Posts Tagged ‘Berkshire Hathaway Inc. (NYSE:BRK.A)’

This is an oldie, but a goodie (via CNN). The travails of buying net nets, as told by the master’s apprentice:

Warren Buffett says Berkshire Hathaway is the “dumbest” stock he ever bought.

He calls his 1964 decision to buy the textile company a $200 billion dollar blunder, sparked by a spiteful urge to retaliate against the CEO who tried to “chisel” Buffett out of an eighth of a point on a tender deal.

Buffett tells the story in response to a question from CNBC’s Becky Quick for a Squawk Box series on the biggest self-admitted mistakes by some of the world’s most successful investors.

Buffett tells Becky that his holding company (presumably with a different name) would be “worth twice as much as it is now” — another $200 billion — if he had bought a good insurance company instead of dumping so much money into the dying textile business.

Here’s his story:

BUFFETT:  The— the dumbest stock I ever bought— was— drum roll here— Berkshire Hathaway.  And— that may require a bit of explanation.  It was early in— 1962, and I was running a small partnership, about seven million.  They call it a hedge fund now.

And here was this cheap stock, cheap by working capital standards or so.  But it was a stock in a— in a textile company that had been going downhill for years.  So it was a huge company originally, and they kept closing one mill after another.  And every time they would close a mill, they would— take the proceeds and they would buy in their stock.  And I figured they were gonna close, they only had a few mills left, but that they would close another one.  I’d buy the stock.  I’d tender it to them and make a small profit.

So I started buying the stock.  And in 1964, we had quite a bit of stock.  And I went back and visited the management,  Mr. (Seabury) Stanton.  And he looked at me and he said, ‘Mr. Buffett.  We’ve just sold some mills.  We got some excess money.  We’re gonna have a tender offer.  And at what price will you tender your stock?’

And I said, ‘11.50.’  And he said, ‘Do you promise me that you’ll tender it 11.50?’  And I said, ‘Mr. Stanton, you have my word that if you do it here in the near future, that I will sell my stock to— at 11.50.’  I went back to Omaha.  And a few weeks later, I opened the mail—

BECKY:  Oh, you have this?

BUFFETT:   And here it is:  a tender offer from Berkshire Hathaway— that’s from 1964.  And if you look carefully, you’ll see the price is—

BECKY:  11 and—

BUFFETT:   —11 and three-eighths.  He chiseled me for an eighth.  And if that letter had come through with 11 and a half, I would have tendered my stock.  But this made me mad.  So I went out and started buying the stock, and I bought control of the company, and fired Mr. Stanton.  (LAUGHTER)

Now, that sounds like a great little morality table— tale at this point.  But the truth is I had now committed a major amount of money to a terrible business.  And Berkshire Hathaway became the base for everything pretty much that I’ve done since.  So in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway.  I really should— should have bought it for a new entity.

Because Berkshire Hathaway was carrying this anchor, all these textile assets.  So initially, it was all textile assets that weren’t any good.  And then, gradually, we built more things on to it.  But always, we were carrying this anchor.  And for 20 years, I fought the textile business before I gave up.  As instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now.  So—

BECKY:  Twice as much?

BUFFETT:  Yeah.  This is $200 billion.  You can— you can figure that— comes about.  Because the genius here thought he could run a textile business. (LAUGHTER)

BECKY:  Why $200 billion?

BUFFETT:  Well, because if you look at taking that same money that I put into the textile business and just putting it into the insurance business, and starting from there, we would have had a company that— because all of this money was a drag.  I mean, we had to— a net worth of $20 million.  And Berkshire Hathaway was earning nothing, year after year after year after year.  And— so there you have it, the story of— a $200 billion— incidentally, if you come back in ten years, I may have one that’s even worse.  (LAUGHTER)

Hat tip SD and David Lau.

