Background of Berkshire Hathaway Inc.
Berkshire Hathaway Inc is one of the most respected companies in the world and it is led by its Chairman and CEO, Mr Warren Buffet. It is a major holding company owning subsidiaries in a number of business sectors. Its main centre of activity is in the insurance sector. It is a multinational company offering insurance and reinsurance services.
The history of this company can be traced back to 1888 where the Hathaway Manufacturing Company was a successful cotton milling firm. In 1955, it merged with Berkshire Fine Spinning Associates, also in the same business line. Then, in the 60s, with the new Chairman, they ventured into insurance business by taking over National Indemnity and National Fire and Marine Insurance. From thereon, the new conglomerate has engaged on an expansion process through acquiring many companies in the same sector and also diversifying in other related sectors. Among the most famous investment was the acquiring of Government Employees Insurance Company, also known as GEICO.
Since then, the company has been riding on the wave of success and reached uprecedented summits on the stock market. Although, it has a relatively small number of shares available on the market for such a big multinational, its market capitalisation is among the highest. This is explained by the high value of its shares.
Description and analysis of Berkshire's performance over time.
As seen in figure 1 below, the annual percentage change in returns was plotted to depict the trend of Berkshire. In 1970, Berkshire engaged in a huge diversification strategy which consisted in acquiring shares in high ranking companies, for e.g.; Blue Chips Stamps in 1970. Five years later, Berkshire began buying shares in GEICO (Government Employees Insurance Company).
Over the years from 1980s to late 1990s, Berkshire achieved positive returns averaging 30%, achieving dramatic peaks at 50% at some times. However, it can be seen that Berkshire suffered an unprecedented plunge in its stock price in 1999 with only a 0.5% return as compared to 48.3% in 1998. This was mainly due to the acquisition of General Re, another insurance company and it added up to a low prospect of any appreciation in the stock price in that year.
From 2002 to 2006, Berkshire seemed to recover although the return was low but steady. It was only to last upto 2008 and the global economic crisis. Berkshire experienced its worst performance since three decades, sporting a sad 9.6% fall in its price.
Using the Compounded annual gain and overall gain, it can be seen that Berkshire could be categorised as a growth stock because it has been able to achieve on average 20.47% positive return over the whole period from 1965 to 2008. The buy-and-hold return of 362,498% indicates that the growth of Berkshire from its original value in 1965.
Comparison of Berkshire's performance with S&P 500
The chart in figure 2 depicts the annual percentage change in the stock price of Berkshire Hathaway alongside the market index, which is the S&P 500. However, it should be emphasised that Berkshire succeeded in outperforming the market.
Berkshire has actually bid the market index 38 years out of the overall 44 years for this data. All this implies that Berkshire has performed better than the market and is a reliable growth stock.
It was found out that Berkshire displayed better results than the market index. The measures of location, that is; the mean and the median of Berkshire are almost twice as high as those of S&P 500. It could be said that the average Berkshire's returns were higher than those of S&P 500.
Also the measures of dispersion, that is; the variance and standard deviation of Berkshire are lower than those of S&P 500. As the S&P 500 is the market index, it can be added that Berkshire was not as volatile as the market.
The degree of kurtosis is positive for Berkshire while it is negative for S&P 500, indicating that Berkshire's returns are more influenced by infrequent extreme values as compared to S&P 600, which has a flatter distribution. The degree of skewness is a measure of asymmetry of the probability distribution. In simple terms, it means that returns of Berkshire were concentrated below the mean as compared to those of S&P 500, which are above.
The frequency distribution of Berkshire and that of S&P 500 as seen in Appendix 4, clearly show that Berkshire's distribution of returns has a high peak, also illustrated by the kurtosis index while that of S&P 500 is quite skewed to the left. It could be said that Berkshire returns are quite near to the normal distribution in shape.
