(Berkshire Hathaway, Warren Buffett 2011 stock outlook story, updated for CEO succession planning commentary)
NEW YORK ( TheStreet) -- Warren Buffett is rightly famed for creating investor value, but as far as Berkshire Hathaway ( BRK.B) shares are concerned, it's harder to see what will trigger a sustained 2011 rally.
The much-discussed topic of what happens, "After Warren Buffett" can be looked at from two perspectives. First, investors expect a pullback in Berkshire Hathaway shares with any succession event. However, many investors also believe the pullback will just be a good opportunity to enter Berkshire Hathaway at a better price.
The big movers in the Berkshire portfolio are the vast insurance operations -- the largest chunk of Berkshire's value -- and Burlington Northern and energy investments led by MidAmerican Energy. For example, Morningstar assigns $55 of its $90 Berkshire Hathaway value to insurance and $19 to the railroad, utilities and energy operations. That's $74 locked up between two business segments of Berkshire Hathaway that have a fairly predictable profile, even if insurance and transportation remain beholden to sector cyclicality. Morningstar expects the revenue growth potential of both insurance and the railroad and energy businesses to be limited to 5% growth per year. These modest assumptions leave Berkshire's consumer-related businesses, which Buffett defines as Berkshire Hathaway's manufacturing, service and retail segment -- and which is assigned a value of $12 in the $90 Berkshire Hathaway price -- as the primary wildcard in Berkshire Hathaway performance. "Any sort of big positive or negative surprise will come from the manufacturing or finance units of Berkshire Hathaway. These are the less predictable parts of the business, but also the smaller parts," notes Morningstar's Warren. Berkshire's noninsurance operating subsidiaries were a source of strength in the most recently reported third quarter, with the manufacturing, service and retailing segment a large driver of internal profit improvement, but it's not clear to what extent those profit improvements were similar to improvements across corporate America, driven by cost reductions, layoffs, and achieving more productivity with less. Therein lays the rub for Berkshire Hathaway as a stock to bet on in 2011. Any type of big surprise to the positive or negative from the actual operating businesses -- and not from a mega acquisition or succession event -- will come from a Berkshire Hathaway business segment that only represents $12 worth of its full value of $90.
So it's no surprise that again in 2011 the primary mover for Berkshire Hathaway performance will be the insurance, railroad and energy segments, and revenue growth coming from each sector (this of course excludes the large swings in quarter-to-quarter Berkshire Hathaway performance based on value of derivatives contracts). Yet it's the Berkshire Hathaway manufacturing, service and retail top line that needs to keep improving. As with the U.S. corporate sector as a whole -- which reached record profit levels in the past quarter -- Berkshire Hathaway has had enough layoffs and cost-cutting measures across its various businesses to see some top-line improvement, but there are still lots of gray areas within the manufacturing, service and retail portfolio. "The real top line improvement in many of these businesses could happen next year or three years from now," the Morningstar analyst said, following up on his comments about the housing sector specifically. There have been improvements across the board in the U.S. economic outlook, and the main economic indicators have looked much more positive of late. Berkshire Hathaway is as close to a proxy for the U.S. economy as any single company can be. Berkshire Hathaway shares gained roughly 21% in 2010. The S&P 500, meanwhile, gained near 13%. Another win for Buffett versus the indexes, but a win that's getting harder to achieve year-in, year-out, and especially without a one-time event like the S&P 500 market inclusion to buoy shares. A new analysis of Berkshire Hathaway from Barclays Capital analyst Jay Gelb predicts some hefty gains from Buffett's stock holdings in Wells Fargo ( WFC) and Coca-Cola ( KO), which rallied in the last quarter of 2010 and could have created a gain of $6.3 billion in the value of Buffett's public stock portfolio.
Eric Rosenbaum. >To follow the writer on Twitter, go to Eric Rosenbaum. >To submit a news tip, send an email to: email@example.com.