The Valor Blog.
Investment News and Views, Direct from Our Team.

These are a few of our favourite things – Berkshire Hathaway (by Marc Lerner)

Some of our favourite things – Berkshire Hathaway

Marc Lerner

Part of the brilliance of Berkshire Hathaway’s structure – in addition to having Warren Buffett as the head of the company – is that it has a source of capital that is literally costless. This is the “float” that is generated by its insurance operations, just part of a massive portfolio of wonderful and diverse businesses. Float is money received in insurance premiums that does not have to be immediately paid out in the form of insurance claims. Assuming the company only breaks even on its insurance operations, float provides Berkshire with a costless source of capital, which can then be used to purchase profitable businesses and stocks.  (In the past, Berkshire has made a profit here as well, but there is no guarantee, as Buffett points out, that this will continue). If the company does manage to at least break even on its insurance operations, this is like a loan – minus the interest! Buffett, in fact, uses float as an alternative supply of funds to borrowing money, with which he likes to be very conservative. In his typical easy-to-understand style, Buffett characterises float as “money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit.”

Buffett then uses this money to purchase businesses, either outright or in the form of shares in the stockmarket. The company owns, outright, businesses in insurance, a major railroad, utilities, energy, and many others, ranging from See’s Candies to Nebraska Furniture Mart. In addition, Berkshire owns significant stock in publicly traded companies – for example, an 8.8% shareholding in the Coca-Cola Company is one large stake. In the past, buying shares in companies in this way was Berkshire’s focus. Given its size, however, in recent decades this has become difficult to do in anything but the largest companies, and Buffett now directs his efforts largely towards buying companies outright.

The fact that so many different businesses are owned gives an investor in Berkshire significant diversification – not being overly exposed to any one sector of the economy, or the fortunes of any one industry in particular. The polar opposite of Berkshire in this regard is a company like Fortescue Metals, which is really just a leveraged bet on the iron ore price – its shareholders are entirely at the mercy of that one figure. In Berkshire, in contrast, it is highly unlikely that Berkshire’s businesses would be performing badly all at once. If this was the case, then chances are pretty much everything else is struggling too.

In the shorter term, another advantage is that Berkshire’s recently announced buyback of shares from a long-term investor’s estate will likely put a floor under the price as Buffett continues to repurchase shares should they fall to levels he considers to be undervalued.