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Fortune magazine has a great profile on David Sokol, Warren Buffett’s Mr. Fix-It:

Buffett first met Sokol in 1999 when Berkshire was buying MidAmerican, the Iowa utility. With longtime Buffett friend Walter Scott, Sokol had bought a small, $28-million-a-year geothermal business in 1991 and built it into that utility powerhouse. MidAmerican, headquartered in Des Moines, now represents an $11.4 billion slice of Berkshire’s revenue (about 10%), and Sokol is its chairman. In 2007, Buffett asked Sokol to get Johns Manville, an underperforming roofing and insulation company, on track, and he did; he is now its chairman. In 2008, Charlie Munger, Buffett’s vice chairman, asked Sokol to fly to China to conduct due diligence on BYD, a battery and electric car maker. Sokol liked what he saw, and Berkshire invested $230 million for 10% of the company. That stake is now worth around $1.5 billion. In April, when Buffett had concerns about a provision in the Senate financial regulation bill that would have required Berkshire and other companies to post billions of collateral on their existing derivatives, it was Sokol he sent to argue his case. Buffett’s side of the argument won.

Last summer Buffett handed Sokol perhaps the biggest assignment of his career: turning around NetJets. The fractional-ownership jet company last year lost $711 million before taxes — not the kind of performance that warms Buffett’s heart. Today the company is profitable, and Fortune got a rare, exclusive view of how Sokol did it

This story about Berkshire’s attempted acquisition of Constellation Energy is superb:

The day after Lehman collapsed in September 2008, David Sokol noticed that the stock of Constellation Energy, a Baltimore utility, was plummeting. He called his boss, Warren Buffett, and said, “I see an opportunity here.” Buffett, who had noticed the same thing, replied after a brief discussion: “Let’s go after it.”

Constellation (CEG, Fortune 500) held vast amounts of energy futures contracts that had gone sour, and the company appeared to be on the verge of bankruptcy. Sokol, as chairman of the Berkshire subsidiary MidAmerican Energy Holdings, knew the utility industry and saw a chance to buy solid assets at a bargain price. The deal, however, had to be done within 48 hours or the company would have to file for bankruptcy.

Sokol phoned the office of Constellation CEO Mayo Shattuck III, who was in an emergency board meeting. When his assistant answered, Sokol told her he’d like to speak to him. The secretary replied that if she interrupted the meeting, she might lose her job. Sokol replied, “If you don’t interrupt the meeting, you might lose your job.”

Sokol boarded a Falcon 50EX and sped to Baltimore. He met with Shattuck and struck a deal that evening to buy the company for $4.7 billion, staving off bankruptcy.

Within weeks, before the acquisition was completed, Constellation’s board received a competing bid from Électricité de France for about a 30% premium. The board liked the offer, and so did Sokol — who walked away with a $1.2 billion breakup fee for Berkshire.

Read the article.

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The WSJ has a more full profile of Li Lu (subscription required), the Chinese-born hedge-fund manager in line to become a successor to Warren Buffett at Berkshire Hathaway Inc.:

Mr. Li, 44 years old, has emerged as a leading candidate to run a chunk of Berkshire’s $100 billion portfolio, stemming from a close friendship with Charlie Munger, Berkshire’s 86-year-old vice chairman. In an interview, Mr. Munger revealed that Mr. Li was likely to become one of the top Berkshire investment officials. “In my mind, it’s a foregone conclusion,” Mr. Munger said.

The profile discusses Li Lu’s investment in BYD:

The Chinese-American investor already has made money for Berkshire: He introduced Mr. Munger to BYD Co., a Chinese battery and auto maker, and Berkshire invested. Since 2008, Berkshire’s BYD stake has surged more than six-fold, generating profit of about $1.2 billion, Mr. Buffett says. Mr. Li’s hedge funds have garnered an annualized compound return of 26.4% since 1998, compared to 2.25% for the Standard & Poor’s 500 stock index during the same period.

Mr. Li’s big hit began in 2002 when he first invested in BYD, then a fledgling Chinese battery company. Its founder came from humble beginnings and started the company in 1995 with $300,000 of borrowed money.

Mr. Li made an initial investment in BYD soon after its initial public offering on the Hong Kong stock exchange. (BYD trades in the U.S. on the Pink Sheets and was recently quoted at $6.90 a share.)

When he opened the fund, he loaded up again on BYD shares, eventually investing a significant share of the $150 million fund with Mr. Munger in BYD, which already was growing quickly and had bought a bankrupt Chinese automaker. “He bought a little early and more later when the stock fell, which is his nature,” Mr. Munger says.

