7 Reasons Not to Buy Berkshire Hathaway

I am a big fan of Warren Buffett. However, I believe it is more advantageous to follow Buffett’s stock picks than own Berkshire Hathaway (BRK.A) for the following reasons:

1. Portfolio Concentrated in US Dollars

Berkshire has a portfolio of 41 stocks. The total portfolio value is $48,025,404,085 as of May 15, 2009, according to CNBC. The top 6 holdings: The Coca-Cola Company (KO), Wells Fargo & Company (WFC), Burlington Northern Santa Fe Corp. (BNI), Procter & Gamble Co. (PG), American Express Company (AXP) and Kraft Foods Inc. (KFT) account for almost 70% of it.

Paul Krugman, the recipient of the 2008 Nobel Price in Economics, in his new, greatly updated edition of The Return of Depression Economics, defines that failures on the demand side of the economy – insufficient private spending to make use of the available productive capacity – have become the clear and present limitation on prosperity for a large part of the world. The quintessential economic sentence is supported to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain.

With US government’s huge stimulate package, the deflated US dollar is unavoidable. With few exceptions, such as POSCO, Sanofi-Aventis (SNY), Swiss Re and Tesco plc, majority of Berkshire’s portfolio and operations are based in US and tired to US Dollar. That’s why I rather own iShares MSCI Emerging Markets Index (EEM) or Vanguard Emerging Markets Stock ETF (VWO).

2. Troubled Derivative Bets

Berkshire is big into the derivatives market, which made more complexity to the already black-box-like conglomerate’s balance sheet. The company as of March 31 had $13.85 billion of paper losses on derivatives, according to Reuters. Contracts tied to junk bond defaults mature between 2009 and 2013, and Buffett admitted they may lose money. S&P said the U.S. junk bond default rate rose to 5.42 percent from 3.96 percent at year-end.

1^st quarter 2009 operating earnings, which exclude investment and derivatives gains and losses, came in at $1.705 billion. In other words, Berkshire’s paper loss in derivatives would wipe out 2 years operating earnings.

3. Buy What You Know

Berkshire is an insurance-focused conglomerate and owns more than 60 subsidiaries including insurance, clothing, furniture, candy, restaurants, natural gas and corporate jet firms. As you can see from the chart I compiled, from its 1^st quarter 2009 report, 34% of revenue was from insurance.

I never understand insurance companies’ financial statements. The only thing I know about insurance is about projections, assumptions, probabilities and promises for future delivery, typically at a far-off date. Most of the products are highly intangible. Every year when I read Warren Buffett's annual letters, I always skipped the insurance portion, otherwise I would have had to reach for some aspirin.

4. Low Margins

Buffett said many of Berkshire's nearly 80 businesses were hurt by the recession and lower consumer spending, including housing-related units that make bricks, insulation and paint. Even if the rescue of the financial system starts to bring credit markets back to life, we might still face a global slump that’s gathering momentum. The only bright spots coming in are its utilities and insurance companies, which include Geico and General Reinsurance.

The 2^nd biggest operation, McLane, is marked by high sales volume and very low profit margins and has been subject to increased price competition in recent years. The gross margin rate was 6.95% in 2009. Approximately one-third of McLane’s annual revenues are from Wal-Mart. A curtailment of purchasing by Wal-Mart (WMT) could have a material adverse impact on the earnings of McLane.

Out of Berkshire's total $260 billion assets, only $48 billion is in equity. In other words, majority continue earnings are still need to come from operational business.

5. Downgrade By Moody's

Two credit rating agencies took away Berkshire's "triple-A" ratings in 2009, including Moody's Investors Service. The global credit crisis might be temporary, but the company could face significant pressure if it persists.

According to CFA ( source: cfapubs.org), between 1980 and 2000, banking sector accounted for 4% of the Japan Nikkei in 1980, peaked at 22%, and then came back to about 4% again. If the same happens to US, then we could still have a long way to go.

6. No Dividend

Berkshire didn’t pay any dividend.

7. “Warren Buffett Premium”

The average Price/Book for Property & Casualty Insurance company is 1.05, while Berkshire’s is 1.35. If anything happens Buffett, the stock might drop 30% instantly. Even something happens to Charlie Munger…

On Jan 2, 2008, Berkshire (BRK.A)’s price was 139,300. By the year-end on Dec 31, 2008, it was 96,600: it dropped over 30%. Though it still performed better than S&P, it was certainly not the loss of 9.6% reported by the Main Street media, which looked at book value only. We need to compare apples to apples.

