Berkshire Hathaway: Hold Off Until Buffett Steps Down

Since "Woodstock For Capitalists" weekend in Omaha is now over, a bit about Berkshire and its leader.

No one will will argue or dispute his past success and what he has done for shareholders. Nor will anyone attempt to belittle the atmosphere and honesty in which he runs the organization and the culture he created. That being said, being a former Berkshire Hathaway Inc. (BRK.A) shareholder, I would not consider purchasing shares until Buffett steps down. The reason? $40 billion in cash and no plans to spend it. Berkshire is, in essence, an insurance company that pays no dividends. Its results the past two years are due to one factor: no major catastrophes.

Buffett has the ability to "buffer" shareholders against the eventual catastrophe and its impact, but refuses to part with his cash. Insurance industry profits have been at all time highs the past two years and even Buffet himself has acknowledged that this cannot continue. Berkshire earnings increases over that span have been due solely to insurance profits, not investing gains or increases in its other operating segments. Industry pricing has already come down and we are one active hurricane season away from watching those record profits evaporate. When they do, Berkshire shares will take a hit with them.

Here is my issue, Buffett has the power to insulate shareholders from this eventuality. His recent purchase of 10% of Burlington Northern Santa Fe Corporation (BNI) and 15% stake in USG Corp. (USG) marked the first time this century he has taken a meaningful stake in any company. In the past six plus years, he has dabbled in shares of Wal-Mart (WMT), Home Depot (HD), Lowe's (LOW) and others without making any meaningful foray into them.

When Berkshire was experiencing its meteoric rise, it was due to Buffett making huge investments in a handful of companies. Now, the definition of huge changes as your size does. $100 million to Berkshire in 1975 was significant, but today is 2% of what Buffet has on hand to invest. That being said, Buffet still has the ability to make portfolio changing investments, he just chooses not to. Berkshire's investment portfolio today resembles a mutual fund with small positions in over 30 companies that are bought and sold regularly.

In the past Buffett has said, "Wait for a fat pitch and then swing for the fences." Why isn't he doing that? Considering the investment possibilities Berkshire has, his recent investing record is one of bunts, not big swings. He has also said in the past "if you would not buy the whole company, why would you buy a single share"? Using his own logic, I have to ask, "Warren, if you are going to invest $160 million in Home Depot, why not $1 billion?" The theory still holds, if you would not buy 100 shares why buy one share and if you would buy one share, why not a hundred of them? An investment of 4% of his available cash is not "swinging for the fences."

25% of Berkshire's current market cap is its cash. Shares trade at a PE of 15 times earnings and given its earnings ability and financial stability, that should be higher. The reason it isn't? People recognize that the $40 billion will be sitting there next quarter and next year and in today's low interest rate environment - money in the bank does not impress anyone. Put it to work and Berkshire's multiple will expand.

Unfortunately, that will not happen until Buffett retires and someone else runs Berkshire's investments.

BRK.A 1-yr chart:

Comments

[scott146:]

Sounds like Bill Gates has been spending too much time with Buffett; Microsoft also has a big cash pile and nothing good to invest it in.

2007 May 16 12:14 PM

[YenKenZen:]

Overall Todd, you made a strong point - though I wonder if this is a reflection of Buffet's "play safe" attitude or he is just not convinced of any available good "swings" for the size of money he is holding. Lets not forget that we are in the record Dow Jones Index territory..

2007 May 16 02:18 PM

[grahdodd:]

A few issues:
1.) You should know that the P-E for Berkshire is a useless tool for many reasons. Your "15 PE" gives credits to Berkshire's Dividends ONLY in its entire Stock Portfolio. So for companies that do not pay a dividend Berkshire gets credit for NONE of that investees Profits that Berkshire "owns". For the 200 Million Shares of KO, for example, you're counting only the share of profits that KO pays to Berkshire as a Dividend.

