Is Berkshire Hathaway Now a Bargain? 16 comments
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After trashing Berkshire Hathaway (BRK.A) (BRK.B) just six months ago (in December), Barron's is now making a case for its purchase with an article this weekend entitled "Cheap Stock?"
To the magazine's credit, the stock has sold off since December. This comes after an article a few weeks ago entitled "The Next Buffett," which discussed how David Sokol, the chairman of MidAmerican Energy (a Berkshire unit), is now the most likely successor to Buffett to be CEO of Berkshire - and more importantly, how he is probably ready for the job. Not wanting to flip-flop too much, or at least to provide some balance, this week's issue also has an interview with Doug Kass, the popular short-selling hedge fund manager, who is still bearish on Berkshire stock, and has reiterated this view for readers.
While the criticism of Berkshire has varied over the years, the issues of the exposure of the company to its insurance business and that of Buffett's age are still often cited as reasons for selling and staying out of the stock. As for the insurance business, its impact seems to show up in October, as seen in the weekly chart below (from stockcharts.com), although this is simply a three year view and anecdotal. Nonetheless, for the past three Octobers, after the annual hurricane and storm season is over and the quarterly results begin to show how much of the float is left for Buffett to invest, the stock often has a nice end of the year rally before leveling off or making a slower accent to the next October.
The difference, of course, has been this year, when the stock has sold off and been more volatile after the December Barron's article and recent news of other hedge fund managers, such as Kass, taking a short position in the stock. The latest positive article and opinion from Barron's may stem the tide, but many of the short-sellers remain.
Even Buffett at the recent "Woodstock for Capitalists" shareholders meeting in May alluded that Berkshire may under-perform (at least its historical returns), and there may therefore be better opportunities elsewhere. But then again, Buffett is known for lowering expectations and feigning a sense of weakness, only to later make large acquisitions and investments, such as the recent decision to help finance the Mars acquisition of Wrigley, while taking a small position for himself.
While it is difficult to value Berkshire Hathaway in comparison to many other public companies, and even more difficult to predict where Buffett is deploying his capital - at least until the quarterly reports are released - it does appear that the recent sell-off of the stock has taken some of the "Buffett premium" out of the stock. This extra boost to the valuation of Berkshire, simply because of his skill and the brand that Buffett has become, is often cited as one of the concerns for the stock as it relates to both the valuation and Buffett's age.
In the past, the premium has seemed justified based on past performance, and still does, but if Buffett were to step down for any reason, there is an expectation that the premium will be immediately taken out of the stock. Yet, Buffett appears to be in good health and even better spirits, not to mention remaining active in looking for investment opportunities (notwithstanding showing up on soap-operas and CNBC at every chance Becky Quick gets).
Still, some investors are waiting on the sidelines for fear that Buffet will be replaced. This seems silly to me, since you are missing out on the opportunity to let one of the greatest investors of all time put your money to work. Furthermore, what happens if Berkshire is then run by someone else, maybe 1, 5, or 10 or years from now? Will this give you a reason to jump in? Sure, succession will be more clear, but the management of your money will be less so, regardless of Barron's pick (or guess) for a successor - for CEO, not CIO(s).
In a sense, it comes down to staying out of the stock while you wait for a pullback and possibly new management, compared to staying in the stock and benefiting from Buffett's expertise, even with a lack of succession clarity. I think many current investors will continue to take their chances.
In the end, the biggest hurdle for Buffett may not be his age, or overcoming the "Buffett premium," or worrying about the next catastrophe that will reduce the investment float. What may be more of a challenge is overcoming the law of large numbers. The company's cash for investment is considerable. To make any dent in the stock price of Berkshire, Buffett has to take a considerable position in an outside company in order for it to register enough to potentially affect earnings and move the stock. This takes time, and certainly offers less flexibility to get in and out at an acceptable price.
More than likely, this is one reason why Berkshire Hathaway has simply made large equity investments and outright purchases of companies in the last few years, although the recent volatility and credit/housing related sell-offs in the stock market have created more of the values that Buffett looks for, and has resulted in more equity positions - recent purchases include Kraft (KFT) , Ingersoll Rand (IR), Burlington Northern Sante Fe (BNI), US Bankcorp (USB), United Health Group (UNH), Wells Fargo (WFC), and Wellpoint (WLP), along with small positions in Carmax (KMX), M&T Bank (MTB), and Sanofi Aventis (SNY). Of these positions, only the added positions in Kraft and Burlington Northern Sante Fe were large enough to generate any interest on the buy side, and even then, they were adding to already existing positions.
