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The Stalwart Rise of Berkshire Hathaway: A Pragmatic Path to Outperforming the S&P 500

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Competing in the world of finances, where higher rewards typically come with higher risks, can sometimes feel like traversing a tightrope during a thunderstorm. But occasionally, an oasis of opportunity emerges that promises to outshine a standard benchmark like the S&P 500 while maintaining a lower level of uncertainty.

Warren Buffett, the revered Oracle of Omaha, recently extolled Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) as one such investment gem in his latest epistle to shareholders. While his endorsement might seem biased given his huge $135 billion stake in the company, Buffett’s rationale is solid, making a strong case for the appeal of the stock.

“Slightly better” Than the Average American Corporation

Having taken the reins of Berkshire Hathaway in 1965, Warren Buffett steered the ship to spectacular heights, outpacing the S&P 500 by a hefty margin. The company’s compound annual gain until 2023 stood at an impressive 19.8%, overshadowing the index’s 10.2%. Buffett, however, foresees a departure from such bonanza returns.

Expressing his outlook, Buffett mentioned he anticipates Berkshire to perform “a bit better than the average American corporation,” while cautioning against harboring expectations beyond “slightly better.” The Berkshire portfolio boasts illustrious holdings like Coca-Cola, American Express, and a burgeoning interest in Occidental Petroleum, among others.

Berkshire Hathaway’s asset mix also features a thriving insurance arm and a robust railway operation, collectively generating $37 billion in operating income last year. Notably, its premier investment in Apple, valued at around $155 billion, underscores Buffett’s profound commitment, constituting over 40% of Berkshire’s equity holdings.

Reflecting on the conglomerate’s evolution, Buffett conveyed to shareholders in February, “After 59 years of curation, the company now oversees either partial or complete ownership of various entities that, on a weighted aggregate, exhibit more promising prospects than the majority of large American corporations.”

The Enormous Protection Policy Sitting on Berkshire’s Balance Sheet

Noteworthy in recent times is Berkshire Hathaway’s staggering cash and equivalents reserves, swelling to $168 billion. This substantial sum is primarily parked in short-term Treasury bills, a move that Buffett regards as potentially excessive. He likens this cash hoard to an insurance safeguarding against a putative fire in a seemingly fireproof edifice.

While the colossal cash reserve shields Berkshire in downturn scenarios, it also acts as a drag on investment returns. Nevertheless, the prevailing interest rates offer solace, with the company reaping more than 5% annual interest on its Treasury holdings.

However, with Federal Reserve Chairman Jerome Powell signaling intentions to reduce interest rates post the latest Federal Open Market Committee meeting, Berkshire’s cash buffer becomes a subject of contemplation. Continuously churning out tens of billions in free cash flow, Buffett faces the challenge of deploying this capital judiciously to generate further gains.

Amid the dilemma of scaling up investments given Berkshire’s expanded size, Buffett has found respite in the company’s robust share buyback program, a move that has proven fruitful given the current stock valuation vis-a-vis future potential.

Does Berkshire belong in your portfolio?

In Buffett’s reckoning, Berkshire is no longer poised to deliver returns surpassing the S&P 500 by the prodigious 9.5 percentage points per annum witnessed in bygone eras. Yet, the company presents an alluring proposition for risk-adjusted returns.

Endowed with a substantial cash cushion, Berkshire stands fortified to weather economic storms, safeguarding its railway and insurance interests. Moreover, this war chest positions Berkshire advantageously to pounce on lucrative opportunities should market conditions deteriorate.

Bolstered by a well-diversified investment portfolio and a reasonable valuation — trading at just 23.7 times the previous year’s operating earnings, sans the probable gains from its equity holdings — Berkshire Hathaway emerges as an undervalued contender. Factor in Buffett’s astute stock-picking acumen, promising a “slightly better” than average performance, and Berkshire comes across as a promising avenue for long-term investors.

While the investment landscape remains as capricious as ever, Berkshire Hathaway’s steadfast approach under Buffett’s stewardship offers a beacon of reliability in an unpredictable world of finance.

American Express is an advertising partner of The Ascent, a Motley Fool company. Adam Levy has positions in Apple. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.

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