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Stock Watch

Berkshire Hathaway Stock: Buy or Sell?

Shares in Warren Buffett’s company are a bargain, but don’t expect too much.

Are Berkshire Hathaway’s best days behind it? Warren Buffett seems to think so. In an essay to mark the firm’s 50th anniversary, the Oracle of Omaha wrote in 2015 that Berkshire Hathaway’s future long-term gains “will not come close to those achieved in the past 50 years.” (The words in italics are reproduced exactly as they appeared.) “The numbers have become too big,” Buffett goes on to say about the Omaha-based conglomerate, which includes insurance businesses, railways, financial-services firms and a mix of manufacturing, service and retail companies. “I think Berkshire will outperform the average American company, but our advantage, if any, won’t be great.”

Quiz: How Well Do You Really Know Warren Buffett?

Although the stock (symbol BRK.A, $265,744) has created enormous wealth for shareholders since 1965, when Buffett’s partnership fully acquired the New Bedford, Mass., textile company Berkshire Hathaway, the conglomerate’s recent price performance has been lackluster. For the record, the shares notched a 20.8% annualized gain from the start of 1965 through 2016. The 9.7% annualized return of Standard & Poor’s 500-stock index over the same period doesn’t come close. (In 1996, Berkshire created less-pricey Class B shares (BRK.B, $176.98), with correspondingly fewer voting rights. For consistency, the shares referred to in this column are the A shares. Prices are as of September 5.)

But since the company’s 50th birthday, results have been less rosy. From the start of 2015 to the end of August 2017, Berkshire’s shares climbed an annualized 7.1%, trailing the S&P 500 by an average of 2.2 percentage points per year. Of course, a period just shy of three years is a mere blip for a long-term investor. But so far, it seems Berkshire’s second act isn’t as rousing as the first.

For starters, there’s a general slowdown in the conglomerate’s overall growth. Revenue growth, in the double-digits in previous decades, clocked in at an annualized 7.6% over the past decade. Increased competition in the insurance industry and a railway business hampered by depressed oil prices has troubled the firm in recent years. Meanwhile, earnings growth, well over 20% annualized in past decades, was flat in 2014 compared with the previous year, rebounded 21% in 2015, but was tepid again in 2016. After reporting disappointing second-quarter results in early August, analysts trimmed estimates for earnings in 2017 and 2018, according to Zacks. Looking ahead, expectations for earnings growth over the next three years is an underwhelming 7% annualized. That lags the 10% growth in earnings expected for the S&P 500 over the same stretch.

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More important, there’s the slowing growth in the firm’s book value (assets minus liabilities). Over the long haul, the price of Berkshire stock has increased at a similar rate to the firm’s growth in book value. The firm’s book value per share increased on an annualized basis at 19% between 1964 and 2016, and the stock climbed commensurately, notching 20.8% annualized gains over that time. But growth in book value per share has slowed to between 6.4% and 10.7% per year between 2014 and 2016. And that’s the growth rate—percentage gains in the mid-to-high single digits—that Morningstar analyst Greggory Warren expects book value and share price to log going forward. Warren sets a fair value for Berkshire Hathaway stock at $290,000, which represents a 9% gain from recent share prices. That’s close to UBS analyst Brian Meredith’s 12-month price target for the stock, $291,000. Both estimates are based on an analysis of the firm’s myriad businesses and applying a sum-of-the-parts value to the company overall.

Finally, there’s the looming question of Berkshire chief executive Buffett’s reign. He’s 87 years old, which means he has a remaining expected life span of 5 years, according to actuarial tables. Who will replace him? Buffett and his partner, Berkshire vice chairman Charlie Munger, who is 93 years old, haven’t said explicitly. But they have hinted that the person or persons already work in some capacity at Berkshire Hathaway. We trust the judgment of Buffett and Munger, but as with any investment, a management change at the top is cause for re-evaluation.

The case for Berkshire

On the plus side, despite the six-figure price tag of A shares, the stock is not expensive. In fact, it’s practically a bargain. At its current price, Berkshire stock trades at 1.4 times book value. That’s just a shade higher than the 1.2 times book valuation that Buffett has said time and again represents a “significant discount” to Berkshire’s intrinsic value. Indeed, 1.2 times book value is the valuation at which Buffett has said he would consider repurchasing shares.

Should you buy shares? Only if you’ve tempered your expectations for the stock and plan to hold it for at least five years. If you already own shares, we advise you to hold on. This isn’t the Berkshire Hathaway of your grandfather’s day. But it’s still a solid company that will continue to grow—albeit more slowly than it has in the past. It’s a cash cow, too. Over the past three years, Berkshire has generated $16 billion annually in free cash flow (cash profits left after the capital expenditures necessary to run the business), according to Warren. The firm uses those funds to invest in other businesses, either by buying stakes in the companies or by buying stock at bargain prices. And the company keeps at least $20 billion (usually more) in cash on hand at all times. To put things in perspective, the cash hoard currently works out to roughly 9% of annual revenue.

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Buffett recently called Berkshire Hathaway a “Rock of Gibraltar” American company. He meant, of course, that it’s steady. It boasts a reliable stream of earnings, holds a hefty amount of cash on its books and little debt. That’s valuable in uncertain times. But big rocks tend to stay in one place. Investors who are new to Berkshire will be wise to keep that in mind.

See also: 30 Greatest Stocks of All Time

Nellie S. Huang owns shares of Berkshire Hathaway.