SEC Letter Results in Buffett Explaining Undervaluation of 5 Stocks

 |  Includes: BRK.A, BRK.B, MDLZ, SNY, SWCEY, USB, WFC
by: Devon Shire

All I can say is thank you SEC, for bringing to my attention 5 securities Warren Buffett thinks are currently undervalued.

On December 10, 2010 the SEC wrote to Berkshire Hathaway (NYSE:BRK.A) challenging them as to why they shouldn’t have to take an “other than temporary” loss on the following stock holdings, which have been underwater for an extended period:

September 30, 2010





Months of

Cost Per Share

Market Price
Per Share

Highest Market
Price Per Share (2)

Kraft Foods












U.S. Bancorp







Swiss Re














Wells Fargo (1)







Click to enlarge

Here is the text from Berkshire’s reply:

Berkshire acquired the five securities described in the tables above based on Berkshire management believing that the prices paid were below each security’s then intrinsic value. Berkshire management believed that such prices continued to be below each security’s intrinsic value at December 31, 2009 and September 30, 2010 and Berkshire management continues to believe this to be true at this date. Berkshire management is very confident that in time each security’s market price will grow to at least the intrinsic value that existed at the dates of acquisition. Accordingly, since Berkshire has both the ability and current intent to hold these securities until this occurs, Berkshire does not believe it to be prudent to record an impairment charge. Additional information specific to these five securities is included in the paragraphs that follow.

A significant portion of the gross unrealized losses over one year in duration as of December 31, 2009 and September 30, 2010 related to common stock investments in entities operating in the banking and financial services sectors (Wells Fargo, U.S. Bancorp and Swiss Re). The housing and credit crises and economic recession that manifested in 2008 resulted in significant loan or investment losses being recognized with respect to many companies operating in these sectors.

Significant government actions were taken and new laws enacted since 2008 in response to the aforementioned crises and recession, many of which impact Wells Fargo, U.S. Bancorp and Swiss Re. New regulations have been and are continuing to be developed by government agencies with respect to implementing the new laws. Uncertainty remains with respect to the impact that the new laws and regulations will have on the future earnings power of these companies. There is also uncertainty as to what actions these companies will take in response to the changing regulatory environment and general or industry market conditions.

Notwithstanding the risks, Berkshire’s management believes that these three entities have maintained or strengthened their business franchises and capital adequacy. Berkshire management also believes that the future earnings potential for these entities is favorable. Each of these entities reported significant earnings in 2009 and through the first nine months of 2010. Each of these entities has repaid preferred equity interests issued in late 2008 and early 2009 during the heart of the crises and have otherwise restricted common shareholder dividends to retain capital. We continue to believe that these entities (a) provide and will continue to provide important services to businesses and individuals alike and (b) are well managed and positioned for earnings growth into the future.

Kraft Foods, a leading global food company, has reported favorable operating results in 2009 and 2010. Given the nature of Kraft’s business and the prominence of its products, Berkshire believes that Kraft possesses a significant economic franchise and the potential for continuing growth in earnings. Kraft’s management has indicated that it expects growth to accelerate in 2011. Unrealized losses on Kraft Foods common stock as a percentage of cost were approximately 18% as of December 31, 2009 and 7% as of September 30, 2010.

Sanofi-Aventis, a large global pharmaceutical company, reported strong earnings in recent periods. Its earnings per share in 2009 increased about 18% versus 2008 and for the first nine months of 2010, earnings per share increased about 9% over the same period in 2009. Berkshire believes that Sanofi-Aventis possesses a significant economic franchise and potential for continued growth in earnings and earnings per share. Berkshire does not believe there are significant negative considerations that are unique to Sanofi-Aventis.

Subsequent to September 30, 2010, the per share market prices of the common stocks of Wells Fargo, U.S. Bancorp and Swiss Re increased between 20% and 25% as compared to September 30, 2010. The per share market prices of Kraft and Sanofi-Aventis were relatively unchanged at December 31, 2010 as compared to September 30, 2010. As a result, Berkshire’s over twelve months unrealized losses associated with these investments will decline by approximately $1.0 billion during the fourth quarter.

At December 31, 2009 and September 30, 2010, Berkshire concluded that it possessed the ability and intent to hold these securities to their anticipated recovery. Historically, Berkshire has demonstrated the ability to hold equity securities for very long periods of time and currently holds certain equity securities that were acquired over 20 years ago. Berkshire continues to believe it is reasonably possible that the market prices for each of these five securities will recover to at least cost within the next one to two years assuming that there are no material adverse events affecting these companies or the industries in which they operate. Although Berkshire currently intends to hold these securities to their eventual recovery, such intentions may change in the future. Berkshire’s intentions to hold securities may change as a result of (a) material adverse changes to the long-term business outlook of the investee or the industry in which the investee operates, (b) alternative investment opportunities that Berkshire deems to be more attractive than the currently held investments or (c) changes in Berkshire’s perceptions with respect to the quality of the management of the investee.

I don’t know about you, but I can sleep pretty well at night buying securities Buffett thinks are currently attractive. We usually know what he holds, but not his current thinking on each position. So again, thanks to the SEC for bringing this to our attention.

Link to the SEC filing

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.