It's a question that has been asked over and over for decades: Is it too late to buy shares of Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B)? As you likely already know, Berkshire has been one of the best-performing stocks in history. Shares have averaged annual returns of roughly 20% for decades. Even a small initial investment would have grown into a fortune with this powerful stock.
Are you too late to the party? The answer might surprise you.
New Berkshire investors must understand this 1 factor
Under the steady guidance of Warren Buffett, Berkshire has developed several key advantages that have allowed it to beat the market for far longer than anyone anticipated. At this core of its outperformance is a skilled investment team that has proven that it can make long-term bets that outpace broader market indexes like the S&P 500. From Coca-Cola and American Express to Amazon and Apple, Buffett and his lieutenants have repeatedly been able to identify and invest in some of the biggest brands in history.
But investing acumen isn't the only advantage that Berkshire enjoys. The holding company also has a structural capital advantage that allows it to deploy capital even when markets turn sour, valuations drop, and outside sources of capital dry up. That's because Berkshire owns a large portfolio of insurance operators that generate excess cash regardless of market conditions.
Insurance companies collect cash when premiums are paid, but they only have to relinquish that cash when a policy claim is made. In the interim, insurers get to keep that cash free of interest. Buffett realized decades ago that due to the stability of insurance markets, he could invest this cash at high rates of return no matter what stock markets were doing, providing a structural capital advantage that few investors enjoy.
For these reasons, Berkshire remains a great option for patient investors looking to beat the S&P 500 over the long term. There's only one problem: Berkshire isn't what it used to be. The underlying business model is still intact, but the company's valuation has soared above $1 trillion. Put simply, there aren't many investments Berkshire can make right now that would move the needle.
Only a few companies that exist today, most of them in the U.S., are large enough to have any sizable effect on Berkshire's gigantic portfolio. "Outside the U.S., there are essentially no candidates that are meaningful options for capital deployment at Berkshire," Buffett recently stressed. "All in all, we have no possibility of eye-popping performance."
Is it too late to invest in Berkshire?
Before investing in Berkshire stock today, there are three major factors to consider. First, Berkshire's structural capital advantages, plus the core investment team responsible for its historical success, are all still in place. Second, due to its gargantuan size, these advantages won't result in the eye-popping performance we've seen in the past. Finally, Berkshire's current valuation doesn't provide much to get excited about. Shares now trade at a price-to-book valuation not seen in years.
Should the combination of these factors scare you off? Not so fast. There's one reason to remain optimistic.
BRK.B Price to Book Value data by YCharts.
It is true that Berkshire's giant returns are likely a thing of the past, and its current valuation isn't obviously attractive. But over long periods of time, paying a small premium for a high-quality company is usually worth it, as that premium can be spread across many years, if not decades. What you're left with, then, is a blue chip stock with structural capital advantages still in place, even if those advantages are weaker than in the past.
Will Berkshire shares beat the market by leaps and bounds over the next decade? Likely not. But it still has an above-average chance of beating the market by some margin, even if it's a slim victory. Throughout its history, there has never been a bad time to buy Berkshire stock, as long as you committed to holding the stock for the long term. The same is likely still true today, despite the company's diminished advantages.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. American Express is an advertising partner of The Ascent, a Motley Fool company. Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Apple, and Berkshire Hathaway. The Motley Fool has a disclosure policy.
