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Berkshire Hathaway Continues to Trade at a Premium on Lower Risk

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Equity investment

Berkshire Hathaway (BRK-B) reported record 3Q15 earnings on a one-time gain of $4.4 billion from the Heinz (HNZ) transaction and improvement in railroad earnings. The company saw lower underwriting income and subdued manufacturing earnings. The stock fell by 5% over the past year, however, it outperformed the S&P 500 Index (SPY) in every five-year period.

The company’s operations can be classified as a combination of active asset management and conglomerate management. Because it doesn’t raise capital directly from the markets, or launch funds or any financial products under its parent company structure, the only way to participate in Warren Buffett’s investments is by purchasing Berkshire Hathaway equity.

Berkshire Hathaway competes with asset managers, such as Blackstone (BX) and BlackRock (BLK), on buying quality assets.

The company’s long track record of outperformance, combined with a highly risk-averse approach towards investments, has enabled it to command a premium over its peers and the overall market.

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Premium valuations

On a one-year forward-price-to-earnings basis, Berkshire Hathaway is trading at 17.2x. In comparison, its peers are trading at 13.6x. Berkshire Hathaway has commanded a premium over the years because of its ability to redeploy excess capital from its subsidiaries toward better opportunities, including better-performing subsidiaries and successful minority investment bets made by Warren Buffett.

In 3Q15, Berkshire Hathaway’s equity portfolio was valued at $110.3 billion as compared to $117.7 billion in the previous quarter. The fall in global equities resulted in lower valuations for stocks as well as derivatives. The company posted a $764 million pretax loss in derivatives, compared with a profit of $258 million in 3Q14. Berkshire Hathaway spent $4.1 billion on equities and $2.4 billion on fixed-maturity securities in 3Q15. It sold $3.6 billion in stock and $169 million of bonds during the period.

The company could continue to trade at around 17x to 19x of its one-year forward earnings. But this will depend on how long Berkshire Hathaway can outperform the S&P 500 Index. As the company has grown, the spreads against the index are diminishing, and this could result in slower growth in the future.

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