Few businesses have created more wealth for investors than Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B). Led by legendary investor Warren Buffett, Berkshire has generated annual gains of greater than 20% for its shareholders over a span of more than 50 years.
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Incredibly, Berkshire appears poised to continue to reward its investors handsomely in the years ahead. Here are three things that can help bring about further gains in Berkshire's stock price.
The market falls
This may seem counter intuitive, but a good chunk of Berkshire's value creation occurs during periods of market distress. As just one example, Buffett seized an opportunity during the early stages of the 2008-2009 financial crisis to invest in Goldman Sachs (NYSE: GS) at fire sale prices.
As my colleague Jordan Wathen notes, Goldman Sachs was in danger of being pulled down by a contagion caused by the failure of multiple interconnected financial institutions. Berkshire provided a lifeline to the troubled investment bank in the form of $5 billion in capital and, perhaps more importantly, the credibility gained from Buffett's endorsement of the firm. In return, Buffett received preferred stock and warrants that would go on to generate more than $3 billion in profits for Berkshire Hathaway as the market -- and Goldman Sachs' stock price -- recovered.
It's this ability to provide liquidity to troubled firms that gives Berkshire a powerful advantage during periods of market turmoil. Thanks to its massive cash reserves, Berkshire is often able to serve as a lender of last resort and invest its capital at highly attractive rates of return during these volatile periods. Market declines also give Buffett the opportunity to further bolster Berkshire's investment portfolio by scooping up shares of strong companies whose stock prices are dragged down with the rest of the market. "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold," says Buffett. When the market pours gold, Buffett stands ready to collect on behalf of Berkshire's shareholders.
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Buffett bags another elephant
A severe market panic could also provide Buffett with a chance to make another blockbuster acquisition. At more than $400 billion, Berkshire's megacap status makes it difficult for Buffett to find attractive deals that can move the needle in terms of the value they add to the company. But if market prices were to fall dramatically, Buffett may have a chance to pull the trigger on his "elephant gun" once again.
Berkshire has about $100 billion in cash, but it likes to maintain at least $20 billion in reserves. If we subtract another $9 billion to account for Berkshire's recently reported bid for Texas-based utility Oncor, that still leaves around $70 billion in dry powder that Buffett could use for another major acquisition.
While large acquisitions often fail, Berkshire's track record of value creation is sterling. Buffett will almost assuredly earn higher returns on Berkshire's capital by purchasing another strong business than by letting the cash languish in the company's coffers. Investors know this, and are therefore likely to bid up Berkshire's shares on any news of a new deal.
Buffett's lieutenants continue to outperform
Buffett isn't the only person investing Berkshire's capital. Todd Combs and Ted Weschler were handpicked by Buffett to help manage Berkshire's investment portfolios, and to eventually take over the reins when Buffett is no longer with the company.
Weschler and Combs have done an excellent job by all accounts, with both handily outperforming the overall market during their time at Berkshire. In turn, Buffett has steadily increased the amount of Berkshire's capital entrusted to them, with each now managing more than $10 billion.
If Combs and Weschler can continue to rack up heady gains, it will go a long way toward assuaging investor concerns that Berkshire's investment performance will decline when Buffett inevitably steps down. In turn, Berkshire's stock price could receive a boost as investors grow more confident in Combs' and Weschler's abilities.
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