You'll Be Surprised at the Size of Berkshire Hathaway's War Chest
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$84.8 billion. That's the total amount of cash and cash equivalents on Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) had quietly amassed on its balance sheet by the end of September. No publicly traded U.S. company has a larger cash hoard. Not Apple , nor Google parent Alphabet -- no one.
(Strictly speaking, that isn't true, but the only companies that are ahead of Berkshire on this measure are a few large banks, including Bank of America and Goldman Sachs Group . We should exclude banks from the comparison, because they have a very specific business model that demands a lot of leverage.)
Free money: Understanding insurance float
In fact, Berkshire's cash is not entirely unencumbered: Remember that one of the company's significant business lines is insurance. At the end of September, Berkshire's insurance operations had invested assets totaling nearly $190 billion, of which $50.2 billion were in cash and cash equivalents. Part of these invested assets represent shareholder capital, including retained earnings, but approximately $91 billion derive from insurance float, i.e. liabilities.
If you're not familiar with the concept of float, here is how Warren Buffett defined it in his 2004 shareholder letter :
[Float] is money that doesn't belong to us but that we temporarily hold. Most of our float arises because (1) premiums are paid upfront though the service we provide -- insurance protection -- is delivered over a period that usually covers a year and; (2) loss events that occur today do not always result in our immediately paying claims, because it sometimes takes many years for losses to be reported (asbestos losses would be an example), negotiated and settled.
As such, float is a "net liability" -- basically, the liability created by an open insurance contract net of the premiums received. However, it's an unusual form of liability that has some attractive properties for the company that bears them. As Buffett explained in his 2015 shareholder letter (emphasis is mine):
So how does our float affect intrinsic value? When Berkshire's book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to think of float as strictly a liability is incorrect. It should instead be viewed as a revolving fund. Daily, we pay old claims and related expenses -- a huge $24.5 billion to more than six million claimants in 2015 -- and that reduces float. Just as surely, we each day write new business that will soon generate its own claims, adding to float.If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability. Owing $1 that in effect will never leave the premises -- because new business is almost certain to deliver a substitute -- is worlds different from owing $1 that will go out the door tomorrow and not be replaced .
The elephant gun is loaded
The very fact that float dollars "will never leave the premises" is what has enabled Berkshire to invest some of the float. The bulk of its public equities portfolio is housed within its insurance operations, for example. Nevertheless, Buffet has said repeatedly that he would not allow Berkshire's cash position to fall below $20 billion -- an amount he considers sufficient to cover large, unexpected insurance losses.
Even after you account for that buffer, however, Buffett's "elephant gun" is well-loaded, with ammunition to spare. (In his lingo, "elephants" are large acquisitions.) Subtract $20 billion from the $84.8 billion cash position leaves you with $64.8 billion -- an amount that is greater than the individual market capitalizations of more than 85% of the companies in the S&P 500.
Ready, aim, ... wait.
What are some possible acquisition candidates? Earlier in the week, I profiled 3 "Warren Buffett" companies : Infant formula manufacturer Mead Johnson Nutrition (market capitalization: $13.3 billion), lubricants specialist Valvoline ($4.2 billion) and ceiling products manufacturer Armstrong World Industries ($2.3 billion). However, they aren't elephants and they might not all be cheap enough for Buffett's taste. (He has to pay a premium for control, after all.) For size and quality, industrials Parker-Hannifin ($19.1 billion) and FANUC ($35.2 billion) fit the bill, but they don't look quite cheap enough, either.
With equity valuations looking a bit rich, it's no surprise that Berkshire Hathaway's war chest has continued to grow. For Buffett-watchers like this Fool, it's great fun to try and anticipate how he will next deplete it (and try to understand his choices, once they are known).
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