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Berkshire Hathaway: The Perfect Storm -Seeking Alpha ArticleBerkshire Hathaway: The Perfect StormSummary
Thesis SummaryBerkshire Hathaway, Inc. (NYSE:BRK.A) (NYSE:BRK.B) has fallen out of favor in the last few months. Mistakes have been made and there is still uncertainty about what the company will do with its portfolio in the future. As a value investor, I believe this is the perfect time to start/increase your position. Not only because of Buffett's track record but also because Berkshire's portfolio and the insurance business will likely benefit from future macroeconomic trends; inflation and higher rates. On top of that, investments in solar energy will provide the icing on the cake. Source: Facebook Losing FaithOver the past few months, people who once worshiped Buffett have begun to question his investment prowess. Berkshire Hathaway has not had a great quarter and, in hindsight, could have made some better decisions regarding its investments. Most notably, the fund sold its positions in airlines very near the current bottom. While the company currently holds a substantial cash position, it has not deployed any of it at the moment. Did Buffett miss the opportunity to invest at the March lows? Has the investment prophet lost his Midas touch? Source: 10-Q Above we can see just how bad the "damage" has been this last quarter. The company recorded a loss of just under $50 billion largely attributable to the fact that $70 billion had to be written off due to investment losses. To make matters worse, Berkshire Hathaway faces significant potential losses from insurance claims due to COVID-19. It is still hard to quantify how much these claims will come up to and even if the company will be made to pay out. As per the company's last quarterly statement, it has increased its losses and adjustment expenses by $346 million, which is 19.5% over 2019. The truth of the matter is Berkshire Hathaway has underperformed the market in recent years, which can be attributed to a couple of reasons. Low interest rates and an emphasis on value as opposed to growth. However, looking at the nature of Berkshire's business and the current economic outlook, the company could hugely benefit if the right macroeconomic circumstances come into play Betting on a "recovery": Inflation and interest ratesWarren Buffett is known best for being a value investor, and Berkshire Hathaway is best known for being an investment and insurance firm. In the last decade, this investment style (value) and its main business (insurance) have simply not been as profitable as they had in the past. For the better part of the last 40 years, interests and inflation have been falling. But could this be an inflection point? After the unprecedented monetary stimulus and historically low interest rates, I suspect we could see a reversal in the form of a "recovery" which would bring about higher inflation and interest rates. The inflation vs. deflation debate has been raging on for the last few months. There is no real consensus among experts but I will give my two cents. Source: St Louis Fed The above chart shows the M2 money supply over the last 18 years. As we can see, the latest actions by the Fed have produced an unprecedented spike. The reason I focus on M2 is that this is a broader definition of money which includes "assets held principally by households". In a sense, we could say that this best reflects the money in the "real economy". The argument in the past has been that despite the increase in M1, all this money was sitting as bank reserves, therefore not filtering through to the real economy and not causing inflation. But this seems to have changed since 2018, and as we can see, the growth in M2 has been speeding up. The latest measures show, once energy is discounted, that inflation is already on the rise. And then there's the question of interest rates. This one is harder to address, as it will depend on the whims of the Fed, but with rates already near 0, there is reason to believe that the Fed will not want to push into negative territory. Firstly, this would hurt banks. In Europe, the negative interest rate experiment has been quite detrimental as banks have had to cope with much lower margins. Secondly, with the Fed now apparently going out and buying ETFs, there are other avenues that it can pursue instead of lowering interest rates. I believe it is more likely we will see fiscal policies put into place rather than monetary ones. In short, I expect a U-shaped recovery that will come along with higher rates and inflation. But why does this matter to Berkshire? Firstly, as an insurance company, Berkshire would greatly increase its returns in a high-interest rate environment. Insurance companies make good money by investing their float in "safe" bonds such as Treasuries. In the past, Berkshire could have easily achieved a 3-4% extra return by investing its float in Treasuries, something which it can't do now, unfortunately. When rates rise, this will be a great tailwind for Berkshire and the insurance companies as a whole. On top of that, given that Buffett's investment style is value-focused, we could expect Berkshire's portfolio to outperform during an inflationary period. Source: Whalewisdom Above we can see some of Berkshire's top holdings. Firstly, notice that Berkshire holds significant positions in the finance sector, which would benefit from increased interest rates. Furthermore, Berkshire has significant exposure in the consumer discretionary sector, which could also be said to be "inflation" proof. As a whole, value investments benefit from higher rates and outperform growth stocks in periods of high inflation. This is because value companies have cash flows today, while a growth stock's value resides in having higher future cash flows. When using the interest rates to discount, the higher rate affects the value of growth stocks more than the value of value stocks. In short, Berkshire's portfolio seems to be very well suited to what comes next. As I already covered in my Bank of America Corp. (NYSE:BAC) article, I feel financials are undervalued and we could see them outperform the broader market. On top of that, Berkshire has a litany of other value and inflation-proof stocks such as Coca-Cola Company (NYSE:KO). Last but not least, Berkshire's energy investments should also perform well in an inflationary environment. Not as boring as you thinkThe other reason people have begun to doubt Buffett and can also explain Berkshire Hathaway's lower returns is the fact that the company has traditionally not invested in the technology sector. However, this has changed with Berkshire now holding positions in Apple (NASDAQ:AAPL) and Amazon.com Inc. (NASDAQ:AMZN). I wouldn't be surprised if it adds some more tech in the coming months to its portfolio. But for those that think Berkshire is "boring," I would answer with one word - Solar. Berkshire Hathaway has been a player in the solar industry for some time, granted with some mixed success. However, last week the government finally approved Berkshire's solar project in Nevada. When finished, the $1 billion Gemini Solar Project is expected to be the 8th largest solar power facility in the world. Through NV Energy, a subsidiary of Berkshire Hathaway, Buffett is making a huge play into solar energy which I believe will certainly pay off. As I already covered briefly in my Tesla (NASDAQ:TSLA) article, I expect solar energy to be the main energy source of the world in the next 20 years. Once the battery technology is there to efficiently store this energy, the sun will power our economies at 0 marginal cost. It is not only a smart idea for the environment, but also from a financial standpoint. This kind of vision and strategic investment is what has provided Buffett with such great returns in the past, and I expect the same in the future. TakeawayBerkshire has undeniably been a great investment since its inception and will continue to be. The knowledge and experience achieved through decades of market investment don't disappear overnight. Warren Buffett says; "Be greedy when others are fearful". In this case, I would add: Be certain when others are doubtful. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BRK.B over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. 65 Likes |
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