Berkshire Hathaway's Sustainable Competitive Advantage

By Markets Fool.com


Berkshire Hathaway owns a major railroad, among many other businesses. Photo: Kurt Haubrich, Flickr

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When it comes to discussing Berkshire Hathaway's sustainable competitive advantage, it's difficult to choose, because there are more than one.

It's a topic worth exploring because Berkshire has been an outstanding investment for shareholders for decades, and is poised to keep performing well in the future, though perhaps, due to its size, not quite as well.

Here's a review of some of its biggest advantages over rivals:

Buffett himself
CEO Warren Buffett won't be a sustainable competitive advantage for many decades to come, but he's been a key one for the company for the past 50 years and stands a decent chance of remaining productively at the helm for another decade. Buffett's asset allocation skills, along with his people skills and business sense, have been a powerful edge for Berkshire, and as evidence, check out its 50-year record: average annual gains in the company's market value of 21.6%, versus just 9.9% for the S&P 500 (with dividends included).

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Buffett considers his shareholders to be his partners. Photo: Roberta Romero, Flickr

Additional investing talent
The company isn't doomed once Buffett moves on to a more celestial realm, either. He has so far recruited two investing lieutenants, Ted Weschler and Todd Combs, and they've been delivering strong results in recent years, as Buffett and partner Charlie Munger have increased the sum they get to invest to more than $7 billion each. Fortune magazine estimated that both failed to beat the market in 2014, but per Fortune, "Combs' portfolio was up by an astounding 51% in 2013. Through the second quarter of last year, his portfolio was up 116% since joining Berkshire. Weschler, who joined Berkshire a year later, was up 81% through the middle of last year."

Buffett is making them even more valuable by placing each of them operationally at the helm of a Berkshire subsidiary, which will impart business experience that can enhance investment decisions.

Diversification
Another edge that Berkshire enjoys is its diversification. Its operations and investments span many industries, such as insurance, railroads, energy, home building, jewelry, furniture, paint, private jets, candy, recreational vehicles, ice cream, chemicals, newspapers, underwear, tools, food-service equipment, and car dealerships, among others. When one sector is in a slump, others may not be, and can provide offsetting effects. That's especially true because some of his businesses are in defensive and not very cyclical industries: When the economy is stalled or slumping, people will still use energy and buy insurance and underwear.

Berkshire Hathaway's subsidiaries range from trains to energy to underwear and ice cream. Photo: davidneubert.com

The business model
Berkshire Hathaway's business model is a thing of beauty, and one that cannot be easily duplicated -- or changed. Think again of the company's extensive diversification and its dozens of subsidiaries. Each of them, ideally, generates profits. But each is different in terms of its capital needs and growth prospects. See's Candies, for example, kicks out many millions in profits, but it doesn't need to reinvest all that money in growing its business since it's a relatively mature business. Meanwhile, subsidiaries such as the BNSF railroad are capital intensive, requiring new equipment and safety upgrades and so on. But whereas a stand-alone railroad is more limited in the cash it can produce and deploy, BNSF has the full force of Berkshire behind it, and can tap those See's dollars, among others. Buffett is expert at allocating capital where it's most needed.

Float
Another key advantage relates to one of Berkshire's primary operations: insurance. A major feature of insurance is "float" -- the money that insurers collect upfront in the form of premiums and which it doesn't have to immediately pay out, as claims roll in throughout the year. Berkshire gets to make money off of that float, and that money can help it grow even bigger, as Buffett invests it as effectively as he can. Berkshire's float as of the end of March, 2015, was nearly $84 billion. That alone is more than the entire market value of Starbucksor Ford Motor Company!

Cash
Cash is a sustainable competitive advantage for Berkshire because Buffett likes to keep at least $10 billion in cash in order to deal with unexpected developments or to help him take advantage of opportunities. Of course, the company often has much, much more than that in cash and liquid assets, with more coming in regularly. Its net income over the past 12 months was around $20 billion. Berkshire's stellar reputation also makes it very credit-worthy, too, with access to even more capital.

Its massive cash pile is another advantage. Photo: Reynermedia, Flickr

At the 2013 annual shareholder meeting, journalist Carol Loomis asked Buffett and Munger what Berkshire's competitive advantage is. Munger replied:

We have tried to stay sane when others like to go crazy.This is a competitive advantage.Second, we have used the golden rule: We treat subsidiaries how we would want to be treated if we were subsidiaries.People come to us who do not want to go elsewhere. That is a long-term advantage.We have tried to be a good partner and that is an advantage.

Buffett added, "Our competitive advantage is that we do not have many competitors."

There are even more competitive advantages that Berkshire Hathaway enjoys, such as its GEICO insurance unit's low operating costs and the excellent reputation of the company's name, which it has been affixing to more of its businesses lately. All together, they have helped turn the company into a formidable fortress. It's not 100% unassailable, but it's hard to imagine the company not continuing to grow for decades to come.

The article Berkshire Hathaway's Sustainable Competitive Advantage originally appeared on Fool.com.

Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, ownsshares of Berkshire Hathaway, Ford, and Starbucks. The Motley Fool recommends Berkshire Hathaway, Ford, and Starbucks. The Motley Fool owns shares of Berkshire Hathaway, Ford, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.