There are two elements to any successful investment – finding a great business, and then paying a reasonable price, based on an assessment of that business' future.
As far as quality businesses – and outstanding track records – go, they don't come much bigger or better than the company run by the world's fourth richest man, Warren Buffett.
Starting life as a textile mill in the US Midwest, Berkshire Hathaway (NYSE: BRK-A, NYSE: BRK-B) was taken over by Buffett decades ago, and while the textile business has long since ceased, the company has gone from strength to strength.
So much so, that since Buffett assumed control of the company in 1964, its book value has increased by 19.7% per year on average. That's impressive by itself, but the aggregate return is nothing short of mind-blowing. If you can compound your money at that rate for almost 50 years, the return is a whopping 586,000%. No, that's not a typo. By contrast, the US S&P 500 is up an average 9.4% per year, for a still impressive, but much lower, 7,433% total return.
Warren Buffett has been lionised by many over the past decade or two, as he climbed the rich lists. The Berkshire Hathaway AGMs have the attendance and aura of a rock concert, with estimates of between 35,000 and 40,000 shareholders converging on Omaha, Nebraska each year, and his every move is followed by investors who are looking for the next market-beating investment.
Looking to the future
The question for investors today is not whether Buffett and Berkshire have been extraordinarily successful in the past, but whether the company is likely to have a market-beating future. After all, Berkshire is now an enormous business, and Buffett, at 82, won't be running it forever.
Indeed, Buffett himself has explained that the company's size will be a drag on returns, and can't hope to match its record in future. Still, with the equity market's long run average return of between 9% and 11% per year (depending on the source and timeframe), a return even a handful of percentage points below Berkshire's historical average would be a stellar result.
At the current price, there are plenty of reasons to believe Berkshire Hathaway is one of the easiest investment decisions you can make.
While Berkshire's reputation has been built largely on the back of Buffett's unparalleled skill and acumen, the business isn't an Apple (Nasdaq: AAPL), where the visionary leader is intimately involved in the company's products and innovation. Far from it, in fact – Buffett is happy to buy a business, and let existing management get on with the job. As such, Berkshire is a conglomerate of great businesses, whose success depends little on the person at the top. Regardless of who is running Berkshire, those subsidiaries will go on growing sales, profits and – as a result – shareholder wealth.
A collection of wonderful businesses
Berkshire owns businesses that cover the waterfront – from insurance and re-insurance companies to railroads, energy generators and a candy manufacturer and retailer. This mix of good and great businesses continue to throw off excess cash, and those that need additional capital are earning strong returns on the extra money invested.
The company also owns something of a 'who's who' of American and global businesses in its listed share portfolio. It owns 13.7% of American Express (NYSE: AXP), 8.9% of Coca-Cola (NYSE: KO), 8.7% of US bank Wells Fargo (NYSE: WFC) and 5% of UK grocer Tesco (LSE: TSCO) as well as a large chunk of IT behemoth IBM (NYSE: IBM). These companies not only increase in value over time, but they also send a steadily growing stream of dividends back to Berkshire.
That growing stream of cash from both sources does give the company a nice problem – how to invest all of the money that is flowing back to headquarters. With one eye on his eventual retirement, Buffett has hired two investment managers, both of whom beat the market average "by double digit margins" last year. While the Oracle himself still controls the vast majority of the company's capital, these two managers are slowly being given larger mandates – each now controlling almost US$5 billion.
An attractive price
Berkshire is a strong business, with loads of cash on its balance sheet, a very large stable of successful and profitable subsidiaries, a listed portfolio of some of the world's best businesses and two proven investment managers – plus Buffett himself.
You'd expect to pay a significant premium for that combination, but the kicker is that Berkshire Hathaway is available for only slightly more than 1.2 times its book value. That's a reasonable valuation for an average business and an attractive one for a good business. In my book, that makes Berkshire – which is an outstanding business by any measure – available at a very attractive valuation indeed.
Buffett himself – in perhaps another nod to his eventual retirement – has instituted a share buy-back at or below 1.2 times book value, providing something of a 'backstop' to the share price. And it's worth noting that as Buffett only buys when he is given a 'margin of safety', he likely believes that's a price that somewhat undervalues the company.
Foolish takeaway
Berkshire Hathaway is rightly referred to as Buffett's masterpiece. It will exist and thrive long after he's left the company (which I don't expect will be soon) and in the meantime, shareholders get the benefit of his stewardship and master capital allocation.
Long term investors looking for a collection of strong, solid businesses with myriad competitive advantages and good growth prospects, a Fort Knox balance sheet and the epitome of shareholder friendly management – available at an attractive price – need look no further than Berkshire Hathaway.
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The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool Investment Analyst Scott Phillips owns shares in Berkshire Hathaway.
