Note from Daily Trade Alert: The following article first appeared in The Growth Stock Advisor, a premium newsletter offered by Investors Alley.

Recently, many young, novice investors have recently begun to trade stocks—think about the news you may have heard about Robinhood, Reddit, Dave Portnoy, etc.

Bloomberg Intelligence estimates that ordinary retail investors have, on average, accounted for 23% of all U.S. stock trading in 2021, more than twice the level of retail trading in 2019. This means that retail investors’ stock market footprint is roughly as big as all hedge funds and mutual funds combined. Retail traders now trail only behind high-frequency traders in their hyperactivity.

That’s great in some ways; however, many of these new investors have a lot of disdain for true investing—that is, looking at a company’s fundamentals basing a purchasing decision on that. In other words, the method used by Warren Buffett.

Many of this new breed of investor, like Dave Portnoy, consider Warren Buffett a joke and washed up. Though Warren Buffett’s legacy as one of the all-time great investors is assured, in recent years, the share price of Berkshire Hathaway (BRK.A or BRK.B) has underperformed S&P index funds.

Is Berkshire a good investment or has Warren lost his touch?

Berkshire Hathaway Performance

Buffett has been doubted before. Twenty years ago, Buffett was accused of not understanding the new world of the internet as he refused to buy grossly overvalued technology and telecom stocks. He was proven right when the dotcom bubble burst spectacularly.

Now, we are hearing echoes of that past as some people once again think that Buffet is out of touch, and has been too slow or unwilling to invest in the businesses that are seen as the drivers of technology and wealth creation in the 21st century.

But if we look at its performance, Berkshire Hathaway continues to do reasonably well.

Of the 11 years from the end of 2009 until the end of 2020, Berkshire has performed better than the S&P 500 in seven. Up until the end of 2018, it had marginally outperformed the index.

It has only been in the past two years—since tech stocks began to surge in value (Tech Bubble 2.0?)—that Berkshire has lagged the index. Remember that, until recently, 25% of the S&P 500 valuation was made up of just five stocks: Apple, Amazon, Microsoft, Alphabet (Google) and Facebook.

But now that tech stocks are falling, the things that have served Buffett and Berkshire well over the decades are still in place. The power of retained earnings and compound interest over time have not gone away.

A Closer Look at Berkshire Hathaway

Buffett’s core strength comes from Berkshire’s insurance business.

It’s a huge advantage for the company that it gets to invest money it doesn’t actually have, without paying for it. This very large pool of money is known as a float and it is a main feature of the insurance business.

Berkshire’s insurance businesses take in money from customers in the form of premiums. The potential claims against those premiums may not have to be paid out at all or for many years. As long as the companies’ premiums are bigger than its claims (the business does make an underwriting profit), the size of the float gets bigger as the size of the business—by generating more premium income—also gets bigger and bigger.

Berkshire’s float was a massive $192 billion at the end of 2020 and has grown substantially over the past decade as premium income has more than doubled, and underwriting profits have been made in all but one year.

Buffett has often said this creates an almost permanent source of money to be invested. Sounds like a perpetual motion money machine to me.

At the end of 2020, $109 billion of Berkshire’s $192 billion float had been invested in stocks. Berkshire’s total stock portfolio was worth $281 billion at the end of 2020. On top of that, the insurance company also had $135 billion of cash and cash equivalents. That’s almost unparalleled financial strength.

And then there is Berkshire’s portfolio of non-insurance operating companies. A prime example of this is one of the biggest railroads in the U.S., Burlington Northern Santa Fe. Burlington has been a very good business since Berkshire bought it in 2010. While 2020 was a difficult year in many regards, operating margins improved and are at a very high level. The railroad also generates decent amounts of free cash flow Berkshire may then reinvest.

Railroads are highly valued on the stock market right now. Union Pacific (UNP) is very similar in revenues and profits to BNSF, currently trading at 26 times historic earnings. BNSF at the same multiple would be worth $134.2 billion.

However, it is the insurance float and cash that underpins the foundations of Buffett’s empire. Without it, there is little cash to invest in stocks or operating companies and grow value for shareholders without issuing new shares or borrowing money.

That will keep Berkshire Hathaway around for a long time…probably longer than some high-flying tech stocks.

And if the recent shift back into value and cyclical shares continues, the shares will likely do very well and beat the S&P 500.

Berkshire Hathaway is up 37.6% over the past 52 weeks and 14.5% year-to-date. And compare its year-to-date gains versus the SPDR S&P 500 ETF (SPY)—up 4%—or the once high-flying Ark Innovation ETF (ARKK), which is down 2% year-to-date.

I will give Berkshire Hathaway a 4-star rating. It does have some slow-growing businesses. And I do not like the high concentration of Apple stock in its portfolio. You can buy the cheaper class B shares at any price up to $300 a share.

— Tony Daltorio

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Source: The Growth Stock Advisor