In 2008, Mr. Munger persuaded Mr. Sokol to investigate BYD for Berkshire as well. Mr. Sokol went to China and when he returned, he and Mr. Munger convinced Mr. Buffett to load up on BYD. In September, Berkshire invested $230 million in BYD for a 10% stake in the company.

BYD’s business has been on fire. It now has close to one-third of the global market for lithium-ion batteries, used in cell phones. Its bigger plans involve the electric and hybrid-vehicle business.

The test for BYD, one of the largest Chinese car makers, will be whether it can deliver on plans to develop the most effective lithium battery on the market that could become an even bigger source of power in the future. Even more promising is the potential to use the lithium battery to store power from other energy sources like solar and wind.

Says Mr. Munger: “The big lithium battery is a game-changer.”

BYD is a big roll of the dice for Mr. Li. He is an informal adviser to the company and owns about 2.5% of the company.

Mr. Li’s fund’s $40 million investment in BYD is now worth about $400 million. Berkshire’s $230 million investment in 2008 now is worth about $1.5 billion. Messrs. Buffett, Munger, Sokol, Li and Microsoft founder and Berkshire Director Bill Gates plan to visit China and BYD in September.

As impressive as that investment is, the WSJ says that Lu’s record is unremarkable without the investment in BYD:

But hiring Mr. Li could be risky. His big bet on BYD is his only large-scale investing home run. Without the BYD profits, his performance as a hedge-fund manager is unremarkable.

It’s unclear whether he could rack up such profits if managing a large portfolio of Berkshire’s.

What’s more, his strategy of “backing up the truck,” to make large investments and not wavering when the markets turn down could backfire in a prolonged bear market. Despite a 200% return in 2009, he was down 13% at the end of June this year, nearly double the 6.6% drop in the S&P-500 during the period.

Mr. Li declined to name his fund’s other holdings. Despite this year’s losses, the $600 million fund is up 338% since its late 2004 launch, an annualized return of around 30%, compared to less than 1% for the S&P 500 index.

Read the article.

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Berkshire Hathaway Inc. (NYSE:BRK.A BRK.B) has been in the news recently as Goldman Sachs initiated coverage on the stock with a “Buy” rating and then Stifel Nicolaus & Co. followed with a “Sell.” It’s not often that the street gets so polarized about a stock, tending to the more tepid “Hold,” so I thought I’d set out the long and short arguments below.


Goldman Sachs’s view is summarized as follows:

Valuation disconnect at a multi-decade high

We initiate coverage of Berkshire Hathaway (BRK.A/BRK.B) with a Buy rating, as the disconnect between the market value of the stock and the intrinsic value of the business is close to a multi-decade high. With the recent inclusion of Berkshire in the S&P 500 and Russell indices and increased investor focus, we attempt to provide a framework for how to invest in the stock. In our view, the company is a unique collection of assets that over time earns a return on those assets – and as such should be valued accordingly.

Transformation: Key shifts in value mix

Post the acquisition of Burlington Northern, we estimate close to half of Berkshire’s intrinsic value will be derived from “operating” entities (as opposed to “securities investments”). This accomplishes two key things, in our view: (a) it reduces the long-term reliance on senior management’s equity investing decisions, and (b) provides greater clarity into the source of future value for the company as a whole.

Structural growth in largest segments

Structurally, Berkshire’s earnings will benefit from the ongoing shift in consumers’ auto insurance buying habits (via the direct-to-consumer GEICO subsidiary), the continuing change in the way goods are transported across the country (via the large intermodal operations at Burlington Northern), and the enduring growth in energy and power demand (via MidAmerican).

Levered to cyclical economic recovery

Cyclically, the non-insurance entities are tied to GDP growth and to a lesser extent, industrial production. Thus, as the economy continues to emerge from its cyclical downturn, we would expect earnings to grow at a faster rate than what appears to be currently discounted in the stock.

Price targets and risks

Our 12-month intrinsic value-based price target is $152,000 for BRK.A and $101 for BRK.B, implying over 25% upside. Key risks include an economic downturn, insured catastrophes, and management succession.

