Morningstar - Summer 2019 - 77

Solid and Consistent
Berkshire Hathaway should continue to increase book value
at a healthy pace.
BEST IDEAS: EQUITY

Greggory Warren

Berkshire Hathaway BRK.A

This article is adapted from a Morningstar equity research report dated
Feb. 23, 2019.

Stats 03/31/2019

Wide-moat Berkshire Hathaway BRK.A had fourth-quarter and full-year
operating results more or less in line with our expectations, and we are leaving
our $360,000 ($240) per Class A (B) share fair value estimate in place.
Full-year operating revenue increased 3.3% to $247.8 billion. Including the
impact of investment and derivative gains/losses, Berkshire's top line
decreased 6.9% to $225.4 billion. With expenses increasing at a slower rate
than revenue and a marked improvement in insurance underwriting profitability,
full-year pretax operating earnings (excluding the impact of investment and
derivative gains/losses and other events) increased 36.4% year over year to
$29.2 billion. Including investment and derivative gains/losses and other
adjustments, full-year net earnings (aided by a reduction in the U.S. corporate
income tax rate) declined 91.1% to $4 billion.
Book value per Class A equivalent share, a good proxy for measuring changes
in Berkshire's intrinsic value, increased just 0.4% year over year to
$212,503, affected by a $3.0 billion noncash loss arising from an impairment
of Berkshire's equity interest in Kraft Heinz KHC and a $20.6 billion loss
associated with changes in unrealized capital gains on the insurer's investment
holdings. The company closed out 2018 with $111.9 billion in cash and cash
equivalents, up from $103.6 billion at the end of the third quarter. While the
company engaged in very little acquisition activity last year, Berkshire
dedicated $43 billion (funded by $19 billion of equity sales) to marketable
equities and spent another $1.3 billion on share repurchases.
We think two big concerns have kept some investors on the sidelines: that
Berkshire Hathaway's size will prevent it from continuing to grow at a decent
clip and that shares will get pummeled once Warren Buffett no longer
runs the show. We do not expect Berkshire to consistently increase its book
value per share at a double-digit rate annually-a feat it achieved six
times from 2009 to 2018-but we do think it is capable of increasing book
value per share at a high-single- to low-double-digit rate. This should
leave returns solidly and consistently above Berkshire's cost of capital, which
is what we expect from companies with wide economic moats.
As for succession planning, Buffett's three main roles-chairman, CEO,
and investment manager-are expected to be split. Our long-standing view

Morningstar Rating
QQQQ

Sector
p Industrials

Industry
Conglomerates

Price
$301,215.00

Fair Value Estimate
$360,000.00

Uncertainty
Medium

Economic Moat
Wide

Stewardship Rating
Exemplary

Market Cap
$504.5 Billion

Price/Fair Value 03/31/2019

$400K
Fair Value Estimate Per Share

360
301

300

Month-End Closing Price

200
04/2016

04/2017

04/2018

has been that Buffett's son, Howard Buffett, will serve as nonexecutive
chairman and that Ted Weschler and Todd Combs will serve as co-investment
managers of Berkshire's investment portfolio. As for the CEO role, we
think there are two fine candidates in Ajit Jain and Greg Abel. Our preference
would be to have Jain take control of all of Berkshire's insurance operations,
while Abel (who has experience with both operations and acquisitions)
fills the role of chief executive.
With investment opportunities few and far between these days, the company
does face another near- to medium-term issue: bulging cash balances
that, absent any sizable deals, will need to be returned to shareholders. While
Buffett has been clear about share repurchases being his preferred option
for reducing excess cash balances, we expect him to be as cost-conscious as
he has been with other investments. As long as the company's shares
trade closer to the firm's five-year average multiple of 1.45 times book value per
share, we think share repurchases are unlikely. K
Greggory Warren is a sector strategist with Morningstar Research Services.

global.morningstar.com/Morningstarmagazine

77
http://global.morningstar.com/Morningstarmagazine
Morningstar - Summer 2019

Table of Contents for the Digital Edition of Morningstar - Summer 2019
