Berkshire Is a Quiet Buy

04/19/2010 12:00 pm EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, and analyst Bill Bergman say Warren Buffett’s conglomerate has a lot of appeal, although the stock has had a nice run.

In modern financial history, there hasn’t been anything like Berkshire Hathaway (NYSE: BRK-B).

Berkshire’s origins lie in insurance and reinsurance, and we think these operations remain the heart of the enterprise. The firm’s wide economic moat—durable competitive advantage—derives in large part from the unparalleled success that these operations have had in melding financial strength, underwriting ability, and investment success.

Insurance enterprises earn incoming premium for risk assumption and can turn a profit on insurance operations if the revenue exceeds losses as well as operating and commission expenses. They also invest the float that is available until payment is required on losses for risk assumed.

Berkshire has a long-proven ability to determine when opportunities are worth seizing, and when it makes those determinations, it does so in a big way. Warren Buffett’s guide to “be fearful when others are greedy, and be greedy when others are fearful” works its way into Berkshire’s underwriting as well as its investments.

Berkshire’s growing list of diverse subsidiaries [is] expected to add value, as well. They operate in a wide range of businesses, from underwear to candy to real estate brokerage, and the enterprise as a whole benefits from their association with the firm’s financial heartbeat—its insurance and reinsurance operations.

Berkshire owns more than 70 businesses, including [the recently acquired] Burlington Northern Santa Fe (NYSE: BNI). The insurance and reinsurance operations are the heart of the firm and include reinsurers General Re and Berkshire Hathaway Reinsurance, along with general insurer National Indemnity and auto insurer Geico.

Berkshire owns large equity stakes in Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC), Procter & Gamble (NYSE: PG), and American Express (NYSE: AXP). The firm’s subsidiaries operate across a broad swath of the economy.

Berkshire’s current senior leaders won’t be with the firm forever, but we think that their contributions will live beyond their own tenures, and that the firm has developed highly capable replacements, as well as deeper managerial expertise.

Warren Buffett and Charlie Munger were instrumental in framing Berkshire’s infrastructure, but they can’t be entirely responsible for the success of such a large, complex organization with a long track record. Berkshire is more than the Warren and Charlie show.

For example, consider the long record of underwriting profitability in Berkshire’s insurance operations. There are too many underwriting decisions, and too many tires to kick, for one person to have been doing that alone.

We think that Berkshire’s Class B shares are worth $88 per share. (They closed Friday below $79—Editor.) Our revenue growth, underwriting, profitability, and investment return assumptions lead to operating income trend growth in the insurance operations of 7% through 2015. For the noninsurance operating subsidiaries, we project average revenue growth of 6% through 2015, with continued modest improvement in profitability.

This is no longer a table-pounding value following a recent spike in the shares, but it is still a solid core holding.

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