2.) You never really attempt to figure what Berkshire is worth. That would be helpful since all of the points you make are more than discounted in the stock price IMO. To help you on this score, I'd suggest you follow Buffett's endorsed methodology, which is simple and conservative. Column A: investments per share (stocks, bonds, cash) Plus Columns B: Pre-Tax Earnings Per Share of Berkshire's owned businesses (Geico, the Furniture Group, etc etc). Column A is about $85,000 per share...Column B is between $4,000 and $5,000 per share. Plug in a multiple for Column B and do the math.

By the way, this method gives NO value to Berkshire's biggest weapon: its Insurance Company Float. This is money Berkshire has controlled for FREE for more than 40 years. It has grown to about $58 Billion. Think about it--Berkshire gets FREE use of $58 Billion. Invested in just cash thats about $3 Billion that comes out of thin air with an infinity return on investment..and is the tonic thats supersized "decent" returns into "extraordinary returns. And I'm valuing that $58 Billion in Float at ZERO. Thats $2,000 a share. Nice head start/

I think you'll see that Berkshire is currently trading at a VERY substantial discount to its Intrinsic value. Morningstrar estimates about $140,000 per A share. Most estimates I have read are between $138,000 and $145,000 per A share.

The issues you raise are OLD news and largely factored in the stock price. The stock tends to gravitate towards intrinsic value, often at a 10-month to 1 year lag. If Berkshire's stock were selling at $150,000 per share --your points would be very valid and useful. No doubt. I woiuld share some of those concerns.

Buffett is no rush to "step down" and when he does, this stock may be more than double its present price. The onmly think you can control is an entry price relative to the stock's worth. Thats strikes me as the only ratiolnal way to evaluate any investment.

I heard your argument when the stock was selling at $16,000 a share. Just a little over a decade ago. Those folks are still waiting for Buffett to "step down". Its been a difficult wait.

2007 May 16 04:24 PM

[Todd Sullivan:]

i agree they are trading at a value, that is my point. they are trading at a value because folks realize the $40 B will be sitting there for years. if he would deploy it, the stock would jump..

you never heard this argument from me before because I was an owner and he was investing based on his statments, not anymore..

2007 Jun 12 08:05 AM

[Todd Sullivan:]

he has been buying shares regularly, just not swinging for then fences

2007 Jun 12 08:02 AM

[bhusach:]

Excellent points, GrahDodd.

Todd: Do you have a response to GrahDodd's observations and analysis?

2007 May 17 12:32 AM

[reinharden:]

Color me petulant, but $100 million out of $40 billion isn't 2%! 2% of 40 billion is $800 million. You meant 0.25%.

All I really know is that the 2006 Shareholder's letter said:
Overall Gain – 1964-2006 361,156%

I'll stick with the man who gave his shareholders a 361,156% gain rather than take the advice of the one who seemingly has more difficulty with math. ;-)

reinharden

2007 May 17 01:59 AM

[FIG trader_:]

As of the last few years, there is only one thing more important to WEB than exceeding market returns. That is not losing any significant amount of money in any one investment. After the "mistakes of General Re" and underdiversifiaction internationally, and perhaps some arrogance in not recognizing some orther global trends, he has repeatedly given his mea culpa. That said, he is setting the stage for the next ten years, not aggressively buying in at the top, but buying enough to keep his asset allocation rather constant, but still conservative. Those clamoring for more deployemnt of cash, and by inference, assuming that is the reason for underperformance are somewhat disingenuous. That view assumes (today) there are investments (private or public) that can yield more than cash over the next ten years, but fail to explain why that is the case. Does the fact that leverage kings keep on buying prove the author right; Not necessarily. In fact, the added risk layered on is increasingly likely to cause an accident; a pileup WEB doesn;t want to be involved in. Only time will tell, but those arguing in favor of more aggressiveness haven't come up with very convincing alternative explanations as to why returns for the next ten/15 years will be much higher than cash + a few hundred beeps

2007 May 19 06:30 AM

[Richard Bra...:]

To sit around and wring ones hands while waiting for Buffet to step down or pass (heaven forbid) reminds me of 2002-2003 when some
people refused to buy a house until prices came down. Oh yea, they
came down alright, but it took five more years and another doubling of home prices....

2008 Jun 14 10:05 PM