JPMorgan analyst Sarah Dewitt just started coverage on famed investor Warren Buffett's Berkshire Hathaway (NYSE:BRK-B) (NYSE:BRK-A), starting the stock with a buy rating. The analyst's optimistic take on Berkshire stock interestingly follows a bullish run recently. Shares are up about 24% in the past year, outperforming the S&P 500's 18% rise during the same period. But she's still betting there's upside.
Is there substance to Dewitt's bullish call on Berkshire stock? Let's have a closer look.
BNSF RAILWAY IS ONE OF BERKSHIRE'S TARGET SUBSIDIARIES. IMAGE SOURCE: BNSF.
DeWitt's bullish outlook for Berkshire
Specifically, DeWitt initiated coverage on Berkshire with an overweight rating, or a Street rating for a stock indicating the security is an above-average bet when compared to benchmark indexes like the S&P 500.
To support her bullish thesis, DeWitt cites Berkshire's "best-in-class businesses," diversified across sectors like insurance, railroads, utilities, and manufacturing. "The businesses benefit from best-in-class managements, unmatched balance sheet strength, and many of the companies have strong brands, scale or low-cost competitive advantages," she explained in a note to clients (via CNBC).
Furthermore, DeWitt said Berkshire's balance sheet is a "significant competitive advantage." She also said her estimates for the stock have upside if Berkshire spends its growing cash hoard on acquisitions.
DeWitt set a $210 price target for the stock, with a time horizon of the end of 2018. At Berkshire's $180 price at the time of this writing, this represents upside of about 17%.
A look at Berkshire's valuation
But are Berkshire's "best-in-class businesses" as undervalued as DeWitt believes they are?
Using one of Buffett's favorite metrics for valuing his own company -- price-to-book ratio -- it could be argued that Berkshire stock is compelling but not necessarily a downright bargain.
As of Buffett's last update on when he would feel compelled for Berkshire to buy back its own stock, Buffett said it would be when the stock dips below 1.2 times book value. Today, Berkshire has a price-to-book ratio of 1.48, above this threshold. But investors should keep in mind several things about Buffett's share buyback target.
First, Buffett's target price-to-book ratio for when to repurchase Berkshire stock isn't a static metric. It changes based on how accurately Buffett believes Berkshire's underlying assets are reflected by its book value. The chairman and CEO has changed the target before, increasing it from 1.1 to 1.2 in 2012. Given the excellent performance of many of Berkshire's biggest subsidiaries in recent years, the company's accounting book value arguably understates the intangible value of its assets more than ever before.
Second, one specific catalyst that could make Berkshire deserving of a higher price-to-book ratio is if the company deploys some of its record cash of just under $100 billion on acquisitions. Given Berkshire's knack for picking companies, cash invested by the Oracle of Omaha is worth more than it is sitting around. And, in support of DeWitt's thesis, Buffett has said he'd love to put the cash to work if he finds the opportunity. "I hate cash," Buffett said in an interview with CNBC in May. He wants to "buy a big business" if the price is right, he told CNBC.
Finally, and probably most importantly, Buffett's target buying threshold of 1.2 times book value represents a level when Buffett believes Berkshire stock is trading at a deep discount. Buffett said last year during Berkshire's annual shareholder meeting that the "stock is worth significantly more than 1.2" times book value -- a statement worth taking seriously when it comes from the world's greatest investor.
With these points in mind, at 1.48 times book value, Berkshire may be more compelling than it might seem at first glance, particularly when considering the future earnings potential of large acquisitions likely on the horizon.
