Fiduciary Management: “We View Berkshire (BRK-B) as a Solid Grower”

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Fiduciary Management, an investment management firm, published its “All Cap Equity Fund” third quarter 2021 investor letter – a copy of which can be downloaded here. The FMI All Cap portfolios declined approximately 1.0% in the September quarter compared to a loss of 0.10% for the Russell 3000 Index and 0.93% for the Russell 3000 Value Index. You can take a look at the fund’s top 5 holdings to have an idea about their best picks for 2021.

Fiduciary Management, in its Q3 2021 investor letter, mentioned Berkshire Hathaway Inc. (NYSE: BRK-B) and discussed its stance on the firm. Berkshire Hathaway Inc. is an Omaha, Nebraska-based multinational conglomerate company with a $639.6 billion market capitalization. BRK-B delivered a 21.87% return since the beginning of the year, while its 12-month returns are up by 34.53%. The stock closed at $282.59 per share on October 18, 2021.

Here is what Fiduciary Management has to say about Berkshire Hathaway Inc. in its Q3 2021 investor letter:

"Berkshire Hathaway is a diversified holding company engaged in several business activities, including Insurance and Reinsurance, Freight Rail Transportation, Utilities and Energy, Manufacturing, Service and Retail, and Finance. Berkshire owns Burlington Northern Santa Fe (BNSF), one of the country’s largest railways and a vital business for transporting a range of products and commodities. Insurers such as GEICO, Berkshire Hathaway Primary Group, and Berkshire Hathaway Reinsurance Group are significant contributors to operating income and generators of “float” for reinvestment. Additionally, well-known manufacturers, wholesalers, and retailers owned by the company include: Precision Castparts Corp. (aerospace components), The Lubrizol Corp. (specialty and performance additives), Marmon Holdings, Inc. (diverse industrials), Clayton Homes (traditional and off-site built housing), Benjamin Moore & Co. (paints and coatings), Shaw Industries Group, Inc. (floor coverings), and McLane Co., Inc. (wholesale distribution), to name a few. The businesses are managed on a decentralized basis. Finally, as of 6/30/21 on Berkshire’s Annual Report, their equity portfolio included significant positions in publicly traded Apple Inc. ($124 billion), Bank of America Corp. ($43 billion), American Express Co. ($25 billion), The Coca-Cola Co. ($22 billion), The Kraft Heinz Co. ($13 billion), and others.

Good Business

• The largest contributors to Berkshire’s pre-tax earnings are: Insurance (26%), Manufacturing, Service and Retail (33%), and BNSF (22%). Insurance, Finance, and Utilities cumulatively account for 45% of after-tax income. Overall, the company has a portfolio of necessary businesses. • The collection of insurance businesses can be defined as market-leading, strongly profitable (95% combined ratio), financially sound, and characterized by recurring premium revenues. All are rated AA+ or higher. • The company’s businesses generally have a significant cost advantage over their competitors. • Berkshire’s float from its insurance units totals over $130 billion and is available for acquisitions. This figure has grown at greater than 17.5% per annum since 1970. • Its share of undistributed earnings from investees is approximately $12 billion, or $5 per Class B share.

Valuation

• The stock currently trades at 1.3 times book value, which is a slight discount to its 15-year average of 1.45 times, and the company’s intrinsic value is estimated to far exceed its historical carrying value. • The company’s share repurchase program limits potential downside, as it will repurchase shares at or below 1.2 times book value, or $250 per B share. • On a sum-of-the parts basis, we conservatively value the Berkshire operating businesses at approximately $210 per B share. The undistributed earnings of the company’s equity portfolio, along with potential returns on the insurance float, adds approximately $140 per B share in value. • Based on “look through” EPS, Berkshire trades at 16.3 times, which is a significant discount to the median of a typical S&P 500 company. At a median multiple, the B shares would trade over $400.

Management

• Warren Buffett (Chairman and CEO, age 91) and Charlie Munger (Vice Chairman, age 97) are the largest shareholders and have been at the helm for over 50 years. Buffett owns 38% of the company. • The quality of Berkshire’s management team is very strong, although Buffett’s succession concerns are warranted. Given his age, we believe the market has already discounted his passing. Should the company then be broken up, the sum of the parts vastly exceeds the current market value. • It appears that Greg Abel, a vice chairman of Berkshire and presider over the non-insurance businesses, will replace Buffett upon his death or retirement. • Todd Combs and Ted Weschler, who both joined in 2011, are very capable investment managers.

Investment Thesis

Berkshire Hathaway has assembled a collection of industry-leading companies that utilize the advantage of a large, permanent capital base to drive performance. There are some very appealing economically offensive aspects of the portfolio, while the large excess cash position provides defensiveness relative to an expensive market. We expect the game plan to continue, i.e., strong operations and value-added acquisitions that will increase the intrinsic value of the company at above-average rates going forward. We view Berkshire as solid grower (8-10% book value growth) that is attractive relative to the overall market."

Stock Market, Investment
Stock Market, Investment

Stock Market, Investment

Based on our calculations, Berkshire Hathaway Inc. (NYSE: BRK-B) ranks 12th in our list of the 30 Most Popular Stocks Among Hedge Funds. BRK-B was in 116 hedge fund portfolios at the end of the first half of 2021, compared to 111 funds in the previous quarter. Berkshire Hathaway Inc. (NYSE: BRK-B) delivered a 2.06% return in the past 3 months.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

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