Berkshire Hathaway may be a buy, even as Warren Buffett departs

Last Updated Oct 7, 2016 7:00 PM EDT

If you already own shares of Berkshire Hathaway (BRK.B), you’re probably quite satisfied about the stock’s solid performance over the years. But if you don’t and have always regretted that, you still have a chance to scoop up shares, most likely at a discount because of some investor concern over Warren Buffett’s impending departure as chairman, CEO and chief investment officer.

A number of investors pulled out of the stock when legendary investor Buffett announced in January his plan to retire and subsequently identified a group of highly experienced investment pros who would succeed him and take command of Berkshire’s operations. Investors feared that Berkshire’s stock would get clobbered once Buffett is no longer running the show, and that the company’s gigantic size would prevent it from achieving its growth plans.

These are legitimate concerns given the scope and power of Buffett’s wizardry in shaping the company over some 70 years into what it is today. But close Berkshire watchers on Wall Street and loyal Buffett supporters passionately believe that a Buffett-less Berkshire will thrive and make Buffett proud about how the show is run after his exit. An insurance-based conglomerate, Berkshire also has interests in railroads, energy,  financial services, publishing, retailing and manufacturing. 

“Berkshire Hathaway will survive the departure of Warren Buffett and [Vice Chairman] Charlie Munger,” proclaims Greggory Warren, senior equity analyst at Morningstar. “With the company’s next CEO expected to fill the role of capital-allocator-in-chief, we see two strong candidates to take the top job: Alit Jain, who runs Berkshire’s reinsurance operations, and Greg Abel, who heads Berkshire’s energy company,” said Warren.

One big positive is that Berkshire will likely focus on eventually 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, Warren noted, and with investment opportunities few and far between, the company continues to build up large amounts of cash on its balance sheet. “We think [barring investment opportunities, cash] should be dedicated to dividends and share repurchases longer term,” said Warren. He doesn’t expect that to happen, however, until Buffett’s departure. 

Although Berkshire is unlikely to consistently increase its book value per share at a double-digit rate, something that Warren noted happened nine times during 2001-2015, and 40 times during 1965-2015, “we think that Berkshire can grow its book value per share at a high single- to double-digit rate going forward, much as we’ve seen since the start of the new millennium.”

Warren believes this type of growth should leave returns solidly and consistently above the company’s cost of capital, which he estimates to be 7.8 percent right now (and somewhere closer to 6 percent when adjusting for the no-cost float generated by Berkshire’s insurance operations). 

Buffett has announced that he has chosen his successor but hasn’t yet identified the person. With Buffett actually having three key jobs -- chairman, CEO and chief investment officer, the succession plan expects those important functions will be handled by one nonexecutive chairman, one CEO and one or more investment managers overseeing the firm’s investment portfolio.

Warren highly regards Abel, who not only has run Berkshire Hathaway Energy but has been involved in every kind of deal the firm has done over the past 20 years, and so Warren believes Abel would make the best CEO replacement. Abel falls into the “relatively young” category and has a lot of operational experience with a capital-intensive firm that has also been fairly acquisitive.

Of course, there isn’t a unanimous agreement on Wall Street that Berkshire would thrive and equal, if not surpass, expectations without Buffett in the picture. Catherine Seifert, equity analyst at S&P Global Market Intelligence, who had been a long-time bull on Berkshire, has now downgraded the stock to a “hold,” mainly because of valuation. Its premium valuation versus the broader market and its peers depends greatly, she said in a recent report, on the company producing profits and revenue growth that are superior to the broader averages.

She has a price target of $152 a share for Berkshire’s B-class stock, currently trading near $144 a share, up from its 52-week low of $123, but below its high of $151.   

Updated to correct the name and title of the Morningstar analyst.