Warren Buffett has built his fortune and legendary reputation with his holding company, Berkshire Hathaway (BRK.A -0.39%) (BRK.B -0.56%). The company's stock has lucratively rewarded those who invested along the way. Despite not paying dividends, the stock has returned over 239,000% since 1980. That's enough to turn $100 into $240,000!
Unsurprisingly, Berkshire Hathaway is one of the world's largest corporations today, worth approximately $1 trillion. That means investors must be somewhat conscious of the price they pay for the stock, because overpaying could stifle investment returns if a high valuation doesn't hold up.
So, is this legendary stock a buy, sell, or hold?
Here is what you need to know.
Why investors should use Berkshire's book value as their compass
Often, investors value a stock on the company's earnings. However, holding companies like Berkshire Hathaway are different in that they have many moving parts that make the bottom-line earnings less meaningful as a reflection of how well the business is performing. Berkshire Hathaway owns dozens of individual companies, including GEICO Insurance, railroads, utilities, and consumer-facing brands like Dairy Queen, Duracell, and Fruit of the Loom. It also owns various stakes in publicly traded companies, like Apple, Coca-Cola, and American Express.
All these parts of Berkshire Hathaway generate cash flow that Berkshire then uses to create value for its shareholders. That may be through share repurchases, acquiring new businesses, or investing in publicly traded companies.
So, using book value is arguably the best way to track how Berkshire is creating shareholder value. You can see below that Berkshire has successfully grown its book value over time:
BRK.B Book Value (Per Share) data by YCharts
Berkshire stock is expensive relative to its historical norms
Buffett is notoriously picky about the prices he pays for investments. Therefore, it's noteworthy that Berkshire opted against spending any money to repurchase its stock in the third quarter. That alone doesn't indicate whether individual investors should buy the stock, but it adds some context to the numbers below.
You can see that Berkshire Hathaway has traded at an average of 1.4 times its book value over the past decade. Today, the stock is at 1.58 times book value, a 13% premium:
BRK.B Price to Book Value data by YCharts
The risk of overpaying, even for a stock like Berkshire, is that high valuations can snap back when something happens, like a broader market downturn. Just look at how Berkshire's price-to-book value has declined significantly at times. Investors should be mindful about paying too high a premium for Berkshire (or any stock).
Ok, the stock may not be a buy -- but here is why you shouldn't sell
Given the hefty premium on Berkshire's valuation and its massive size (which can drag on growth), it's hard to call Berkshire a buy today.
The good news is that Berkshire currently enjoys remarkable financial flexibility. Just as an investor should look to see how a company could grow its earnings in the future, Berkshire has an opportunity to increase its book value over the coming years. Buffett has steadily raised cash by trimming Berkshire's investments in overweight holdings like Apple, piling up a whopping $325 billion in cash and short-term investments. That's enough money for a game-changing move (or moves), even for a company as large as Berkshire.
Berkshire must use that money wisely to create value for shareholders, which is no guarantee. However, Berkshire's stellar track record may understandably earn a leap of faith from investors. That's why the stock should remain in your portfolio if it's already there. It's hard to sell world-class companies like Berkshire Hathaway, as they tend to steadily generate value that lifts their share price and limits the times they are undervalued to rare occurrences. In other words, buy Berkshire Hathaway stock at a fair price, arguably closer to its historical norms.
While the stock may not be priced right for buyers at the moment, the stock is an easy hold.
