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Why Warren Buffett Should Buy Berkshire Hathaway

Created by: iChange 2017.11.25 16:28
Warren Buffett is a laggard. Buffett seems to be an investor who is unlikely to overreact to such underperformance, and actually if one looks at the monthly data (I use Morningstar as my source for relative performance data), Berkshire was beating the S&P for all those periods as of the end of October. Berkshire doesn't own much tech, and this market loves tech.

Berkshire's only tech exposure is through the newly acquired stake in Apple (AAPL) , which joined Berkshire's top five holdings in the first quarter, essentially replacing once-and-future laggard IBM (IBM) . Holding onto IBM was Buffett's worst decision in years, but in a diversified portfolio there will usually be a dog or two. The real issue with Berkshire is its portfolio of majority-owned companies, not its minority stakes in other publicly held entities. The insurance business is volatile (and, sadly, this was a summer of catastrophes), as I have written many times in Real Money and elsewhere, but the rest of Berkshire's portfolio of owned companies is composed of domestically focused, old-technology companies. To use portfolio managers' current favorite term, the titans of Berkshire -- food distributor McLane, Kraft Heinz, Burlington Northern Santa Fe, Precision Castparts -- are not disrupting anything. 

Yet, despite that lack of innovation, Berkshire's B shares are trading at 22.8x the consensus estimate of $8 per share for 2018 EPS. That's a significant premium to the S&P 500, which -- even after hitting a new all-time high today -- is still trading at "only" 17.8x FactSet consensus for 2018 EPS for the index. That doesn't tell the whole story, though. The S&P 500's valuation is being restrained by the representation from groups such as retail and energy that have been out of favor for much of 2017. Data from Birinyi Associates -- my first employer on Wall Street -- shows the Nasdaq 100 trading at about 26.5x forward earnings as of today. 

Berkshire's "Buffett Premium" may be illusory, and I don't see any way the Oracle can catch up with this raging Nasdaq. Substituting a handset company (Apple) for a cloud services company (IBM) is not the transformative move that would be needed to move the needle on BRK's valuation. Also, paying a ridiculous multiple to take over a publicly traded tech company for Berkshire would likely be dilutive to BRK's current 22.8x EPS multiple. A dilutive acquisition would not solve Berkshire's relevance issues in a market where portfolio managers are willing to overlook near-term cash drain for long-term dreams of sustainability -- in the case of Tesla (TSLA) , for instance. 

So what's the solution? What should Warren buy next? Well, I would love to see him put his money where his mouth is and buy his favorite company ... Berkshire Hathaway. Berkshire has not bought back stock in any meaningful amount since 2012, and Buffett has stated numerous times in the past five years that Berkshire will implement a share repurchase only in instances where BRK is trading at less than 1.2x book value. According to Zacks, Berkshire is trading at 1.45x book value today, so it would take a paradigm shift for Buffett to buy his own stock. 

But why wouldn't he? Buffett has lauded the anti-dilutive effects of share repurchases at Berkshire's portfolio holdings, and since Berkshire is unlikely to ever pay a dividend (despite collecting tens of billions in dividends annually from its public portfolio), a buyback would allow shareholders to realize a real return from Berkshire's cash hoard. That cash pile stood at $104 as of Sept. 30, and while some of that cash is needed to backstop GEICO and the reinsurance operations, the vast majority of it is just sitting there, hampering Berkshire's return on equity. 

If Buffett were to go on CNBC and say, "We don't see anything in the public markets more attractive than our own stock," I believe BRK shares would go bananas and make the recent lag in performance a distant memory. As another group of Omahans (the band 311) once said, "You've got to bet on yourself, now start, 'cause that's your best bet!"