
Evaluating Warren Buffett's Berkshire Hathaway -- Should You Buy?
Warren Buffett's Berkshire Hathaway (BRK.A) - Get Report (BRK.B) - Get Report has racked up a less than stellar 2015 so far, but the year isn't over yet.
If we glance at total returns, we notice a 11% loss for Berkshire year-to-date, significantly under-performing the insurance-diversified sector as well as the S&P 500 total returns index. That said, third-quarter numbers have more meat on their bones, and resurgence for Berkshire could be right around the corner.
Warren Buffett uses a method of investing that made him one of the most followed stick pickers on the planet. Here is a look at many aspects of Berkshire's year-to-date performance and decipher what lies ahead for the stock and what it could mean for your portfolio.
The Benefits of Size
With its market capitalization at $331 billion and its enterprise value topping $350 billion, Berkshire Hathaway isn't a single, comprehensive entity -- instead it's a massive conglomeration of a significant number of businesses.
Buffett's creation is a holding company, owning subsidiaries engaged in a number of business activities, including property and casualty insurance and reinsurance, utilities and energy, finance, manufacturing, services and retailing. Berkshire Hathaway's fortunes are dependent on a plethora of factors and sub-factors, intersecting and impacting each other.
So, how did this one-stock portfolio perform in terms of earnings? Quarterly earnings-per-share (EPS) lagged estimates in two out of the last four periods -- for the third quarter, EPS just about got home, barely hitting estimates. For the fourth quarter, EPS is estimated at $1.75 cents compared to $1.61 a year ago. Now all of this adds up to a feeble 4.5% growth for 2015 (assuming the fourth quarter doesn't disappoint -- or impress).
In the third quarter, net income grew to $9.4 billion, driven by a massive gain on investments. Operating profit from Berkshire's portfolio of companies fell about 4% to $4.55 billion, down from 2014's $4.7 billion.
The writing on the wall for Berkshire is pretty clear: If you own Berkshire or want a part of it, earnings volatility is a reality you need to accept and live with, given the sheer nature of the company's portfolio approach. Insurance firms within the larger Berkshire fold have reported mixed earnings for third quarter. Its railroad business saw almost no growth in volumes, while the utility business found itself on a stable plateau.
(The recent acquisition of Van Tuyl Group, the largest privately held car dealership group in the U.S., won't hugely affect the fate of Berkshire.)
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Putting Expectations Into Context
With an estimated 16.5% growth in EPS for 2016, Berkshire would be performing in line with industry expectations. This, however, is largely a repeat of its performance this year and represents growth that's average at best.
To be fair, Berkshire doesn't have direct competitors because of its portfolio business; different divisions face different challenges -- Allstate Corp. and ING GroepNV will remain competitors for the insurance division, while KKR & Co. is the closest rival for its investment business.
A company like Berkshire is best valued going by book value. For the last 35 years, Berkshire's stock has been trading at between one-to-two times its book value. At its current price, it trades at 1.34 times its most recent quarter book value of $149,697.16 per share. This is higher than like-sized peers including Allianz (1.2 times), American International Group (0.8 times), and Aviva plc (0.9 times).
Unless Berkshire's book is worth more than what it tells us, or its growth is faster than its peers, a premium valuation is simply unjustifiable. On a forward earnings basis, Berkshire is trading at 14.3 times, which is also on the higher side compared to peers. On a five-year expected price to earnings growth estimate, it trades at 2 times. For the next five years, EPS growth is slated to hover around a good 9.7% -- hardly a huge deal when compared to the 9.31% estimate for the industry and 12.16% for the sector.
Moreover, Berkshire adheres to a "no-dividend" policy, because chairman and CEO Warren Buffett believes apportioning the company's earnings in new ways is more promising than yield-creation.
This year, Berkshire Hathaway is still a work in progress. It's probably poised to end the year on a strong note, but wait for earnings to recover at a better pace, before you grab a bite of the stock.
But remember, Warren Buffett's methodology made him a billionaire. With a personal net worth of roughly $63 billion, the Oracle of Omaha has much to teach us about investing. To learn more about the methodology and the specific stocks that continue to make him rich, click here.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.









