In the 56 years since Warren Buffett took over a struggling textile manufacturer called Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B), the company has been one of the biggest investment success stories of all time, averaging returns of more than 20% per year for investors.
Now a conglomerate with more than 60 subsidiary businesses in a variety of industries and a diverse stock portfolio worth more than $200 billion, Berkshire has a market capitalization of about $464 billion as I write this. However, Berkshire's stock performance has been lackluster over the past few years, so what would have to happen for it to reach a trillion dollar market capitalization.
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Investors would need to get excited
One of the biggest reasons Berkshire's market cap isn't closer to $1 trillion is that investors simply don't seem too excited about the company's future potential.
This can be seen plain as day in Berkshire's current price-to-book multiple of less than 1.25, which is historically low for the company. Just before the COVID-19 pandemic hit, Berkshire's P/B was about 1.3 and has spent much of the past three years between 1.4 and 1.5.
While the company certainly hasn't been completely immune to the pandemic, most of its larger business segments have been largely unaffected. Insurance premiums are still being paid and so are utility bills, just to name a couple. Instead, a big part of the depressed valuation is likely because investors are having a tough time getting excited about Berkshire's potential.
One big reason is because of the lack of investment activity we've been seeing lately. Since buying Precision Castparts in 2015, Berkshire hasn't made any major acquisitions and activity in its stock portfolio has been rather low. As a result, Berkshire's cash stockpile has swelled to $137 billion at the end of the first quarter – its highest level ever. And to the disappointment of many shareholders, Berkshire was actually a net seller of stocks during the first quarter of 2020 when the market plunged.
Plus, while I wholeheartedly believe that Warren Buffet is one of the greatest investors who ever lived, the Oracle of Omaha has certainly picked some duds in recent years when he has chosen to put money to work. The company's investments in the four major U.S. airlines that were sold at a loss once the COVID-19 pandemic hit were the most recent example, but Buffett's massive Kraft Heinz (NASDAQ: KHC) stake has been an absolute bust as well. And recall that aside from the huge Apple (NASDAQ: AAPL) investment, Berkshire's stock portfolio is highly concentrated in the financial sector, which has been one of the worst-performing parts of the stock market in 2020.
Small investments in relatively boring industries like Berkshire's recent purchase of Dominion's (NYSE: D) natural gas assets aren't going to do it. But if Berkshire can get investors exciting by aggressively deploying its massive stockpile of cash in undervalued stocks and businesses with potential for growth, I wouldn't be surprised to see Berkshire's valuation shoot higher.
Strong stock performance would help get Berkshire to $1 trillion
It's also worth pointing out that much of Berkshire's performance is out of its hands, thanks to its massive portfolio of common stocks. In other words, if Berkshire's stock portfolio were to rise in value by 50%, it would (theoretically) add more than $100 billion to the company's market cap all by itself.
Berkshire's Apple (NASDAQ: AAPL) investment has been a big help, but many of the other large stock investments, especially financials such as Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), and American Express (NYSE: AXP) are significantly lower than their pre-pandemic prices. So, if Berkshire's stock portfolio performs strongly over the next year or two as the pandemic (hopefully) winds down, it could be a major catalyst that drives Berkshire's market cap closer to the trillion-dollar mark.
It's likely a "when," not an "if"
To be clear, Berkshire Hathaway will almost certainly join the $1 trillion club eventually – it's just a question of when. Even if Berkshire's stock simply matches the S&P 500's historic rate of return, it would take less than eight years to reach a trillion-dollar market cap.
Having said that, under the right circumstances (strong portfolio performance and able to find attractive ways to deploy capital), Berkshire could reach the $1 trillion club much sooner.
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Matthew Frankel, CFP owns shares of American Express, Apple, Bank of America, and Berkshire Hathaway (B shares) and has the following options: short October 2020 $20 puts on Wells Fargo. The Motley Fool owns shares of and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends Dominion Energy, Inc and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short September 2020 $200 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.