Warren Buffett could be considered the greatest investor of all time. Nobody could beat him when it comes to investing results. Under his leadership and his capital allocation talent, Berkshire Hathaway's (NYSE: BRK-A) operating performance has kept growing, leading to magnificent share price growth, from only $15 per share in 1965 to $176,500 per share at the time of writing, marking an incredible annualized gain of 21.5% in the past 48 years.
A close look at Berkshire Hathaway’s derivative positions
Recently, Berkshire Hathaway posted huge growth in its second-quarter earnings results. In the second quarter, Berkshire Hathaway increased its revenue from $38.55 billion to nearly $44.7 billion. The year-over-year revenue growth was due to a 13% growth in the insurance business, 7.2% growth in railroad, utilities and energy segment, and a significant improvement in derivative positions, from a loss of more than $1 billion last year to a profit of $461 million this year.
The huge gain in its derivative positions could be mainly attributed to the gain in the European equity index put options, written on four major equity indexes including S&P 500, FTSE 100, the Euro Stoxx 50, and the Nikkei 225, with the expiration dates in the range of June 2018 to January 2026. The remaining weighted average life of all contracts were estimated to be around 7.5 years as of June 2013.
Writing European style put options with long maturities let Warren Buffett have much more cash in premium to go investing and earn decent returns on it. He does not have to pay his counterparty until maturity, and the payment is made only if the reference index to which the put was tied goes lower than it was at the inception of the contract.
Dated back to 2009, Warren Buffett has explained the “equity put” portfolio in detail in his letter to shareholders, he mentioned that “only the price on the final day that counts.” In order for Berkshire Hathaway to lose nearly $31 billion in options, all of those four major indexes have to fall to zero on their various termination dates. Thus, the increase in value in many major indexes in the past year has been the main factor for the significant rise in the equity index putoptions value.
In the operating business, Berkshire Hathaway experienced the highest gain from the railroad BNSF business, from $1.28 billion to nearly $1.4 billion. Moreover, the growth also happens in the financial products, Marmon, McLane and MidAmerican businesses.
Berkshire Hathaway’s two biggest equity positions
For the long-term, Warren Buffett is still bullish on Wells Fargo (NYSE: WFC)and Coca-Cola (NYSE: KO). Those two companies are the two largest positions in the Berkshire Hathaway investment portfolio. With more than 458.17 million shares, Wells Fargo was the largest position, accounting for 19.9% of his total portfolio, while Coca-Cola, with 400 million shares, ranked second, accounting for 19% of his total portfolio as of March 2013.
Wells Fargo is known to have conservative lending practices, which might generate lower income than its peers in a boom phase, but it would let its shareholders sleep well in challenging times. The bank, with presence in nearly 9,100 stores, serving more than 70 million customers, is considered the market leader in consumer and small business lending, residential mortgage, and the commercial market. In the long run, the bank targets its efficiency ratio at 55%-59%, with the ROA in the range of 1.40%-1.60%, while the ROE could be in the range of 12%-15%.
Income investors might like Wells Fargo with its capital plan. For full year 2013, the bank estimates to spend more money than 2012 to buy back its shares. If Wells Fargo spent the equivalent amount of money like last year, of $4 billion, for share repurchases, the repurchase yield could be around 1.7% at its current price. It is trading at $44.50 per share, with the total market cap of $235.6 billion. The market values Wells Fargo at 1.57 times its book value. The dividend yield comes in at 2.80%.
Coca-Cola has also been a favorite long-term stock for investors with its marvelous concentrates. It has a long operating history dated back to 1886, having more than 500 beverage brands in more than 200 countries. Coke has become the global product for all walks of life, from the rich to the poor, from a billionaire to farmer. It has a global leading position with nearly 42% market share, while PepsiCo, its closet competitor, has only around 30% of the market. Other non-alcoholic ready-to-drinks (NARTD) products including Fanta, Sprite, and Del Valle are also the leaders in their markets.
In the second quarter, Coke reported sluggish results, due to the “challenging global macroeconomic environment and unusually poor weather conditions in the quarter.” Despite the recent not-so-good quarter, the company sticks to its 2020 Vision. Its Chairman and CEO, Muhtar Kent, remained bullish in the large NARTD market of 585 million, 37% under the age of 21 and more than 18 million in the emerging middle class.
By 2020, the company expects to double its system revenue with higher margins. The number of servings is estimated to double to more than 3 billion a day, equivalent to around 3%-4% annual volume growth. It is trading at around $40.20 per share, with a total market cap of $178.3 billion. The market values Coke at as much as 15 times its trailing EBITDA.
My Foolish take
Berkshire Hathaway, under Warren Buffett’s leadership, will still be a great long-term stock for patient investors. With more than 70 diversified great operating businesses, Berkshire Hathaway should deliver decent returns for its shareholders in the future. Long-term common stock investors could also invest in Coke and Wells Fargo, due to their global market leading positions, decent profitability, and potential growth.