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Berkshire Hathaway’s Valuation Premium High amid Stable Earnings

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Recent outperformance

As of September 2017, Berkshire Hathaway (BRK.B) stock has risen 1.5% in the past month and 25.7% in the past year. By comparison, the S&P 500 (SPX-INDEX) (SPY) has risen 2.2% in the past month and 15.3% in the past year. In 2Q17, Berkshire saw an 11.0% fall in operating profits to $4.1 billion, largely due to reinsurance losses and lower profitability in energy and services. Utilities fell further in 3Q17, which could further impact Berkshire’s energy earnings. The weakness was partially offset by a strong recovery in shipments for BNSF Railway and growth in the manufacturing space.

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Berkshire’s fund-raising is modeled on insurance premiums, whereas in deployment, it competes with asset managers such as BlackRock (BLK) and Blackstone Group (BX). Berkshire’s business model is a mix of conglomerate and active asset management. The model provides it the flexibility of retaining capital free from pressures of limited partners, which is prevalent in the private equity model.

Valuation premium widens

On a one-year forward PE (price-to-earnings) basis, Berkshire is trading at 22.5x, while its peers are trading at an average of 13.1x. The premium has widened further in 2016–2017 as Berkshire adds companies and generates strong cash flows from its existing subsidiaries. As of June 30, 2017, Berkshire Hathaway’s equity portfolio was valued at $162.0 billion compared to $163.0 billion in the previous quarter. In 3Q17 to date, its major holdings have had the following performances:

  • American Express (AXP): 4.7% rise
  • Coca-Cola (KO): 1.9% rise
  • International Business Machines (IBM): 5.2% fall
  • Kraft Heinz (KHC): 8.4% fall
  • Apple (AAPL): 4.5% rise
  • Wells Fargo (WFC): 2.5% fall

Warren Buffett’s strong track record and steadier deployment of a portfolio to new managers for future management could help the company garner continued valuations in the upcoming quarters. The company’s current levels don’t provide any major bargain on valuations, but some investors may add the stock at lower prices.

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