Last Friday, May 15, 2009, the Wall Street Journal reported that the Treasury department will make $22 billion federal bailout funds available to a number of life insurers. This will certainly help insurance industry as a whole. In addition, as Donald Guloien, new President and Chief Executive Officer of Manulife Financial Corporation (MFC) stated in his memo to Manulife employees on May 4, 2009, “We would expect that global financial regulators may require higher levels of capital, and this will favor the stronger and more conservative companies.” People are looking for reliable, strong and trustworthy companies, and there will be a “flight to quality” that will favor Berkshire as well. However, you can always buy ETFs such as Financial Select Sector SPDR (XLF), if you like the financial sector.

By not owning Berkshire, you are not benefiting from deals and terms that are only available to it, such as Harley Davidson's (HOG) 15% and Tiffany's (TIF) 10% debt offerings, GE and Goldman Sachs Group Inc.'s 10% preferred stock, etc. To make that up, you might check into iShares S&P U.S. Preferred Stock Index (PFF) that might give you something in comfort.

Disclose: I have long position on EEM.

Comments

[RonB:]

The last time people like this author came out in force and said to avoid Berkshire was in 2001, at the height of the Internet bubble. At the time, people said Buffett had lost it, was outmoded, etc. Berkshire's stock had dropped nearly 50% in the previous nine months. It as a tremendous bargain, and nearly tripled over the next seven years.

Buffett's portfolio is solid and undervalued, his insurance business should soon be recovering from cyclical lows, Geico is doing very well, and his deriviatives investments are very misunderstood. The stock is very attractively priced and offers low risk in a high risk environment. Berkshire is a substantial holding in my personal and client portfolios. Note also that Mason Hawkins took a large position last quarter.

May 17 09:42 AM

[donzoab:]

There are just too many things wrong with this article on which to comment. First and foremost is the obvious lack or proof reading.
Most disturbing is the total lack of focus on the insurance float. This FCF gives Buffet enormous leverage in investments.
The only thing preventing Buffet from doubling the share price from here would be his death. His diet of cherry coke and dairy queen should hasten this. I don't use most of his companies products but recognize the value of the holdings.

May 17 10:06 AM

[David Durant:]

From a intrinsic value standpoint, the stock is only fairly undervalued (www.wikiwealth.com/res...). Not worth buying right now because there are plenty of great companies for cheap; otherwise, Buffett would buy back his own shares.

May 17 11:11 AM

[robert99:]

If BRK.B touches it's 52 week low again, I'm a buyer. The biggest reasons I don't already own some are that: a) It's already huge - not much of a return left for an aggressive investor, and, more importantly, b) Buffet's probably going to retire soon. I need a deep discount to account for those two issues.

May 17 02:50 PM

[ilovesum:]

I agree with you several points and your overall skepticism of Berkshire.
Stock price versus book value has been played on, good observation.
Look at the purchase of Conocophilips , buying while the
price of crude was at a historic high was not a wise choice.
Buying Karmax at a inflated level when the market bubble was bursting, buying Kraft at a market high rather than holding onto cash. Not reducing shares in Bank of America , which is probably ""the one bank he owns but would not buy more of " . Goes against his practice of owning what he knows and margin of safety. He's said one bank is not good so why did he ever buy it and still own it ?
I bought Karmax, Bank of america , Kraft , USG early based on his
ownership , although I had strong reservations about them at the time.
The GE , GS , HOG , TIF , USG are money in the bank. His derivatives will work out.
In October 2008 his WSJ article was too early, his March storm comments were a good buying opportunity rather than the beginning of the end . He was saying this yet buying ?? Thanks for the misdirection.
Even before that , Berkshire was sitting on 40 billion . Why were they sitting on cash but making these token purchases?
As with Ken Lewis , I wondered if the comments were not solicited or demanded from someone higher up to give the market some stability.
If equities were the place to be why did Buffet buy these preferred shares ?
If these equities were a good buy , how come Buffett didn't go all in as he said in his October letter ? Berkshire still has cash on hand.
My take on this is that they expect more downward movement and have cash to take advantage of it.
Maybe the Moody's and S&P downgrade tell us that there are some questionable things going on ?
Why did the annual shareholders meeting have pre-arranged questions ?
Another question , when his fortune gets donated to charity , since he doesn't pay a dividend , how can they acess the money without selling ?

May 17 03:16 PM

[Peter Cooper:]

Its the economy stupid! Look at what President Obama's top advisor Martin Feldstein had to say last week in Brazil, see:
arabianmoney.net/2009/.../

May 18 12:37 AM

[Mike Stathis:]

The fact that BRK pays no dividend is something that is a bit bothersome to me. I too addressed this point in a previous article as a reason why I would never buy the fund. Good of you to notice, since the masses rarely criticize him.

seekingalpha.com/artic...

