If you have heard of Warren Buffett, you probably know about Berkshire Hathaway. Berkshire Hathaway just released its Q3 2020 results on 7th Nov. If you are curious to find out more about Berkshire Hathaway and wondering if you should be adding it into your portfolio after its latest results release, this article might be interesting to you.
Let's start with some basic history and facts of Berkshire Hathaway.
Berkshire Hathaway has an interesting history. It wasn't a multinational conglomerate holding company when it first started. In fact, it was a textile manufacturing company to begin with. And no, Warren Buffett wasn't the founder of Berkshire Hathaway in case you are thinking along this direction. The founder of Berkshire Hathaway is Oliver Chace. Warren Buffett was just a shareholder at the beginning. At one point of time, Warren Buffett nearly even sold all his shares. Due to some twist and turn (coupled with some emotions), Warren Buffett ends up being the major shareholder of the company (if you are interested, you could check out the history here) and that begins the transformation of Berkshire Hathaway into what it is today.
There are mainly two classes of shares for Berkshire Hathaway (Berkshire Hathaway Class A shares (BRK.A) and Berkshire Hathaway Class B shares (BRK.B)). At one glance, you could tell the big difference in price. BRK.A is now trading at a price around 330,600 USD a share while BRK.A is now trading at a price around 221.50 USD a share. As you could see, BRK.B is more tailored for the mass market investors while BRK.A is not. If you go a bit deeper, there are a few more key differences between these two classes of shares. For instance, BRK.A could not be split but BRK.B could be split. Also, BRK.B shareholders only have 1/10,000th of the voting rights of BRK.A shareholders for every share they hold. The most interesting part is that even though both classes of shares belong to the same company, they do not necessarily have the same performance in share price as these two classes of shares are traded by predominantly different groups of people.
For the purposes of this article, I would focus on BRK.B shares as this is the class of shares which most of us will probably be buying/trading.
Now, what are the companies which Berkshire Hathaway holds in its portfolio?
For an overview of these companies, please refer here. There is a long list of companies which Berkshire Hathaway holds (and yes, they have Amazon shares too). What you should be aware of though is that despite the long list of companies which Berkshire Hathaway holds, the 5 largest positions of Berkshire Hathaway actually accounts for 80% of the stock's price. These 5 largest positions are namely Apple, Bank of America, Coca-cola, America Express and Kraft Heinz. Out of these positions, Apple is the largest holding which accounts for nearly half of the stock's price. This is probably due to the fact that Apple share has had some very legendary returns over the past few years and that inevitably causes it to grow much faster in its proportion in the portfolio as compared to other companies. This also means that Berkshire Hathaway's stock performance is likely to have a huge correlation with Apple's stock. If you think about it, holding Berkshire Hathaway shares right now is not necessarily the same as holding an ETF like what many could have thought as its performance is very heavily affected by just 5 companies.
One of the most common questions people asked about Berkshire Hathaway is how does its performance stand against SPY (S&P 500).
Here is a backtest showing the performances of both BRK.B and SPY.
(source: Portfolio Visualizer)
If you were to invest $10,000 from 1st Jan 1997 into BRK.B, your $10,000 will now be worth $90,782. Comparatively, the same amount when invested into SPY for the same duration will give you $67,873. This is some significant difference as the CAGR for BRK.B for this period is 9.7% while SPY is 8.37%. When comparing other metrics such as the Max Drawdown and Sortino ratio, BRK.B is still the better out of the two with a lower Max Drawdown and a higher Sortino ratio. At one glance, it seems as though BRK.B is a better performer out of the two.
However, a different story unfolds if you focus on the recent years.
(source: Portfolio Visualizer)
When comparing returns between BRK.B and SPY over the recent years, you could see that the returns of BRK.B are inferior as compared to SPY in all time periods of recent history (10 year, 5 year, 3 year, 1 year, YTD). This shows that the outperformance of BRK.B against SPY has largely occurred before 2010. Since 2010, BRK.B has been trailing SPY in performance. This then leads to many current investors wondering if the heydays of BRK.B are long over.
Well, I have a personal take to it. If you look at the data closely, you would see that BRK.B usually trails SPY when it is bull market. Out of all the 24 years (from 1997 to now), there are 19 years where the market has a positive annual return and 5 years where the market has a negative annual return. Out of the 19 years where the market has a positive annual return, BRK.B has a worse performance than SPY 12 out of 19 years. However, BRK.B beats SPY for all the 5 years when the market has a negative annual return. And if you recall, we are in a bull market for the majority of the last decade- which fits in the trend where BRK.B does not perform as well as the market during the bull periods. It did perform very well in the bear periods as you could see.
I do think this outperformance during the bear periods is primarily due to the investing philosophy of Berkshire Hathaway. The selection of companies in their portfolio tends to be more defensive in nature and are able to weather through the economic downturns better than the other companies. If you have been reading up on Warren Buffett, you probably understand that he is a strong proponent of value investing- investing in stocks which appears to be trading less than their intrinsic value. This probably also limits any further downside these stocks might have during the bear periods and hence results in their outperformance against the broader market. Interestingly, the past decade has also been a poor period for value investors (which coincide with Berkshire Hathaway's dismal performance against the broader market). I wrote an article on value investing not too long ago and you might like to check it out here.
From the recent Q3 2020 results, you could see that Berkshire Hathaway has not stopped on its tracks to steadily increase their Free Cash Flow. In 2019, the company generated nearly $23 billion in Free Cash Flow. This growth in Free Cash Flow allows the company to continually repurchase their shares and hence generates shareholder value in the long term. If they continue with their current rate of using ~65% of their annual Free Cash Flow on stock purchases, it would still take them more than a decade before the cash pile runs out so shareholders could be assured of the company's ability to continually do share buybacks when needed. In Q3 2020 alone, the company spends $9B in share buybacks.
Generally, I do think that Berkshire Hathaway could be a good addition in your portfolio if you are looking to be more defensive in your portfolio allocation. Despite the less than ideal performance of value investing in the last decade, I do think that value investing still has its place and having Berkshire Hathaway in your portfolio could be a wise choice should value investing outperforms again in the next decade. The one concern I have though is the fact that the top 5 holdings of the company's portfolio accounts for 80% of the stock price. That seems to me a little too concentrated and could prompt me to choose SPY instead simply because it's more diversified.
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