Berkshire Hathaway—the Epitome of Value Investing - Cabot Wealth Network

Berkshire Hathaway—the Epitome of Value Investing

Applying Warren Buffett’s Value Measures

In a recent Daily Alert for our Wall Street’s Best Investments, I featured a recommendation for Berkshire Hathaway B (BRK-B), courtesy of our contributor Russ Kaplan, editor of The Heartland Adviser.

Russ had this to say about the company and its famous leader, Warren Buffett:

“In the running for the bluest of the blue chips is Berkshire Hathaway B (BRK-B). One of the value measures Mr. Buffett likes to use when evaluating a firm for purchase is book value. In accounting, book value is a conservative measure of what a company would be worth if all the assets were sold off. The price of Berkshire B is slightly above 1.2 times book value right now. In the past, Warren Buffet has stated he would repurchase his own stock at about 1.2 times book value.

“What will happen to Berkshire once Warren Buffet is no longer with us? This is a common question, as Warren Buffett is 85 years old. Berkshire Hathaway is composed of numerous companies, each under their own management. These should continue to be well run, even without their leader.”

Russ recommended the B shares of Berkshire, as the A shares—trading at $199,000 per share as of close yesterday—are out of the reach of most of us, whereas the B shares closed at $132.68.

I have to admit to being biased towards Berkshire Hathaway and Mr. Buffett—for several reasons. But his reputation as a value investor—buying companies whose intrinsic values are more than what he pays for them—is my primary motive.

When I first began my career in investing, I read every book I could find about Buffett and value investing. And while I love growth and momentum stocks, the secret to Buffett—and my own successes—is undeniably value investing.

I’ve been using this value/growth investing model for more than 20 years, and it has rewarded me with average annual gains of 29%. Most of my criteria are simple to employ, and include these fundamental characteristics:

• Reasonable debt so that the company is not overextended during challenging economic cycles. In the case of Berkshire, the company’s debt-to-equity ratio stands at about 34, reasonable by today’s standards.

• Good cash flow from the primary operations of the company, with deep cash pockets ready to be employed for expansion and acquisitions. Berkshire’s net cash flows from operating activities have continued to increase, coming in at $32,010 million, $27,704 million and $20,950 million in 2014, 2013 and 2012, respectively.

• Low price/earnings ratios, compared to its peers and its historical valuation, so that you are buying the shares at a discount. Berkshire’s average five-year P/E is 14.9, less than the P/E of the S&P 500.

• Double-digit growth in sales and earnings, which tend to lead to higher stock prices. Berkshire’s five-year growth rates average 11.59% for sales and 18.42% for earnings.

Normally, I would compare a company’s ratios with its peers, but since this company is composed of 60 wholly owned subsidiaries and owns significant shares in 30 more businesses in just about every industry (bricks, diamonds, shoes, candy, automobile, media, insurance, manufactured homes, furniture, financial, food, energy, retail, etc.), a comparison to the S&P 500 makes more sense. And in that case, Berkshire stands heads above the rest in nearly every evaluation.

What You See is What You Get

With Buffett, what you see is what you get. I was fortunate to be able to attend one of Berkshire Hathaway’s annual meetings in Omaha, Nebraska a few years ago. Buffett and Charlie Munger, his second-in-command, spoke for almost six hours from the stage of the convention hall, answering question after question from the more than 30,000 shareholders in attendance. It was amazing to see how his folksy manner inspired almost a cult following from his shareholders. And when he walked through the convention hall, meeting and greeting, and even playing his ukulele, you would have thought a rock star was passing through.

His common-sense style of investing comes through in the company’s no-frills website (http://www.berkshirehathaway.com/), as well as his direct, no-nonsense annual letters to stockholders (http://www.berkshirehathaway.com/letters/2014ltr.pdf).

I’ve read hundreds of annual reports in my career, and Buffett’s “tell it like it is” style is a breath of fresh air, compared to some of the slick, obfuscated treatises that pass my desk. The company makes it easy to see exactly what it is investing in, and then tells you just how well—or poorly—those investments are doing.

The Proof is in the Gains

If you had purchased one share in Berkshire Hathaway on March 17, 1980—as of yesterday’s market close, that holding would be worth $199,000. Need I say more?

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