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Quarter-End Insights

Financial Services: Berkshire Is Bigger Than Buffett

Although the wide-moat firm is unlikely to grow book value like it did in the past, future returns should still come in solidly and consistently above the firm's cost of capital.

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  • The financial-services sector remains reasonably undervalued and recently traded at a market-cap-weighted price/fair value estimate ratio of 0.94.
  • Berkshire Hathaway will survive the departure of Warren Buffett and Charlie Munger. With the company's next CEO expected to fill the role of capital-allocator-in-chief, we see two strong candidates in line to take the top job: Ajit Jain, who runs Berkshire's reinsurance operations, and Greg Abel, who heads up Berkshire Hathaway Energy. Although Jain is probably the first name on the board of directors' list for the position, we believe Berkshire would likely be better served longer term by having him focus on overseeing the entire insurance business while Abel--working closely with Jain, as well as Ted Weschler and Todd Combs--focuses on properly allocating Berkshire's capital.
  • Berkshire will eventually focus on returning more cash to shareholders. During the past three calendar years, Berkshire has generated an average of $16.3 billion annually in free cash flow. With investment opportunities few and far between, the company continues to build up large amounts of cash on its balance sheet, which we think (barring investment opportunities) should be dedicated to dividends and share repurchases longer term. While Berkshire's share repurchase policy is well-known, we believe the firm could easily return one third of its annual free cash flow to shareholders. That said, we don't expect that to occur until after Buffett departs the scene.

 

Stephen Ellis does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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