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Buffett's Berkshire Could Post Double-Digit Gains -2-

20 May 2017 5:16 am

Geico expanded its policyholders by 700,000 in the first four months of this year -- compared with roughly 300,000 in all of last year -- to a total of more than 15 million because of favorable conditions in the auto insurance market. Premiums are rising to reflect higher claims, in part the result of texting drivers. Berkshire is willing to accept losses in the first year of the policies, reflecting acquisition costs, including advertising, to get customers who should be profitable over the long term. Russo estimates the loss on a new policy at $250 annually, but the subsequent payback could be $2,000 per policy.

"Nothing in life distracts him from building Berkshire's intrinsic value on a per share basis," Russo says. The per-share emphasis is critical to Berkshire's success.

BUFFETT IS LOATH to issue stock for acquisitions, preferring cash. In his latest annual letter, Buffett highlighted an impressive statistic: Since the company began redirecting its cash flow to buying businesses in 1999, its net income from operations has risen to almost $18 billion from under $1 billion, with just an 8.3% rise in the share count.

Berkshire remains underrepresented in institutional portfolios. Many big investors want direct access to management, and Buffett rarely obliges. The company holds no earnings conference calls or investor days, aside from the annual meeting, and has little analyst coverage, a reflection in part of the company's complexity.

Buffett has said Berkshire's ample and diversified earnings and financial strength ought to make it an ideal choice for pension funds and endowments, but there's scant interest. And Berkshire is a bargain compared with hedge funds, with Buffett still earning a salary of just $100,000 annually. His net worth is over $70 billion in Berkshire stock, despite his having given away 40% of his shares, mostly to the Bill and Melinda Gates Foundation, since 2006.

There's understandable concern about the post-Buffett Berkshire, given his incomparable record. The likely leadership structure will involve an as-yet-unnamed CEO, with Buffett's son Howard as nonexecutive chairman. Two current investment managers, Ted Weschler and Todd Combs, who oversee more than $20 billion of equities, will probably take control of the entire investment portfolio while playing an advisory role with the new CEO.

Buffett, who has been highly critical of professional money managers, particularly those who run hedge funds, for their fees, favorably noted at the meeting that Combs and Weschler earn a relatively modest $1 million annually, getting a bonus only if they beat the S&P 500.

WE HANDICAP GREG ABEL, the head of Berkshire Energy, as noted above, as the favorite to take over for Buffett. Berkshire Energy had net income of $2.5 billion last year, making it one of the largest utilities in the country. The other oft-mentioned candidate is Ajit Jain, who is 65 and lacks experience running a large organization. Buffett indicated at the meeting that his successor could be named while he's still alive. The longer he stays CEO, the higher those chances.

While prospects for corporate tax reduction have dimmed with Trump's fortunes, Berkshire would be a big winner if it happens. At a 20% corporate tax rate, Berkshire's book value could see a 9% boost from a reduction in its deferred tax liabilities, and its earnings could rise about 15%, estimates Barclays' Gelb. Those tax liabilities stem largely from unrealized gains in the company's equity portfolio. A lower tax rate would reduce the liability, boosting shareholder equity.

With a combination of offensive and defensive qualities, Berkshire is a good bet to top the S&P 500 in the coming years -- although the gap is apt to be closer to one or two percentage points, which has been the experience over the past 10 and 20 years, than the staggering 11-point advantage over Buffett's 52-year tenure. Berkshire doesn't need Buffett to remain a good investment.

Email: editors@barrons.com

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(END) Dow Jones Newswires

May 20, 2017 01:16 ET (05:16 GMT)

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