In order to enable a sensible comparison between Berkshire and S&P 500, tests of significance should be carried out. A significance level of 95% was used for all of the tests computed. The null and alternative hypothesis will be as follows:
- H0: Berkshire Returns = S&P 500 Returns
- H0: Berkshire returns - S&P 500 returns= 5%
- H0: Berkshire returns - S&P 500 = 10%
H1: Berkshire Returns > S&P 500 Returns
It can be seen that as the t critical value was lower than the t statistics, the alternative hypothesis was accepted. In fact, this means that Berkshire was able to earn significantly higher returns than S&P 500.
H1: Berkshire returns - S&P 500 returns > 5%
Both the t-statistic and the p-value when compared to the t-critical value and significance level (5%) respectively, showed than Berkshire' returns were significantly greater than those of S&P 500, by more than 5%.
H1: Berkshire returns - S&P 500 returns > 10%
For the third part, the objective was to test whether Berkshire bid S&P 500 by more than 10%. For this test, it was seen that the t-statistic and the p-value were greater than the t-critical value and the significance level respectively, as seen in table (iii) in Appendix 5. Therefore, it can be concluded that Berkshire was not able to outperform S&P 500 by more 10% at the 95% significance level.
Analysis of Berkshire's performance using CAPM
The Capital Asset-Pricing Model tries to predict the relationship between the risk of an asset and its expected return. However, for the model to work there are some assumptions that need to be present, namely;
- All investors are rational,
- No taxes on returns and no transaction costs.
- Information is publicly available to everyone.
The CAPM equation is as follows:
BerkshireExcess Return = α+ β*S&P 500Excess Return
Beta, α coefficient is a measure of the sensitivity of the stock excess returns to changes in the market excess returns. The coefficient β is also known as the intercept of the regression model. If α is positive and significant, it would mean the Berkshire was able to score even higher returns than the market risk premium.
Regression model for monthly returns from Jan 1988 to Dec 2008
BerkshireExcess Return = 0.0094 + 0.6735*S&P 500Excess Return
Coefficient α was found to be significant at the 95% significance level when the p-value was lower than the significance level. This means that Bekshire was able to earn excess returns even if the market excess return was zero. The β coefficient, being also significant, is positive thereby implying a positive unit change in S&P 500 would increase Berkshire's excess return by 67%, holding everything else constant. The correlation (the term 'correlation' can be used as it is a simple regression model) between excess return of S&P 500 and that of Berkshire is illustrated by the Adjusted R Square calculation and it is found to be very low (although it is significant because of the large F Statistic).
Regression model for monthly returns from Jan 1988 to Jun 1998
BerkshireExcess Return = 0.0136 + 0.9719*S&P 500Excess Return
Here α was significant at the 95% level and as it is positive, it means that Berkshire was achieving higher returns than the market. Also the beta coefficient suggests that S&P 500 would cause a change of about 97% in Berkshire excess returns, ceteris paribus. Overall the model is also significant and Adjusted R Square is 0.269, meaning that model only determines about 26% of variability in the dependent variable.
Regression model for monthly returns from Jul 1998 to Dec 2008
BerkshireExcess Return = 0.0017 + 0.4605*S&P 500Excess Return
The coefficient, α is insignificant,implying tha its value could well have been zero, the impact on the model would not have been significant. It also implies that Berkshire's excess returns were only able to earn a proportion of excess return of the market equivalent to beta.
In addition to running a regression model, scatter diagrams for all the three tests were constructed. It was found that there is a clustering of values around the trendline for the data of the whole period. However, when the data was halved, the scatter plots showed more extreme values.
After having carried out a thorough study on Berkshire Hathaway Inc, it can be concluded that the Company's stock was among the most highly regarded ones on the market. It has also been statistically proved that the stock was able to outperform the market index by a minimum of 5% over the whole 44 years of the study. The reression models and the scatter plots helped in this analysis, by confirming the correlation between the market and the individual stock. It was also able to see that the stock was a growth stock and not very responsive to market changes.
Being a growth stock, the stock will be bounce back easily from the crisis. However, it has still maintained its credibility amongst investors. Therefore, it can be said although since four decades, Berkshire Hathaway Inc has been a thriving company but was stifled by the crisis and needs to diversify in order to regain its rank.