Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) has a lot of positive momentum going into 2018. The stock rose by 22% in 2017, and is off to a great start in 2018, up another 4% less than two weeks into the year. With strong momentum and several positive catalysts that could propel the company's profits higher, could 2018 be Berkshire Hathaway's best year yet?
Berkshire will benefit from tax reform
Tax reform is an obvious catalyst that could help Berkshire in 2018. For starters, Berkshire has massive deferred tax liability from unrealized gains in its stock portfolio, which instantly became much lower. Also, Berkshire's current effective tax rate is about 27%, so the new 21% corporate tax rate could certainly boost profitability.
Analysts seem to agree. Barclays estimates that Berkshire's book value increased by about $37 billion as a result of tax reform, and its ongoing earnings power could rise by 12%.
Buffett himself recently said that he doesn't think tax reform is fully priced into the stock market just yet, so once the effects of the lower tax rate are more apparent (in Berkshire's earnings reports throughout 2018), we could see the stock rise.
Many stocks in Berkshire's portfolio could have great years as well
There are far too many variables that could affect the 2018 performance of the roughly four dozen stocks in Berkshire's portfolio, but some of the company's largest positions are looking strong as we head into the new year.
For example, Berkshire's portfolio is very bank-heavy, with massive investments in Wells Fargo, Bank of America, and American Express, as well as smaller positions in Goldman Sachs, Bank of New York Mellon, among others. Banks have several catalysts that could send earnings higher. Tax reform is the most obvious, as most of Berkshire's banks operate at effective tax rates in excess of 30%. Rising interest rates could also help increase banks' profit margins, as the Federal Reserve is expected to raise rates another three times during the year.
Apple is another of Berkshire's large stock holdings that could have an interesting year. The new tax law will allow the company to finally repatriate its quarter-trillion dollar cash hoard, which opens up a world of possible acquisitions and other capital deployment strategies.
Berkshire could finally deploy its war chest of cash
Speaking of cash hoards, another thing I'll be keeping an eye on in 2018 is whether Berkshire finally decides what to do with its stockpile of cash, which stood at nearly $110 billion at the end of the third quarter, and has likely grown since then.
Berkshire's preferred use for its cash is to either acquire entire companies or invest in common stocks. The problem is that the stock market has been going almost straight up for about nine years, and attractive investment opportunities have become scarce, which is why the company is sitting on so much cash.
Buffett and his team acknowledge that this is a problem, and that they would love to use some of this cash. After all, $100 billion sitting there earning little to no returns isn't exactly a profitable business strategy. Buffett has mentioned the possibility of buying back shares or even paying a dividend if the cash continues to grow, so there are several possible ways that Berkshire could use its cash. If the company manages to use it to significantly increase its per-share earnings power through acquisitions, stock investments, or share buybacks, it could be a major positive catalyst for the stock.
The best year ever?
To be clear, I think that Berkshire Hathaway will have an excellent year in 2018. However, nobody has a crystal ball that can predict the stock market's performance, and if a market correction comes in 2018, like many experts have been predicting, it's certainly possible that Berkshire's share price will go down.
Warren Buffett's main focus isn't delivering stock price gains for Berkshire's shareholders every year. What Buffett does aim to do is to increase Berkshire's earnings power every year, and on this front, it's entirely possible that 2018 could rank among Berkshire's best years ever.
Having said that, it would take a lot for 2018 to be the best year in Berkshire's history. Since Buffett took over 54 years ago, Berkshire's stock price has increased by 50% or more in 10 different years, and by over 100% twice. The company's book value has increased by 40% or more seven times and has only decreased twice. So, while I'm confident that Berkshire will have a great 2018, it's important to realize that the company has had some incredible years since Warren Buffett has been in charge.
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Matthew Frankel owns shares of American Express, Apple, Bank of America, and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.