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Bill Ackman explains his big bet on Warren Buffett's Berkshire Hathaway

Julia La Roche
·3 min read

Billionaire hedge fund manager Bill Ackman believes that Berkshire Hathaway should see its share price "increase substantially" in the coming years.

"The catalyst for our current investment in Berkshire is our view that the company is currently trading at one of the widest discounts to its intrinsic value in many years, at a time when we expect the operating performance of its subsidiaries to improve as a result of certain managerial and organizational changes at the company," Ackman wrote in an investor letter dated August 15.

During the second quarter ended June 30, Ackman’s Pershing Square Hathaway snapped up 3.51 million shares of Berkshire Hathaway’s B shares (BRK-B), a position valued at north of $702 million.

Ackman, a longtime student of Warren Buffett, has followed the high-profile investor "extremely closely" for decades. In fact, Ackman even credited Buffett’s teachings for his own turnaround in performance this year. Pershing Square has delivered returns of 48.9% through August 15, surpassing the S&P 500's performance of 18.2% in that time. Berkshire's stock was the only detractor to Pershing Square's performance this year.

While Buffett is one of the most-watched investors in the world, Ackman believes that Berkshire is undervalued, in part, because it's "one of the least followed and misunderstood mega-cap companies."

Berkshire is about more than Buffett’s stock picks

One of this mistakes is that a great deal of focus is often on Buffett's "extraordinary stock-picking ability," leading people to believe that the returns rely on those investments. However, the "primary asset" for Berkshire today is its massive insurance business, Ackman explained.

"Today, Berkshire is a $500 billion market cap holding company with about half of its value residing in its insurance subsidiaries, and the balance in controlling stakes in highly diversified operating companies," Ackman wrote. “Mr. Buffett has clearly designed the company to succeed decades after he is no longer running the company. As a result, we believe that Berkshire should continue to generate high returns for shareholders from the current stock price even if the investment returns from the company's large cash holdings and marketable securities portfolio are similar to that of the broad market indices.”

Bill Ackman, CEO and founder of Pershing Square Capital, visits the floor of the New York Stock Exchange, Tuesday, Nov. 10, 2015. (AP Photo/Richard Drew)
Bill Ackman, CEO and founder of Pershing Square Capital, visits the floor of the New York Stock Exchange, Tuesday, Nov. 10, 2015. (AP Photo/Richard Drew)

Ackman went on to explain how Berkshire has produced extraordinary results that surpass other insurance peers. Specifically, Ackman called out that over the last decade Berkshire has grown its float (the difference between premiums collected and claims paid) at an 8% compounded annual growth rate while achieving a negative 2% average cost of float. That’s impressive when most lose money on their insurance operations and are only profitable when they take into account their investment returns. What’s more, Berkshire’s profitable underwriting ability has only resulted in only one underwriting loss in the last 15 years.

“The world's greatest insurance company architect”

"While Mr. Buffett is best known as a great investor, he should perhaps also be considered the world's greatest insurance company architect and CEO because the returns Berkshire has achieved on investment would not be nearly as good without the material benefits it realized by financing these investments with low-cost insurance float," Ackman wrote.

Elsewhere in the letter, Ackman also pointed to Berkshire's other "high-quality" businesses outside of insurance, including Burlington Northern Santa Fe railroad and Precision Castparts.

Another positive for the investor is that management’s ability to "intelligently deploy" the $100 billion in cash into value-enhancing acquisitions and share repurchases.

Speaking of the "deep bench of managerial and investment talent," Ackman praised the promotion of Ajit Jain and Greg Able who oversee insurance and non-insurance business, respectively.

"We expect this new management structure will empower them to enhance the operational performance of Berkshire's businesses that have underperformed their peers."

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.