But the fact is that all value investments MUST pay a dividend. One could argue that the reinvestment of the dividend has enabled BRK to achieve the growth similar to that seen in a growth stock/fund, but with less risk. My counter would be this...leave it to each investor to determine whether they want the dividends reinvested.

Another reason I would not be in favor of buying BRK (esp. during this bear market) is the fact that BRK has no ability to avoid market risk.

Also, you should note that Buffett invests in insurance companies mainly because they are cash cows. And having cash is essential to his asset management strategy, since, like mutual funds, BRK works primarily to lower the cost basis of positions during market declines, as opposed to minimizing market risk via liquidating positions. This is something I also discuss in the same article.

May 18 02:36 AM

[LA Tech:]

Funny to hear anyone talk about a Moody's or S&P upgrade or downgrade because both groups completely missed the all the financial problems relating to credit default swaps.

Moody's and S&P cannot be trusted anymore, period!

May 18 06:43 AM

[RonB:]

Let's pay attention to Hao Jin and not Warren Buffett. Yeah. That makes sense.

May 22 01:28 PM

[U338129:]

The only thing that is at all in question about BRK is Buffett's longevity. If Buffett was only 50 years old, there wouldn't be such negativity or worry among investors. People would simply look at the deals he's made over the last year and realize that for every COP mistake there was a GE, GS, Harley, and Mars/Wrigley opportunity that he took advantage of. The capital allocation decisions that Berkshire made recently will lead to major windfalls of income/value going forward (in terms of debt repayments, dividends, current use of the money from the very smart derivative plays, as well as any/all market value increase in the equity holdings).

The main problem is that nobody knows for sure what will happen to BRK (both the stock and company) when Buffett is no longer there. Anyone that tries to play this off is fooling themselves. Just look at the last time rumors hit about Buffett's health and notice how fast the stock nosedived. Precendence was set at that time that clearly shows that the stock will fall when Buffett leaves his post. That, and the lack of a clearly defined and publicly announced succession plan, has a lot of investors shying away from one of the best companies in the world.

I think the lack of dividends do play a part; but not as big as people make them out to be. If people (in general) were so great at reinvesting their dividends by themselves then we'd have a lot more investing success stories than what's being reported. The fact is that Buffett (and Berkshire managers) is much better than most at reallocating capital and he gets far more advantageous opportunities to do so than the retail investor ever will. That's why most BRK owners don't care about the lack of dividends.

May 26 07:06 PM

[U338129:]

To add, if you're using an agency downgrade as one of your criteria, that's utterly insane. You're quoting the same agency that said on CNBC's "House of Cards" that they would "turn garbage into AAA in order to market it and sell it."

Throughout this downturn, the people that lost the most in terms of credibility were any/all ratings agencies. How they are still in business is simply beyond comprehension. They have failed the investing community for decades and their "analysis" isn't worth the paper it's written on.

May 26 07:10 PM

[Quaker:]

There's really no argueing with Buffett lovers. It's a cult.

IMO, Buffet has been perfectly worthless over the last 10 years. He may have beaten the S&P 500 over the lastt en years, but any idiot could have beaten the S&P. I kicked the crap out of the S&P.

The trade since 2000 has been commodities,plain and simple. Buffet had one big play there, Petro China. I trade stocks from my sofa and I had Petro China a year before he did.

My biggest problem with Buffet is that I simply can't stand the guy. He spends his entire day looking for a camer to to get in front of. His investment philosophy is, "give me your money, you ain't getting it back".

Then there's the nauseating "Habits of a billionaire" crap he throws out. Warren drinks cokes, Warren eats hambergers, Warren doesn't tip, Warren jerks off... As Katie Couric once said,in talking about twitter. Only an idiot would care what I had for lunch.

Buffet said gold would fall. It went up 400%. Warren missed on oil. It went up 1,400%. Warren missed on agriculture. The biggest plays in the decade were Agrium, Monsanto and Mosaic.

His only major hit in this was BNI. Over the last ten years, a managed portfolio of MOS, AGU,MON, BNI and a couple oilcompanies, along with a 50% holding in ten year treasuries would have beaten Berkshires pants off at a small fraction of the downside risk.

Jun 20 09:16 AM

[Quaker:]

BTW, Kudo's to Hoa for his synthesis of Berkshire. Absolutely 100% correct. Only one thing to add. You don't know misery until you've had to get service from GEICO.

Jun 20 09:18 AM