Monday, March 06, 2006

Berkshire Hathaway: Law of Large Numbers Catching Up

Superinvestor Warren Buffett's company, Berkshire Hathaway, recently announced a 54% increase in quarterly earnings, and a 16% increase year over year. Performance like this has led Berkshire's shares to attain lofty prices, and to continue to outpace the broader market, year after year.

However, just like the mouse on the left would have more trouble gaining 10% of its weight than the mouse on the right, Berkshire is - as Mr. Buffett has repeatedly warned - going to have trouble continuing to outpace the S&P500 as the company becomes larger and larger.

In fact, more and more of Mr. Buffett's acquisitions take him farther and farther from his preferred investments - such as insurance companies and banks, and companies that commend "top of mind" presence with the element of repeated purchase present (i.e. think Coca-Cola, a major holding of Berkshire). Some recent acquisitions include home builders and RV makers. These obviously don't fit that profile and tend to be more in commodity-oriented type venues, where price becomes a larger factor than prestige or habit.

In fact, just as Mr. Buffett warned, his marked outperformance vs. the S&P500 is clearly waning. The following info is taken from the Berkshire web-site and shows his average annual outperformance of internal book value vs. the S&P500 by decade:
  • 1970s - 15.8% better per annum
  • 1980s - 11.4% better per annum
  • 1990s - 6.3% better per annum
  • last ten years - 5.6% better per annum
This isn't to say that Berkshire shares don't still represent an above-average investment and probably offer better value than the standard mutual fund - just that the outperformance going forward is unlikely to match that of the past. In fact, in three of the most recent seven years, Berkshire's increase in book value per share, didn't meet the return of the S&P500 - an unprecedented result!

Nevertheless, Mr. Buffett has a remarkable record of outperformance, and that outperformance - albeit by a diminishing margin - may very well stay intact for many years into the future.

You can buy one share of Berkshire Hathaway "A" series (BRK-A) for a cool $87,400, or one of the "B" series (1/30 economic value) for $2,911 (BRK-B).


The Confused Capitalist

No comments: