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Since famed 95-year-old investor, Warren Buffett, announced in May that he’d pass his chief executive role at Berkshire Hathaway to long-time colleague, Greg Abel, next year, shares in the conglomerate have fallen nearly 10pc.
It may seem logical for the stock to lose its “Buffett premium”, yet Berkshire has gained in popularity with the world’s best fund managers since the announcement. The biggest fan among these elite managers is Larry Pitkowsky, who holds over 17pc of his top-performing GoodHaven Fund in Berkshire.
Quoting from his latest letter to GoodHaven shareholders, Pitkowsky said: “In another selfless act, amidst a lifetime of selfless behaviour, Mr Buffett, and subsequently the Berkshire board of directors, confirmed that Greg Abel will assume the chief executive role.
“Contrary to criticisms of Berkshire’s succession plans, this is one of the more well-telegraphed plans we’ve seen.”
The succession also addresses the age-related concerns expressed by this column in 2021 that underpinned sell advice.
Central to what Pitkowsky and other Berkshire backers are betting on is the legacy of Buffett, who will remain as chairman, and his business partner, Charlie Munger, who died in late 2023. There is good reason to believe Berkshire has the pair’s wisdom is baked in.
These investors are all among the top 3pc of managers globally out of over 10,000 monitored by financial publisher, Citywire. Berkshire is held by 15 of these individuals, and its growing popularity with them saw it this month enter Citywire’s Global Elite Companies index, which tracks the 76 very best stock ideas from about 6,000 held across top managers’ portfolios.
The $1.1 trillion (£810bn) company that Buffett and Munger built from a failing New England textile business is structured around the core principles of value creation.
The ability of any business to create value for its owners depends, at heart, on just two things: the profits made from investments, known by City types as “return on capital”, and the cost of raising money to make those investments, known as “cost of capital”.
While many investors obsess over the razzmatazz of companies’ returns, Berkshire’s biggest advantage arguably lies in Buffett and Munger’s shrewd focus on cost of capital when creating Berkshire’s structure and culture.
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Central to Berkshire’s cost advantage is its giant insurance operation, which accounts for just over half of profits. This business gives Berkshire access to what is known as a “float”, which represents premiums collected to cover future insurance claims.
Berkshire uses its float, worth $174bn at the last count, to invest in the businesses it owns along with an unusually large and concentrated equity portfolio compared with other insurers. Because its insurance operations are profitable, this source of capital has a negative cost.
Cost of capital also depends on the reliability of a company’s cashflows. For Berkshire, this is underpinned by the diversity of its activities, overcapitalisation of its insurance operations and the dependable nature of the businesses it owns and invests in. These low-risk attractions are reflected in an AA- Standard & Poor’s credit rating.
The company’s understanding of risk also recognises that having access to low-cost capital is far more valuable when money is scarce. Such points in the business cycle, when others have pulled in their horns, is when investments can be made at bargain prices.
This ethos is reflected in Berkshire’s strategy of keeping a lot of cash on hand. The $300bn-plus it is currently sitting on – about 27pc of assets – has become a point of contention for some. However, Abel feels it positions Berkshire to profit from burgeoning capital needs of certain industries, particularly energy.
Maximising the potential to generate strong returns on capital is also central to how Berkshire is structured. While operational management of the conglomerate’s more than 60 subsidiaries is highly decentralised, the opposite is true of decisions about how to spend the cash the subsidiaries generate.
The ability of Berkshire’s top management to get the best returns from investment is helped by a forever-owner mentality. The company also has a large spread of investment options: internal, acquisitions, listed equities and buying its own shares.
Managers of subsidiaries, meanwhile, are incentivised to focus on return on capital, which fosters a culture steeped in a quest to create shareholder value.
The recent setback for Berkshire shares reflects some mixed trading and high cash levels, as well as Buffett’s decision to step down. However, many of the world’s best managers have faith in Buffett and Munger’s legacy being a company that is structured to maximise value creation for its owners. This column agrees.
British buyers of Berkshire shares should check for extra dealing charges and complete paperwork to minimise withholding taxes.
Questor says: buy
Ticker: NYSE:BKR.B
Share price: $493.74
Algy Hall is editor of Citywire Elite Companies.
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