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Berkshire Hathaway – Added to the FFJ Portfolio

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Typically I will write an article in which I analyze a company and indicate in advance what investment action I intend to take. In the case of my Berkshire Hathaway (BRK) investment, however, this is an 'after the fact' article; I acquired 200 Class B shares (NYSE: BRK-b) for the FFJ Portfolio on May 16, 2018 and this article is merely to provide disclosure.

I will not analyze the company since I strongly suspect all readers know of Buffett, Munger, and Berkshire Hathaway (NYSE: BRK-a and NYSE: BRK-b).

I fully recognize Buffett and Munger are well into their 80s and 90s. Should they pass away, it is entirely possible investors will punish the stock price. I am not concerned about this. I am confident a proper succession plan is in place and the individuals who have been making some of the astute investment decisions in recent years will carry on doing so.

My decision to acquire shares today has been a long time coming. I once owned BRK-b shares but my August 29, 2017 article explains one of my worst investment mistakes.

Rather than analyze BRK, this article addresses my rationale for investing in the company.

Reason #1

The primary reason for my decision to invest in BRK is that it is extremely profitable. Not only does it generate earnings from the companies it owns outright but it also earns money from the companies in which it owns minority equity positions.

This is a cash rich company which is not at the mercy of lenders. In fact, during the Financial Crisis, General Electric (NYSE: GE) and Bank of America (NYSE: BAC) turned to BRK for financial assistance…at very attractive interest rates for BRK.

Furthermore, in 2017, Home Capital (TSX: HCG) had to turn to BRK for financial support.

I am a risk adverse investor and whenever I see a business that relies heavily on debt it adds another layer of concern. It certainly is an uncomfortable feeling to be an investor in a company which must refinance its debt during a period of adversity.

Many other bloggers tend to focus on various quantitative metrics yet they overlook a company’s credit rating. I review a company’s credit ratings in my analysis.

Moody’s rates BRK Aa2 and S&P Global rates it AA. Both ratings are the middle tier of the High Grade rating description.

(Source: Berkshire Hathaway December 31, 2017 10-K page 112 of 148)

Reason #2

BRK’s management appeals to me. As a shareholder, I rely on other people to run the business. I, therefore, need to ensure the character / integrity of management is not suspect. These are the people who will make the business a success or failure. In addition, these individuals must have the ability to run the business properly. Character / integrity and ability are not independent of each other.

Someone who has great character / integrity but no ability might make a great neighbor but you certainly would not want that individual to head up a company.

If you have someone with the ability (eg. they are whip-smart or highly skilled) to run a company but they have a character / integrity flaw of some sort….they may do well but I strongly suspect all will not end well for outside, silent, non-controlling partners.

Reason #3

Reinvestment dynamics (the compounding feature) is also critically important.

Ben Franklin said:

‘Money makes money. And the money that money makes, makes money’

Albert Einstein said:

‘Compound interest is the most powerful force in the universe. Those who understand compound interest earn it and those who do not understand it pay it.’

When looking at a business I ask myself ‘How big can this be?’ ‘How scalable or replicable is this business?’ A perfect example would be a high class restaurant versus McDonald’s (NYSE: MCD). The former is likely very difficult to replicate while MCD is highly replicable.

A perfect business is one that earns very good returns on its capital and can take the capital it generates from the business to reinvest in the business to generate more capital. Essentially we’re talking about compounding earnings at a similar or better rate year after year after year. BRK has perfected this!

Reason #4

Many investors get bogged down in an inordinate amount of quantitative analysis (ie. P/E/ P/BV/ Dividend Yield, etc.). I, for one, occasionally fall in this trap. It is important to include quantitative factors in the thought process. The problem is there are two types of errors which can be made when trying to assign a price / value to a stock.

The first is to make a judgment that a business is worth $x yet it truly is worth a fraction of that value.

The second type of error is where you do your analysis and determine a value for which you are prepared to make an investment. The problem is the price for which you would be able to acquire an investment interest is greater than the value you have determined from your analysis so you never ‘pull the trigger’. While you’re waiting for the stock price to retrace to ‘your’ level, the stock price continues to rise and rise and rise.

Does the second type of error sound familiar? It certainly sounds familiar to me! While we tend to talk about or remember things very vividly that we did, especially recently, we tend not to talk about those things we did NOT do; we are apt to brush them off relatively easily.

The problem is that the second type of error often turns out to be extremely costly!

Final Thoughts

I still make investment mistakes and I know there are some companies for which I have recently decided to pass in the hopes of a more favorable entry point. I may get those favorable entry points for those companies at some stage but for now I have decided to finally take my head out of the sand and to reinvest in BRK.

Some investors may view me as being foolish for investing in BRK because BRK does not distribute a dividend. Not a problem. I am willing to forego a dividend if I think superior investment returns can be achieved by retaining earnings in the company. I have had reasonably good success with No dividend or low dividend yielding stocks and am confident I will be well rewarded over the long-term from my investment in BRK.

I hope you enjoyed this post and I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to charles@financialfreedomisajourney.com

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long BRK-b.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.

Members of the FFJ community can access reports I generate on high quality companies which add long-term shareholder value. In an effort to help you determine whether my offering is of any value to you I am pleased to offer 30 days' free access to all sections of my site. No commitments. No obligations. That's 30 days from the time you register at absolutely no cost to you!

By |May 16th, 2018|General Investing|Comments Off on Berkshire Hathaway – Added to the FFJ Portfolio

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