S&P's Outlook for Buffett's Berkshire

05/22/2015 8:00 am EST

Focus: STOCKS

This insurance-based conglomerate—our latest Focus Stock—is headed by famed value investor Warren Buffett, notes Cathy Seifert, S&P Capital IQ equity analyst in Standard & Poor's The Outlook.

Berkshire Hathaway Class B (BRK.B) carries S&P Capital IQ’s highest investment recommendation of 5-Stars or Strong Buy.

One of the concepts central to Berkshire’s operating strategy is that insurance entities generate float, large sums of investible funds that arise from the timing between when an insurer collects premiums from policyholders and when a portion of those funds get paid out as claims.

To put this in perspective, Berkshire’s float in 1970 was $39 million. By 2014, it had grown to $84 billion.

The largest—and probably best known—company within Berkshire’s insurance division is GEICO, the direct-to-consumer auto insurer that has grown from a second tier insurer to the second-largest private passenger auto insurer in the United States.

In addition to the financial strength of its parent, GEICO also has a significant cost advantage over insurers who rely upon third parties (i.e. agents and brokers) to distribute their products.

The other significant component of Berkshire’s insurance operations consists of a number of reinsurance and specialty commercial lines insurers, including General Re and Berkshire Hathaway Reinsurance Group.

Another strategy central to Berkshire’s business model is growth through acquisitions. Berkshire has a well-articulated acquisition strategy: large purchases; demonstrated consistent earnings power; a good return on equity while employing little or no debt; a management team in place; and a simple business model.

However, the company is not opposed to doing smaller, strategic bolt-on acquisitions, as evidenced by the 31 acquisitions it made in 2014 for a total cost of around $7.8 billion.

We expect Berkshire to produce an 8% to 10% rise in organic revenues in 2015. Our forecast assumes that several of Berkshire’s economically sensitive units will see momentum amid a recovering economy.

This also assumes stable underwriting margins in the core insurance units and a normal level of catastrophe claims.

We note that Chairman and CEO Warren Buffett is in his 80s, and while the company has stated that a succession plan is in place, we believe the lack of a more clearly articulated succession strategy poses a risk for the shares.

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