I introduce Berkshire Hathaway as the first company in stock analysis because Berkshire's business report reveals a lot of investment principles.
Berkshire Hathaway's business structure is a profitable model for subsidiary operations and investment portfolios.
1. Subsidiary operation
Based on Berkshire's long-standing cash supplier, insurance, and based on the investment philosophy of Warren Buffett and Charlie Munger, it has fully acquired many companies.
Its current operations include companies with a high market share in industries essential to the US economy such as insurance, railroad, energy, manufacturing, services and retail.
Looking at the leading companies and businesses in each industry,
Insurance: GEICO, the second largest auto insurance company in the United States,
Railroad industry: BNSF, the largest railroad company in North America
Energy industry: Berkshire Hathaway Energy (BHE) operates a business that generates, transmits, stores, distributes and supplies energy, generates stable cash flows and has high barriers to entry.
Manufacturing: Classified as industrial, building, and consumer goods, it produces a wide range of products from capital-intensive businesses such as special chemicals and aerospace parts to batteries and clothing.
Service Business: It operates a variety of service businesses such as grocery distribution, electronics distribution, and aviation training programs.
Below is Berkshire Hathaway's revenue by industry for Q2 2020.
Here, you can understand that the proportion of revenue by industry is not biased.
The model you must understand for Berkshire's subsidiary operations is the insurance industry. The insurance industry is a float, a model that receives insurance money from the current customer and pays it after a long time. It is a model that can attract money with very little cost. This money can be invested in a non-insurance subsidiary or reinvested in the operation of an investment portfolio, resulting in a leverage effect.
In the case of general insurers, rate cuts reduce their returns, but Berkshire Hathaway does not. Since there is solid cash flow from the non-insurance industry, it is possible to make up for losses in the insurance industry and to make aggressive investments using low interest rates.
To sum up, the insurance industry collects money at a low cost, fully acquires and operates a subsidiary company that has a high share of the industry essential to the US economy. It also creates a natural leverage effect by investing that money in its investment portfolio.
This is the principle behind Berkshire Hathaway's remarkable investment performance.
2. Investment Portfolio
Below is Berkshire's investment sector.
You can check the share of cash equivalents and stock investments, including short-term US bonds.
About 1/3 of the investment amount is held as cash equivalents. This is to prepare for the risk of an overheated stock market and to increase the share of stocks or invest in new stocks when the stock market declines.
Having enormous amounts of cash allows Berkshire Hathaway to tackle financial problems without much difficulty, even in the face of extreme external shocks. In addition, when the entire stock market declines due to the economic downturn, this cash allows you to increase the share of your stocks or invest in new stocks. By paying a much lower price than usual.
Here are the top 10 stocks Berkshire is investing in.
For Berkshire, when allocating holdings, the priority is to reinvest in companies that already own and invest. When looking for a new investment or acquiring a company, the company always considers the following conditions:
1. Is it producing a high return on the net tangible capital required for the business?
2. Is it run by competent and honest management?
3. Isn't the price expensive compared to the corporate value?
After considering these three conditions, more precisely, it checks whether they are using excessive debt to generate high returns, whether they can improve or maintain our market share, and whether future cash flow forecasts are simple and robust.
3. Realization of shareholder value
Berkshire Hathaway does not pay dividends. However, when Berkshire's stock price is trading at a lower price than the company's intrinsic value, Berkshire prioritizes shareholder value and buys treasury stock. Not only Berkshire, but also the companies Berkshire invests in.
Under the conditions considered above, competent and honest management refers to a manager who maintains high productivity, expands business steadily, and puts shareholder value first.
Dividends are also a means of shareholder value, but treasury stock purchases and cancellations are more beneficial to shareholders. When a company pays dividends to its shareholders, the company's net profits simply go to the shareholders' account, which in the process pays taxes to the government. However, buying and canceling treasury stocks has the effect of increasing the share of shareholders' shares without tax as a corporate profit.
Therefore, it is desirable to pay dividends mainly for shareholder value when the business in which the company operates is mature and it is difficult to expand further. If the business remains open to expansion and R&D is necessary for the company's competitiveness, it is wise to reinvest in the ongoing business rather than dividend.
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