Welcome to Finance and Fury, the Say What Wednesday edition. Today’s question comes from Mario.

“With the success of Warren Buffett’s Berkshire Hathaway would it be wise to invest in their Class B shares? It is often said that Berkshire Hathaway is one of most successful investment houses and so I wonder if it’s a really good long term horizon investment? Class A shares are so high and out of the reach of most people but I note Class B shares are more accessible but come with risk of changes and further dilution from Berkshire Hathaway. Also from a yield perspective I was unable to understand if they actually pay consistent dividends but then given Berkshire Hathaway view is about value investing am correct in thinking this stock is more growth oriented?”

Thanks so much for your thoughts and views – Mario

In this episode – Look at difference between class a and b shares – long term growth prospects and dividends, then the difference between growth and value

Berkshire – Difference between class A and B

  1. The primary difference between Berkshire Hathaway Class A stock and Class B stock is one of price.
    1. Class A – current $267,080 – was $342,122
    2. Class B – current $178 – was $228 – both have had about a 22% loss
  2. Because of the price difference, Class B shares offer increased flexibility for investors because Warren Buffett has declared that the Class A shares will never experience a stock split
    1. because he believes the high share price attracts like-minded investors, those focused on long-term profits rather than on short-term price movements
    2. Imagine owning just one share of Class A share – if you need $50k, need to sell the whole thing as opposed to selling a chunk of your class b shares –
  3. Where did they come from – and how do they operate – In 1996, Buffett created Class B shares (BRK-B)
    1. Initially offering investors the ability to invest in Berkshire Hathaway for one-thirtieth the price of a Class A shares
    2. Then a 50-to-one stock split in 2010 sent the ratio to one-1,500th.
    3. Does this mean that you are at risk of further dilution? Yes and no – yes the shares can be further diluted – but unlike say share placements – which are issued to the public – the shares are split and you retain ownership – so your 1 share turns into 50 shares – then over the years people sell off and the ownership spreads around
    4. Class B shares carry correspondingly lower voting rights as well. Buffet stated that the purpose of creating the Class B shares was to give smaller investors the opportunity to invest directly in Berkshire Hathaway, rather than only participating indirectly through mutual funds that mirror Berkshire Hathaway’s holdings.
    5. One final difference is that Class A shares can be converted into an equivalent amount of Class B shares any time a Class A shareholder wishes to so do. The conversion privilege does not exist in reverse. Class B shareholders can only convert their holdings to Class A by selling their Class B shares and then buying the equivalent in Class A shares.
  4. Summary – There’s no substantive difference between the two, except that a share of Class B stock has 1/1500th the value of a Class A share and a corresponding fraction of its voting power.
    1. A and B: Pros and Cons – for those investors who are able to either choose between investing in a smaller number of Class A shares or a much larger number of Class B shares, there are a few pros and cons of each to keep in mind.
    2. pure performance – there is normally no difference between Class A and Class B shares (represent stakes in same company) – but there can be due to market dynamics and differing pools of investors -mainly due to liquidity however – those investors in class A shares may spot this and jump across – so isnt really a factor
    3. Flexibility – Class B is obviously better – but for same voting rights, would need to own 1,500 b shares for one A share

Difference between the type of internal investing style versus the Berkshire shares

  1. Value investing – Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. Value investors actively ferret out stocks they think the stock market is underestimating
    1. High-profile proponents of value investing, including Berkshire Hathaway chairman Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the “margin of safety”.
    2. buying securities that appear under priced by some form of fundamental analysis
  2. Growth Investing – Growth investing is a style of investment strategy focused on capital appreciation. Those who follow this style, known as growth investors, invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios.
  3. Internally – they buy companies based on Value –
    1. They buy out whole companies – but only if they see value – metrics can be based on synergies or restructuring – as a conglomerate can act differently to an individual or institutional growth investor
  4. But Berkshire shares don’t really trade like value – they are Growth
    1. One metric is the PE ratio – sitting at about 43 – which is in the growth territory

When it comes to Berkshire Hathaway Class B shares, they are definitely a long-term growth focus as they don’t pay any dividends.

Why don’t they pay dividends  – Reinvesting is Top Priority –

  1. reinvest profits in the companies he controls for a number of reasons – can be to expand their reach, create new products and services, etc
    1. Rather than pay investors income – wants to pay them back in capital growth
  2. Major uses of cash – he has said that he has three priorities for using cash that are ahead of any dividend:
    1. Reinvesting in the businesses
    2. making new acquisitions – may be preparing for a major acquisition – hadn’t made one in nearly four years
      1. recently sold out of airlines and other companies the company having a record amount of cash on hand – $130 billion – more than enough to buy out CBA twice over with the currency exchange
    3. buying back stock when he feels that it is selling at “a meaningful discount to conservatively estimated intrinsic value.”
      1. It purchased $700 million of its own stock in the third quarter of 2019

Also – total returns needs to be remembered – income + growth = total

  1. BRK shares look like they grow a lot (and they do when compounding) – because no income is passed back on to individuals –
  2. Comparison in total returns – Look at Vanguard International index (hedged so all in USD) – has almost the same returns assuming income is reinvested –
    1. 10y 9.02% vs 8.45% for BRK
    2. 5y 3.97% vs 4.02% for BRK
  3. But – what BRK does well is tax deferral investing – they are the master at this – you pay no tax along the way – and internally nor do they really – so no cuts to reinvestments – that is how they truly perform well – good for investors as well until they sell – and get CGT

However, when it comes to the long-term focus on the company, Warren is 89 so his longevity in the business may be limited.

  1. The future success of the business comes down to how well the company is managed without his presence, but I think it will be just fine
  2. I can imagine that this is on the companies mind as well – as well as the major institutional investors –
  3. There might be a bit of a panic when he passes – especially as he has 30% of voting rights and 16.45% of direct ownership – so this may be split up or given to trusts – probably wont cause a spike in supply –

Summary – little difference from class of shares – just at a fraction

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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