The Goldman report also sets out Goldman’s rationale for calculating BRK intrinsic value with a very interesting back-test of the reasoning:

(1) Intrinsic Value

While Berkshire is a unique set of assets, we believe intrinsic value can be calculated in a manner similar to other companies. In our view the company is a collection of assets which earns a return on those assets over time – and thus the present value of such returns should equal the intrinsic value. Using historical drivers of returns (i.e. historical operating profits, market value of investments, interest rates, etc.) we can assess how Berkshire’s stock has tracked a derived intrinsic value over time. Importantly, however, the company has a long track record of producing significantly above-average returns on its assets and thus – while previous investment returns are no guarantee of future performance – we believe it is appropriate to factor above-average yields into intrinsic value. Specifically, we assess the intrinsic value as comprised of three main components:

1. The value of the investment portfolio (minus the insurance liabilities). This would be akin to a “book value” metric for other financial institutions. In other words, after liquidating the assets and having repaid all of the insurance obligations, the remainder would be the value left for shareholders.

2. The value of the float within the insurance operations. Float is the amount of funds an insurance company holds for future obligations and which can be invested for its own account. We ascribe a value to the float based on estimated future returns and growth. We will describe this analysis in more detail within the Insurance section below, however we would note this is the most unique component to the value of Berkshire, as there are few, if any, financial institutions with a track record of generating similar levels of consistent returns (see Exhibits 11-14 below).

3. The value of the non-insurance operating businesses. Outside of insurance, Berkshire owns majority stakes in a wide array of businesses. While the underlying operations are very diverse (i.e. railroads, utilities, carpet manufacturers, and even Dairy Queen), the businesses tend to share a common characteristic in that almost all maintain leading market share for either their industry or their geography. This is important when ascribing an intrinsic or long-term value to the operations, as the risk of obsolescence for the majority of the operations is considerably lower than other individual companies within the market. The idea of a real competitive advantage – or “moat” – suggests that at worst the companies will grow with the economy and at best will continue to compound returns at a rate higher than their peers. When valuing the non-insurance operations of Berkshire, we utilize a discounted cash flow model by aggregating expected earnings and applying a modest (and declining) 3-year growth rate and then a terminal growth rate of 2.5%.

Other key points to note:

  • Historically, the majority of the value derived from Berkshire has been sourced from the insurance operations – i.e. components one and two above. However, post the Burlington Northern acquisition, the contribution from non-insurance earnings will be larger than at any previous time in BRK’s history. We believe this is likely a concerted effort by current management over the past few years to allow for the “investing” component of BRK’s value to become less of a variable in the future – and thereby reducing the risk of lower investment returns impacting the value of Berkshire in the future (see Exhibits 5 and 6 below).
  • When we back-test our intrinsic value (as seen in Exhibit 4 above), we can show that comments or actions (as highlighted in the exhibit) made by Berkshire are consistent with the relationship depicted between intrinsic value and the market value ascribed to Berkshire stock. For example, in 1998, when Berkshire purchased General Re with stock, our analysis clearly shows the market value of the stock exceeded the intrinsic value of the company – thus, making the acquisition with “share currency” a significant value addition to the overall shares (ignoring however the future liability problems that General Re wound up disclosing).
  • When we back-test our intrinsic value model, we use a market cost of equity – i.e. the 10-year risk free rate and an applied equity risk premium for the US stock market. Not surprisingly, the general declining cost of capital over the past 30 years has helped to raise the value of Berkshire as well as the market.
  • While Berkshire can be shown to be largely impacted by cyclical industrial forces within the US, we note that the dual nature of the operations (i.e. insurance and non-insurance) allows for uncorrelated value creation opportunities. In other words, despite the recent recession’s negative impact on the future cash flows of the noninsurance businesses, the continued increase in insurance float (and the corresponding high-yielding investments made with that float) helped to mute the negative impact on the overall value of Berkshire.

Here’s Goldman’s calculation of intrinsic value:

The best part of the Goldman analysis is their comparison of BRK market price to Goldman’s calculation of intrinsic value since 1981:

Click here to see Goldman Sachs’s BRK report.


The short argument for BRK is described by Meyer Shields of Stifel Nicolaus & Co.. Shields’s view, from the WSJ’s Market Beat column, is as follows:

Q: Meyer, thanks a lot for taking the time to parry a few of our questions. First things first, does it feel strange to hit the sell button on Buffett?

