My Recommendation: Look To Berkshire Hathaway

Berkshire Hathaway is sitting on an overwhelming amount of cash. It overshadows just about every other company I study in terms of raw, untapped earnings power. As of last quarter, Warren Buffett had $62 billion in cash sitting on Berkshire’s balance sheet. The market capitalization of the stock is $360 billion, meaning 17.2% of your purchase price is sitting in cash alone. If you buy a share of Berkshire for $145, your look-through portion of cash is $24.94 per share. The only other companies in similar situations are tech giants like Microsoft and Apple where the long-term business model is subject to rapid changes in technology in a way that Berkshire Hathaway is not.

Absent a hurricane or natural disaster in the near-term that cause Berkshire’s insurance subsidiaries to make large payouts, Berkshire should generate $20 billion in cash per year based on the company’s current earnings power (it is more like $24 billion per year if you count the retained earnings of Wells Fargo, IBM, Coca-Cola, and American Express that are not paid out as dividends but nevertheless represent Berkshire’s claim on ownership.)

In other words, if Buffett does not make a big acquisition within the next two years, and if there is no large natural disaster, Berkshire Hathaway will be sitting upon $100 billion in cash that will be ready for Buffett to deploy quickly. A few years ago, Berkshire bought Heinz. Now, it’s annexing Kraft. Those weren’t one-off unusual acquisitions. In the shareholder letter from last year, Buffett mentioned that Berkshire owns 9.5 of the Fortune 500 and still had 490.5 to go. That was a joke with a lot of truth in it.

Because Berkshire does not pay a dividend, and because the company only repurchases its own stock at a valuation of 1.2x book value which rarely happens, the structure of Berkshire is set up so the company can make perpetual acquisitions. And even when Berkshire makes an acquisition, the cash flow is self-replenishing. If Berkshire made a big purchase right now, it would accumulate $20 billion in cash between now and next May to do something new. The infrastructure exists for significant growth in the years ahead.

Duracell, Van Tuyl Group, Restaurant Brands International. Those are just three examples of what Buffett has been able to do in the past two quarters. And the acquisitions will continue. There seems to be this running dialogue where people keep wondering, “When will the end come for Buffett?” that they have stopped appreciating what Berkshire Hathaway has been able to do while Buffett has been old and the company has been mobbed by attention. He and Munger have grown the company from a profit base of $8 billion annually in 2005 to $20 billion annually in 2015.

There are three options going forward. One is that Buffett continues to deploy the capital and make large acquisitions in the coming years to buy companies like Kellogg or Mondelez (both those companies seem like they have industry high costs that would be easy pickings for 3G while possessing the well-established industry brands that Buffett likes). The second option is that the cash on hand could be used to support a huge repurchase program at some point 10+ years from now. The cash on hand is so enormous that Berkshire could conceivably reduce its share count by 25% if you had a situation in 2025 where Buffett’s estate traded Buffett’s shares of Berkshire stock for cash on the balance sheet to go towards the Gates Foundation and be used for charitable purposes that way.

And the last option is the eventual dividend. My guess is that when Berkshire reliably generates between $40 billion and $50 billion per year in profits, Berkshire will begin some kind of dividend policy. We are probably seven years away from that happening. Earnings per share would be around $25 per share at that point, and the dividend payout would be something like $12 per share. Someone buying at today’s price would eventually collect a dividend yield around 8% for waiting a decade, and get to capture the capital gains along the way until then.

When the best capital allocator in the world is sitting on $62 billion in cash, good things will continue to happen for shareholders. I cannot predict precisely what they will be—it depends on Buffett’s longevity and the deals made available to him—but the earnings base of Berkshire is set to increase in the coming years. Plus, you get the growing dividends from Coca-Cola, Wells Fargo, IBM, American Express and operational growth from Burlington Northern Santa Fe, GEICO, and Lubrizol that continue to trickle in to headquarters. If you’re looking for a fair deal in today’s market, Berkshire is definitely on the list of intelligent long-term moves you can make.

Originally posted 2015-05-22 12:07:07.

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