wedgewood Partners in St. Louis. “I love the risk-reward, embedded safety, and diversity of the earnings flows.”
Berkshire’s stock, however, hasn’t been unscathed during the current market downturn. The class A shares (BRK.A), which Tuesday fell 0.8%, or $2,500, to $294,500, are off 12% from their October high of nearly $336,000. The class A shares are down about 1% this year. The more liquid class B shares declined $1.54, to $196.52, on Tuesday. Buffett couldn’t be reached for comment for this article.
The stock has come under pressure because of the losses so far this quarter in Berkshire’s $200-billion-plus equity portfolio and the conglomerate’s ownership of a number of economically sensitive businesses. Berkshire owns the Burlington Northern railroad, Lubrizol, a chemicals maker, and assorted housing-related businesses, including Shaw Industries, a leading carpet and flooring company.
The stock trades for a reasonable 1.3 times its Sept. 30 book value of nearly $229,000.
Book, however, should take a hit in the current quarter given the losses in the company’s equity portfolio, which is heavy in Apple and bank stocks like Wells Fargo (WFC) and Bank of America (BAC). Barron’s calculates that the portfolio was down about $30 billion through Monday from the end of the third quarter.
In hindsight, Buffett and his two investment lieutenants, Todd Combs and Ted Weschler, were too aggressive in buying stocks in the third quarter, when the company added a net $24 billion of stocks with more than half of that coming in the banking sector, including a new $4 billion holding in JPMorgan Chase (JPM).
Book value could fall between $7,000 and $10,000 per share in the current quarter assuming no change in equity markets until year end, Barron’scalculates. Even with the likely drop in book value, Rolfe likes Berkshire. He values the B shares for at least $240 to $250 a share, or about 25% above the current price.
While Berkshire’s earnings do have economic sensitivity, the company owns large businesses like Geico, the No. 2 auto insurer behind State Farm, and Berkshire Hathaway Energy, one of the country’s largest electric utilities, whose profits are resilient. Berkshire’s operating profits ran at an after-tax rate of nearly $28 billion in the third quarter, giving Buffett plenty of fresh funds for potential investments.
Rolfe and others will focus on Berkshire’s share buyback activity in the fourth quarter as a gauge of Buffett’s enthusiasm for the stock. Berkshire bought back $928 million of stock in the third quarter, the first period of the company’s more flexible repurchase guidelines that allow Buffett and the vice chairman, Charlie Munger, to buy back stock when it trades below their conservative estimate of the company’s intrinsic value.
Given the very limited buyback history, it’s tough to guess, but investors would like to see a buyback of at least $1 billion during the quarter. Otherwise, Wall Street may question whether Buffett believes that Berkshire’s stock is cheap.
Another intriguing possibility is a Berkshire investment in General Electric. Berkshire held no GE stock on Sept. 30 and Buffett said earlier this year that he wasn’t interested in buying the stock. But that was when it traded around $14, against the current price of around $7,
Berkshire could invest if GE decides to issue equity to shore up its balance sheet. JP Morgan analyst Stephen Tusa raised the possibility of a $25 billion GE equity raise in his upgrade of the stock on Friday to Neutral from Underweight, or Sell. GE’s chief executive, Larry Culp, has said that the company has no need to issue equity. Berkshire, of course, could purchase GE stock in the open market.
In the past, Berkshire has bought attractively priced preferred stock with warrants that enabled the company to take a 7% holding in Bank of America.
Berkshire is a good sleep-at-night stock. Investors can take comfort that Buffett likely is actively monitoring the markets in Omaha and waiting for an opportunity to pounce.