Warren Buffett has a record amount of cash – what is next?
Berkshire Hathaway’s cash holdings have increased to $157b in the latest earnings report.
Mentioned: Berkshire Hathaway Inc (BRK.A)
With wide-moat Berkshire Hathaway (NYSE: BRK.A) reporting third-quarter results that were in line with Morningstar strategist Greggory Warren’s expectations.
The firm closed out September 2023 with a record $157.2 billion in cash and cash equivalents, up from $147.4 billion at the end of June 2023. Unutilized free cash flow owing to a lack of viable investment opportunities, along with net stock sales of $5.3 billion, left cash balances firmly above the $150 billion threshold CEO Warren Buffett has claimed would be difficult to defend.
We view Berkshire's decentralized business model, broad business diversification, high cash-generation capabilities, and unmatched balance sheet strength as true differentiators for the firm.
While these advantages have been overshadowed during much of the past decade by the company's ever expanding cash balances—which earned next to nothing in a near-zero short-term interest rate environment—we believe the company has finally hit a nexus where it is focused on reducing its cash hoard through a mixture of stock investments and share repurchases.
Over the past 12 calendar quarters, the company has repurchased close to $60 billion worth of its common stock, equivalent to $4.9 billion per quarter on average, which has eliminated just over 10% of the company's total shares outstanding.
The company has also pursued higher dividend yielding securities when purchasing equity securities and is benefiting from higher short-term rates on its cash balances. With the firm closing out June 2023 with an estimated $107 billion in dry powder and valuations not quite where they need to be for many of the types of quality assets Buffett would prefer to acquire outright, we expect the bulk of the company's excess capital allocation to be focused on stock and bond investments and share repurchases.
Berkshire’s economic moat
We've historically believed that Berkshire's economic moat is more than just a sum of its parts, although the parts that make up the whole are fairly moaty in their own regard.
The insurance operations—Geico, Berkshire Hathaway Reinsurance Group, and Berkshire Hathaway Primary Group—remain important contributors to the overall business.
Not only are they expected to account for around 30% of Berkshire's pretax earnings (and 50% of our valuation of the firm), but they are overcapitalized (maintaining a larger-than-normal equity investment portfolio for a property and casualty insurer) and generate low-cost float.
These temporary cash holdings, which arise from premiums being collected in advance of future claims, have allowed Berkshire to generate additional returns as the company invests these funds in assets that are commensurate with the duration of the business being underwritten. And they have tended to come at little to no cost to Berkshire, given the company's proclivity for generating underwriting gains the past several decades.
Our fair value
We've increased our fair value estimate for Berkshire Hathaway to $600,000 per Class A share from $555,000 after updating our forecasts for the company's operating businesses and insurance investment portfolio.
Our new fair value estimate is equivalent to 1.43 and 1.32 times our estimates for Berkshire's book value per share, respectively, at the end of 2024 and 2025. For some perspective, during the past five years the shares have traded at an average of 1.40 and over the past ten years at 1.43 trailing calendar year-end book value per share. We use a 9.0% cost of equity in our valuation and assume that Berkshire pays a minimum of 15% corporate alternative minimum tax on adjusted financial statement income for taxable years beginning in 2023.
Our fair value estimate is derived using a sum-of-the-parts methodology, valuing each of Berkshire's operating segments separately and then adding them back together for the total estimate.