Kristopher Rosemann
December 06, 2016
Associate Investment Analyst at Valuentum Securities Inc.

Berkshire Hathaway Always Seems To Deliver

We added a 5% position in Warren Buffett's Berkshire Hathaway (BRK.B) in the Best Ideas Newsletter portfolio in April of this year at ~$146 per share with the idea of gaining exposure to high quality businesses in an overheated market. The idea has worked out as planned, as Berkshire Hathaway has been a relatively stable holding in the Best Ideas Newsletter portfolio in a time of uncertainty in the broader market before breaking out to all-time highs following a solid third-quarter report, released November 4, and a business-friendly Presidential election. We continue to be fans of a range of businesses included in the Berkshire portfolio, particularly its recent addition of Precision Castparts, a long-time Valuentum favorite in the aerospace supply chain. 

Berkshire Hathaway's third quarter profit levels weren't nearly as bad as year-over-year comparisons indicate, as its 'Investments and Derivatives Gains/Losses' suffered from a tough comparable period due to the merger of Kraft Foods and HJ Heinz (KHC) in July of last year, which resulted in Berkshire reporting an after-tax non-cash holding gain of $4.4 billion in the third quarter of 2015. Operating earnings in the firm's sprawling portfolio of businesses advanced 6.5% from the year-ago period thanks in part to gains in its 'Utilities and Energy' and 'Manufacturing, Service and Retailing' businesses, the latter of which was pushed higher by the additions of Precision Castparts and Duracell. Its 'Financial and Financial Products' businesses performed well in the period, though the segment makes up a much less material portion of its overall operating portfolio. 

Businesses providing a drag on Berkshire's profits in the quarter, aside from the tough comparisons in 'Investments and Derivatives Gains/Losses,' were its 'Insurance-Underwriting' (KIE) and 'Railroad' businesses. The firm's underwriting operations are evaluated separately from the resulting investment income or gains that may come from the investment of premiums received, which has been the core driver of Berkshire's expansion over the past several decades. The timing and amount of property losses can produce material periodic volatility in its insurance businesses' underwriting results, and we do not view its 34% drop in underwriting earnings as a cause for concern due to such a dynamic. Its 'Railroad' business, Burlington Northern Santa Fe, continues to feel the pressure of volume declines commonly seen across the US railroad industry as of late , "Tough Times for Rails."  

What's made the difference for Berkshire Hathaway shares--and CEO Warren Buffett's net worth, which now sits above $70 billion and ranks him as the world's third richest person--are expectations surrounding the results of the Presidential election. The idea that Donald Trump winning the election is what has pushed Berkshire and Buffett to new heights is an interesting consideration due to the fervor with which Buffett spoke out against the now President-elect.  For Valuentum's dive into how the election will impact the markets, please read, "Assessing Reactions to Trump's Victory." The note covers a lot of ground.

It's no surprise that such a high-quality name would participate in a broader market rally, but certain portions of Berkshire's portfolio found themselves in the middle of the excitement, too. Its railroad operations, which accounted for 15% of Berkshire's profits in the third quarter of 2016 despite continued volume declines, figure to benefit from Trump's promises to revive the coal market (KOL) by easing regulations and boosting spending on energy and infrastructure projects. The banking and financial services industry (XLF) is another area that expects to prosper under the coming Trump administration, and Berkshire's material exposure to the industry, namely through its 10% stake in the currently embattled Wells Fargo (WFC), has boosted investor sentiment surrounding its shares following the election. Berkshire Hathaway's businesses in energy, consumer-facing sectors, and portions of manufacturing, such as Precision Castparts in aerospace (ITA), expect to benefit from Trump's agenda as well. 

Following the election, Mr. Buffett reminded investors of his high level of confidence in the performance of equities over the long-run, no matter who may win a Presidential election between now and then, "The stock market will be higher 10, 20, 30 years from now. It would have been with Hillary, and it... will be with Trump." While we are not debating 'The Oracle's' opinion on the general trajectory of the market, we do note that stock selection is still key: Buffett did not become the third wealthiest person on the planet via exposure to the broader market. He most certainly has an eye for quality, and that's exactly what investors get when they take a position in Berkshire Hathaway. We're going to stick with our position in the firm for the foreseeable future, and we continue to expect it to be a solid anchor for the Best Ideas Newsletter portfolio while providing the potential for a pop in shares, just as we have seen in the past week. 

Now read, "Part I: Nelson's Evaluation of Berkshire's 2015 Annual Report" - www.valuentum.com/articles/20160310

"Assessing Reactions to Trump's Victory" - www.valuentum.com/articles/Assessing_Reactions_to_Trumps_Victory

"Tough Times for Rails" - www.valuentum.com/articles/20161021_4

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