October 21, 2016
Berkshire Hathaway Inc. stock shows strong signs of entering a consolidation and maturity phase, being a safe long-term stock pick
-Solid financial performance but having difficulty generating excess market returns in the future
-Valuation is not too expensive, signaling not any red flags compared to its main industry peers
-Wells Fargo recent scandal may however have a negative effect to Berkshire Hathaway Inc. if in the future a global banking financial system crisis occur
Berkshire Hathaway Inc. stock class B (NYSE:BRK.B) has so far this year an identical performance compared to major market indices S&P and Dow Jones, showing a gain of about 12%. Having a beta of 0.77 means that in fact being a defensive stock, actually performed better than the general stock market. The company is actually a conglomerate, being in the financial sector and insurance industry, but having a diverse portfolio of businesses.
The stock has a solid financial performance last year, but in the future there are risks of not being able to provide excess returns
According to a survey by IDC about challenges and trends for the insurance industry in 2016, 2 major risks are the threat of new entrants entering in the market and rising competition, and new investments required in the digital era to face new forms of threats. While profitability for last 5 years is good and shows a rising trend as both net profit margin ratio and return on equity ratio have increased, growth in net income and earnings per share seems to decrease. 5 years revenue growth also seems to increase at a diminishing rate. Free cash flow growth on a yearly basis for last 5 years shows a very erratic move, with a very significant decrease in last year, while debt/equity ratio shows a remarkable stability and is low enough, showing financial strength and stability. 5 years earnings growth forecast is 7.1% which is not too excessive and shows a mature growth company.
Valuation of Berkshire Hathaway Inc. stock class B (NYSE:BRK.B) is not too expensive, although price growth is expected not to be excessive
Current valuation of stock price class B for Berkshire Hathaway Inc. compared to its industry show that the stock has a lower Price/Earnings ratio of 14 compared to the Price/Earnings ratio of 17 for the insurance industry, while the stock has higher Price/Book, Price/Sales and Price/Cash Flow ratios than relevant industry ratios. Operating Margin and Net Profit Margin ratios for the company on a 5 years average are both significant higher than the ratios of the insurance industry. The same result applies also for Return on Equity ratio for the company, showing a better profitability and management effectiveness compared to its industry.
Wells Fargo recent scandal could be a high risk event as Berkshire Hathaway Inc. is the largest institutional owner of Wells Fargo stock
As a conglomerate the significant investment in Wells Fargo stock at about 9.5% total ownership is both promising and risky. In many cases stocks that have bad related news, such as scandals about financial statements tend to underperform the general stock market as the demand for their shares falls significantly. A significant drop in the stock price of Wells Fargo due to the recent scandal could have negative impact on the overall profitability of Berkshire Hathaway Inc. The banking sector is fragile this period as another important global bank, Deutsche bank is under pressure having to deal with an enormous amount of fine, $14 billions, imposed to it by the US Department of Justice for selling mortgage securities in the US a few years ago. A domino effect scenario in the financial sector and banks with a new crisis can only hurt Berkshire Hathaway Inc. At the same time the company has increased its position in Apple(Nasdaq:AAPL), and so far Apple stock is performing well enough having increased lately due to strong sales of new IPhone 7.
Conclusion of investment thesis
We think that Berkshire Hathaway Inc. stock class B having closed on September 28th 2016 at $145.28 per share is a hold. Valuation does not seem to be excessive, but at projected future 5 years earnings growth of 7.1% the potential for stock price increases, but at a moderate pace. We have a 12 months price target increase of 8-10% from current level or $156-$160 per share, ideally buying shares at any possible sell-off for a better risk adjusted return.
Sources and legal disclaimer:
The author does not owe any BRK.B stocks, this is not an investing recommendation,just financial analysis
Reuters.com, MorningStar.com, Google finance