Stocks

Berkshire Hathaway an Enduring Investment

Berkshire Hathaway an Enduring Investment

  • The economy is about to go into a recession and cash is king 
  • Berkshire Hathaway is well positioned with the companies it owns to power through a recession 
  • Warren Buffett has a 100 Billion to buy equities when the recession hits and its primary business will continue to perform even in an economic contraction.

Introduction: 

The Federal Reserve has been tightening monetary policies and raising interest rates.  In addition to the Fed’s tightening policies, the 3-year and 5-year yield curves have inverted.  These changes come at a time when global economic growth has been slowing and after the longest economic expansion in history.  It is clear we are within two to three years of a major economic recession. As legendary hedge fund manager Ray Dalio said, “we are in the 7th inning of the current economic cycle.” Thus, with the looming recession, investors must look for securities that perform well in times of economic contractions. Berkshire Hathway is well positioned to not only survive but perform exceedingly well in the upcoming recession. 

 

Breakdown of Berkshire Hathway: 

There are two main components of Berkshire Hathaway.  The first is the investment side of Berkshire.  I define this side as the minority holdings in publicly traded companies and the income created from investing with the insurance float.  The second component of Berkshire is the fully owned subsidiaries.  I term this side of Berkshire “Physical Berkshire”.  Each component offers a path for Berkshire to succeed in the upcoming recession.  

Physical Berkshire: 

This component comprising of the wholly-owned subsidiaries is imperative to the success of the company and accounts for slightly more than 10 billion dollars about half of Berkshire’s net earnings (Earning not including Tax Cut).   

Net earnings                                                                                                 2017     2016      2015 

Insurance – underwriting …………………………………………………$(2,219) $ 1,370 $ 1,162 

Railroad …………………………………………………………………………………3,959     3,569    4,248  

Utilities and energy …………………………………………………………… 2,083      2,287   2,132  

Manufacturing, service and retailing ………………………………6,208      5,631   4,683 

Physical Berkshire, during times of high interest rates, benefits greatly from the cash it can borrow cheaply from the investment side.  This free flow of capital is great for capital-intensive activities like railroad and manufacturing.  As the Fed continues to increase interest rates, Berkshire will be more successful than the broader market.  While this company will be more competitive relative to its peers, it too will suffer during an economic contraction.  

The manufacturing, service and retailing portion of Berkshire Hathway will suffer significantly during a recession.  This portion of Berkshire accounts for about half of Physical Berkshires’ net income.  While the recession will hurt Berkshire in this area it will be more than made up for by its investment arm.  Physical Berkshire also includes its insurance underwriting segment.  The underwriting segment will begin to incur increasing losses due to climate change.  As major catastrophes begin to become more common the underwriting portion of Berkshire will see material adverse changes.  We have already begun to see this with the loss incurred from Hurricane Harvey in 2017.  However, the fully damaging effects of climate change will not need to be considered within the next decade.  Thus, in the near future, we can expect the net income from the underwriting segment to be positive. 

Each portion of Physical Berkshire save manufacturing, service, and retail are recession proof.  Insurance, energy, and railroad are all necessities in the face of an economic slowdown.  These industries will continue to produce large returns even in a recession something many other companies will struggle with.  This makes Berkshire Hathway a sound long-term investment especially with a recession on the way.  

Investment Berkshire: 

The investment portion of Berkshire contains Insurance – investment income, Finance, and Financial products, as well as investments.  These investments account for a significant portion of Berkshire Hathaway’s net earnings. 

 

Net earnings                                                                                         2017     2016     2015 

Insurance – investment income ………………………………………………..$ 3,917   $3,636   $3,725 

Finance and financial products …………………………………………………..1,335    1,427    1,378 

Investment and derivative gains/losses ……………………………………1,377    6,497    6,725 

Right now, Warren Buffets portfolio is split between equities and cash.  Cash currently accounts for 34% of Berkshire Hathaway’s portfolio. 

 

 

 

Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 

 Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 

Conclusion: 

Berkshire’s cheap capital allows for Berkshire to perform well even with increasing restrictions on credit.  Berkshire Hathway is also poised to utilize its capital to make strategic acquisitions to further its competitive edge in its physical segment.  These factors make Berkshire Hathway a solid long-term investment even in the face of an economic recession. 

 

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