Berkshire Hathaway case study:
(Part of my Business school project at Baruch College, Zicklin School of Business. Contributions by fellow team members Huiru Xiang & Kathyleen Vazquez)
Berkshire Hathaway Inc. is a multinational conglomerate holding company and is headquartered in Omaha, Nebraska, U.S.
The company wholly owns GEICO, BNSF, Lubrizol, Dairy Queen, Fruit of the Loom, Helzberg Diamonds, FlightSafety International and NetJets and also owns significant minority holdings in Kraft Heinz Company, Mars, American Express, The Coca-Cola Company, Wells Fargo, IBM and Restaurant Brands International.
The Company is led by Warren Buffett, the company’s Chairman of the Board, President and Chief Executive Officer, and Charlie Munger, the company’s Vice-Chairman of the Board of Directors.
2. SWOT Analysis
- Cost free capital for investment
- Buffet brand
- Diversified holdings to prevent risks
Berkshire uses float funds, which come from the timing difference between collecting money and paying for insurance claims, to invest in new businesses for Berkshire’s gain. The financial statements do not include the gain and size of the float funds, but “float(s) generate significant investment income because of the assets it allows us to hold”. In this way Berkshire is able to finance new businesses while keeping minimal debt. This float, which “grew from $41 billion to $88 billion in 2015“ has created a barrier to competition.
Chart1. Underwriting earnings and float by division
The “Buffet” brand is goodwill and reputation of Berkshire. With this name, Berkshire is easily able to attract shareholders and purchase promising companies. The repurchase price for treasury stock is as low as 120% of book value, but people are still eager to buy Berkshire’s stock because of the Buffet brand and excellent investment.
Berkshire is very diverse in its investments, ranging from insurance, energy, railroad, home furnishing, manufacturers, newspaper publishing, etc. This strengthens its capability to withstand natural and market catastrophes.
- Changes in market conditions and regulatory authority effects on business verticals
- Over dependence of wholesale distribution on significant customers
- Succession instability
- Increase in revenues contributed by non-operating activities during 2015 year
Changes in regulation by various federal, state and local agencies in the Railroad and Energy business , one of the largest revenue sources, could have a large impact on Berkshire. In terms of environmental impact of the railroad business (sub leased land to industries that may have released harmful elements into the area) coupled pricing regulation and environmental regulation in the energy/natural gas sector, fines penalties are always a threat to these verticals. GEICO’s premium volume may shrink because of driverless cars.
McLane and company (wholesale distribution of groceries and non-food items and second largest revenue earner after energy vertical for Berkshire) operates businesses that are wholesale distributors of distilled spirits, wine and beer (“beverage unit”). The grocery and foodservice units are marked by high sales volume and very low profit margins and have several significant customers, including Wal-Mart, 7-Eleven and Yum! Brands. A curtailment of purchasing by any of its significant customers could have a significant adverse impact on McLane’s periodic revenues and earnings.
Warren Buffett is a brand and he is 86. His partner, Charlie Munger, is 92. Buffett recently recovered from Stage 1 cancer in 2012. Without a clear succession plan the company outlook could be not very rosy after him.
2015 Increase in revenue is due to investment and derivative income. This is not the primary businesses verticals.
- International Expansion
- Young Talent
Berkshire Hathaway is primarily focused on domestic companies. There is an opportunity to expand into international companies, such as swiss insurance company ACE. Investing in international companies could hedge against risk in the event of a U.S. stock market crash.
Berkshire Hathaway is a company that many young people would love to work for. They should take advantage of this fact. If Warren Buffett hired young talent to work in his corporate office he could train that talent to keep the Berkshire Hathaway culture and his thought process alive after he passes on. Hiring young talent has plenty of benefits, aside from keeping the culture alive, that Warren Buffett and the Berkshire Hathaway brand should consider.
Berkshire Hathaway’s activities are divided into three main categories: insurance and other, railroad, utilities and energy and finance and financial products. In an effort to hedge against weaknesses that the majority of Berkshire Hathaway business face they could invest in other industries such as technology and healthcare.
- Stock Market Crash
- Unanticipated Catastrophes
- High Competition in the Insurance Industry
Berkshire Hathaway is subject to the same economic cycles that affect the industries in which they operate. “In the event that the economy deteriorates for a prolonged period of time, one or more of our [Berkshire Hathaway’s] significant operations could be materially harmed.” Warren Buffett says himself in an interview with CNBC that “there will be another financial crisis ‘someday’ in the years ahead that will shock financial markets… Berkshire stock has dropped 50 percent four times in history, but has always recovered.” Though Berkshire has recovered this is still a very real threat for them.
Insurance underwriting operation is one of the top valuable businesses of Berkshire Hathaway. It mainly focuses on automobile insurance, casualty insurance and reinsurance, which contain high risk of losing earnings. Although the increased costs from insurance compensations might be made up by increased premiums, it is almost impossible to estimate insurance claim costs precisely. Any unanticipated natural catastrophes or acts of terrorism would bring the extra costs of claims, resulting in lower retained earnings.
Except for regulatory considerations, there are virtually no barriers to entry into the insurance and reinsurance industry, one of Berkshire’s “Powerhouse Five” verticals. Competitors may be domestic or foreign, as well as licensed or unlicensed. The number of competitors within the industry is not known. Insurers and reinsurers compete on the basis of reliability, financial strength and stability, financial ratings, underwriting consistency, service, business ethics, price, performance, capacity, policy terms and coverage conditions.
News Affecting Berkshire Hathaway Investment(s)
The Wells Fargo perspective:
Wells Fargo is the second largest investment in publicly listed companies by Berkshire Hathaway, second only to the Kraft Heinz Company (KHC). Berkshire Hathaway is the largest shareholder of WFC and has been buying its stock since 1989.
Recently the Consumer Financial Protection Bureau (CFPB) directed Wells Fargo to pay USD $185 million to resolve claims that bank employees opened deposit and credit-card accounts without customer’s approval in order to meet sales targets and earn financial rewards.
Effects on Financial Statements:
- Since the news broke out: The “Income Statement” would be affected since there would be a change in unrealized gains/losses in marketable securities/investments because of “Marked-to-Market” rule during the current quarter.
- No change in “Cash flow from Investing Activities”, since the loss is notional and hasn’t been exercised.
- If the Balance Sheet was to be prepared today, the investment in Wells Fargo, classified as marketable securities (short term assets), would be reported at the current market value. Long term assets are reported at acquisition costs.