So what is an investor to do? Barron's does provide some guidance by referring to an analysis by the hedge fund T2 Partners. T2 highlights that the intrinsic value of Berkshire has continued to grow steadily and significantly over the last few years. From Barron's:
"Meanwhile, for a truly big company -- with a market cap of $190 billion, total assets at last count of $281 billion, total equity of $119 billion and book value per share of $77,014 -- it has been enjoying quite impressive growth, especially where it really counts. The value of investments per share has climbed to $90,343 in 2007, from $52,507 five years earlier; during this stretch, pretax earnings per share, excluding investment income, has quadrupled from the $1,479 posted in '02; and intrinsic value -- which T2 calculates as investments per share, plus 12 times earnings per share excluding investment income -- at the end of last year ran somewhere between $156,300 and $158,700 a share, or comfortably more than double '02's $70,000."
As a result, T2 believes that Berkshire is undervalued by approximately 20%. Furthermore, if you are to assuming a 10% growth rate for the intrinsic value of the company, which is not speculative for Berkshire by any measure, with a business and cash buildup of $6,000 per share over the next year, the total intrinsic value could approach $178,700 per share. Given the current price, this represents a 46% premium on the stock. Going out further to two years, the number approaches $200,000.
While short-sellers like Kass will continue to short Berkshire, and give good explanations - such as Buffett's age and lack of a visible succession plan, new hedge-fund competition, new uncharacteristic exposure to derivatives, and waning benefits from the insurance industry - it is difficult to bet against someone with so much cash to deploy, as well as a track record for wisely putting it to work. While the stock has been volatile, and is receiving attention from the short side, it is difficult for many investors to sell at these levels until more of the issues that Kass describes come to light.
For the time being, most of the current long investors will no doubt hold, and look for others to join in - maybe in October.
Disclosure: Long BRK.B
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This article has 16 comments:
As for myself, I have 16 shares of BRKB. I'm disappointed that the man who called dirrivatives "weapons of mass distruction", allowed those same WMD to produce huge insurance losses for his stockholders. Consequently, I have no reason to wait for the announcement of his successor, I have placed limit sales as the stock price recovers near term.
The man is a legend and a 30% premium is not unreasonable. Being how close he is to retirement, this is one of 3 reasons I will never own BRK. The other 2 being valuation(Buffett wouldn't buy it if it wasn't his, either will I) and no dividend.
If Kass had actually read the letter to shareholders, he would know that Berkshire merely SOLD options. It has ZERO counter-party risk for this contract.
If Kass can't even do this simple research, his opinion shouldn't count for much.
Chartists who are blind to fundamentals always make for a good laugh.
Let's talk about intrinsic value first. Despite its present size, berkshire's oerating businesses should grow earnings at a 10+% clip over a full business cycle. Performance will be lumpy (insurance pricing, super cat performance, housing and economy), but for someone with a long term view, these businesses will grow earnings. This portion of berkshire does not have a huge dependence of Buffet as performance is driven by talented and motivated managers. Moving to investments, it's investment portfolio is positioned superbly. If I'm doing my math right, Buffet deployed 20 billion in bonds recently and still has a war chest of 20+ billion remaining (growing by 8+ billion every year). Most of the existing 70+ billion equity portfolio is invested in 15+% ROE opportunities. It's safe to say that intrinsic value over longer periods of time will grow at 15% but growth will be lumpy.
The stock price will be affected by two factos: lumpy growth and how markets value liquidity. Lumpy growth has been a way of life at berkshire and is one of things I like about berkshire. When liquidity is freely available and the rest of world is levering (tons of stupid money chasing all kinds of model driven gains), berkshire's stock price will languish. When the opposite happens and the leverage is unwound, people will disregard buffet's age and embrace the war chest and AAA rating.
If your edge is patience and a longer time horizon, a long position in berkshire at today's prices can double your money in the next 5-6 years. Beyond that, there are any number of ways to make something simple more complicated.
Bottom line Berkshire has been adding a full zero to the end of peoples entire net worth for a looongtime anyone who wants to short it an scrape out a measily 20% and go to the golf course and brag about betting against Buffett I say enjoy it. Berkshire is receiving the identical media/analyst treatment that Apple has received in the last 4-5 months...look at the opportunity lose the media created there. I for one jumped into Apple and I continue to add to my Berkshire on a monthly basis as I have been doing for years.
A few years ago some one told me an "EXPERT" is just that ,some one that was a "PERT".