A: It does, because it sounds like I’m saying that I know more about investing or markets than Buffett does, which is nuts. All I’m saying is that I think the share price underperforms in the near-term.

Q: And from the looks of your note, you’re not saying that the Buffmeister has lost his edge. A lot of your analysis is about your outlook for the economy right? So, put simply: The slower the economy, the slower the results at all the multivarious businesses Berkshire owns?

A: With the exception of insurance, which is pretty well-insulated from the economy, yes. Berkshire’s more exposed to homebuilding and less exposed to technology than the overall economy, but the bottom line is that if unemployment stays high, spending stays low, both for the U.S. in general and Berkshire in particular.

Q: So, if a weak economy is bad for both Berkshire and the U.S. in general. Why would Berkshire underperform in the near-term?

A: On top of its own businesses’ exposure to the economy, Berkshire sold some equity index put options that are marked to market every quarter, so its book value gets hit twice.

Q: Ahah! So Berkshire sold puts — options that make money when the underlying falls in price. That means essentially Berkshire is on the hook to pay-up for the falloff we saw during the correction. Right?

A: Yes, except that it would only be on the hook for that sort of falloff if there’s no recovery until 2018 and beyond. In the meanwhile, the only issue is the mark-to-market, but in March 2009, that was enough to spook investors.

Q: Ah, ok. So, Berkshire is going to have to take a paper loss this quarter on those puts it sold. Got it. You note that Berkshire has been outperforming the S&P 500 by about 26% year-to-date. I’m wondering how much of that may have to do with the Baby Berks being added to the S&P 500? (A lot of index funds had to buy.) Wondering if you have any other thoughts on what Berkshire’s addition to the index might mean for the shares?

A: I think there were three implications of the addition to the S&P. First, a lot of funds had to buy the stock. Second, the resulting share price appreciation meant that it cost Buffett fewer Berkshire shares to purchase Burlington Northern. Third (and this is less positive), with widespread professional ownership, the “cult-stock” aspect (some investors use valuation methods for Berkshire that don’t work for any other name) will weaken, making the shares more “normal.”

Q: Interesting. You mean “cult,” like, less of the long-term loyalists that stick with the stock through thick and thin?

A: Exactly. I think we’ll see bigger reactions to good and bad quarters than we’ve seen in the past.

Q: Good stuff. Thanks a lot for taking the time. We’ll be watching to see how the call pans out. We’d wish you good luck, but then some of Buffett’s cult following might attack us in the comments section, and accuse us of anti-Buffett bias. So, we’ll just wish you a generalized, not-specific-to-this-call, good luck.

A: I love Warren Buffett, and I look forward to the stock trading down to a point where I can rate it a Buy.

[Full Disclosure:  No positions. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Yesterday I ran a guest post on the short case for Berkshire Hathaway Inc. (NYSE:BRK.A, BRK.B) by S. Raj Rajagopal, an MBA student at Johnson Graduate School of Management at Cornell University. The post generated several requests for the valuation supporting Raj’s short thesis, which Raj has provided and I’ve reproduced below.

Here is the valuation underpinning Raj’s short case for Berkshire Hathaway Inc. (NYSE:BRK.A,BRK.B):

(Click to enlarge)

Click here to download the full presentation including the updated valuation for the Berkshire Hathaway short case (.pdf).

Please contact Raj if you would like to discuss his valuation or his short case.

[Full Disclosure: I do not hold a position in BRK.A or BRK.B. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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S. Raj Rajagopal has provided a guest post outlining his argument for a short position in Berkshire Hathaway Inc. (NYSE:BRK.A, BRK.B). Raj is an MBA student at Johnson Graduate School of Management at Cornell University graduating in May this year. He has worked as a portfolio manager at the Cayuga Fund, LLC, the Johnson Graduate School’s $12M hedge fund, and is currently seeking full-time employment in the investment management area. Here is his resume and his website, Gordian Knots. Please contact Raj if you would like to see his valuation on BRK.A / BRK.B.

Raj’s short case for Berkshire Hathaway Inc. (NYSE:BRK.A,BRK.B) is set out below:

(Click to enlarge)

Click here to download the Short Case for Berkshire Hathaway in full (.pdf)

[Full Disclosure: I do not hold BRK.A or BRK.B. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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