The Berkshire Annual letter is a must-read item for investors every year. Many readers are eager to learn from the Oracle of Omaha, who may share his investment insights in words.
The intrinsic value of the company
As mentioned in his letter, Warren and his partner Charlie Munger never predict stock price movement. Instead, he focuses on the difference between the intrinsic value of a firm and its market price. If the price is reasonable, they will buy the entire firm or part of its interests.
Investors can divide the assets of the Berkshire into five categories. The first three categories are Berkshire holding companies. The difference between the three is only the percentage of ownership or shareholding structure. The fourth type of asset is cash or cash equivalents, such as US government bonds. As of the end of last year, the Berkshire had a total of $112 billion in liquid assets.
The secret weapon of the Oracle of Omaha
The fifth type of asset is the insurance business. It is the most essential secret weapon of Buffett, besides his ability to calculate the intrinsic value of the enterprise. The insurance business has given Buffett a lot of float, which is premiums received and Buffett uses it as a financing instrument for investment. The float in the Berkshire has risen from $39 million in 1970 to $122,732 million in 2018, rising more than 3,146.97 times (see Figure 1).
Figure 1: The float of the Berkshire
Source: The Berkshire Annual letter 2019
Can we replicate Buffett’s investment strategy?
In 2013, Andrea Frazzini, David Kabiller and Lasse Heje Pedersen of AQR Capital Management published a research article “Buffett’s Alpha”. Its conclusion is that Buffett’s success is not due to luck, but the use of leverage to invest cheap and quality stocks. However, even if your stock picking ability is as good as Warren’s, you can’t replicate the success of the Oracle of Omaha. It is because the average leverage cost of the Berkshire is only 1.7%, an extremely low level.
(Declaration of interest: writer does not hold any position of the Berkshire.)