Monday, August 29, 2011

Berkshire Hathaway - A Diversified Portfolio

What does One Class A share of Berkshire Hathaway buy you?  (BRK.a = $109,340)

Shares              Company                         % of an ‘A’ Share

122                  Coca-Cola                              7.4 %
209                  Wells Fargo                            6.1 %
93                    American Express                  3.8 %
47                    Procter & Gamble                   2.6 %
64                    Kraft                                      1.8 %
26                    Johnson & Johnson                 1.4 %
18                    ConocoPhilips                        1.3 %
3                      Wesco Financial                    1.2 %
24                    Walmart                                 1.1 %
42                    US Bankcorp                          1.0 %
17                    Moody's                                 <1%
3                      M&T Bank
3                      Costco
10                    USG
2                      Torchmark
5                      General Electric
2                      Sanofi
1                      UPS

Total Market Value of $32,600 (as of June 30, 2011)


What does 100 shares of Class B shares in Berkshire Hathaway buy you?  (100 BRK.b = $7,260)

Shares              Company                         % of 100 ‘B’ Shares

8                      Coca-Cola                               7.4 %
14                    Wells Fargo                             6.1 %
6                      American Express                   3.8 %
3                      Procter & Gamble                    2.6 %
4                      Kraft                                       1.8 %
2                      Johnson & Johnson                 1.4 %
1                      ConocoPhilips                         1.3 %
0.2                   Wesco Financial                      1.2 %
2                      Walmart                                  1.1%
3                      US Bankcorp                           1.0%
1                      Moody's                                   <1% 
0.2                   M&T Bank
0.2                   Costco
1                      USG
& a fraction of a share of Torchmark, General Electric, Sanofi, & UPS.

Total Market Value = $2,174 (as of June 30, 2011)


Commentary

These top 19 positions in the Berkshire Portfolio account for about a 30% of the market value of the A or B shares. 

The top 4 positions account for just about 20% of the purchase price of the A or B shares.  These are Coca-Cola, Wells Fargo, American Express, & Procter & Gamble.

The top 2 positions account for 13.5% of the purchase price of the A or B shares.  These are Coca-Cola and Wells Fargo. 

Buying a share of Berkshire stock gives you access to a fantastic group of businesses. 

The remainder of the purchase price in the stock buys an interest in another group of wholly owned business, which as a whole have compounded earnings at over 20% for the past decade. 

Buffett's recent $5 billion investment in Bank of America now ranks 4th on the above list, just behind American Express ($6.9 billion) and ahead of Proctor & Gamble ($4.7 billion). 


Best Regards,
Kevin

Disclosure - Long BRK.B, WFC, BAC, GE, JNJ, & KFT.  

Sunday, August 21, 2011

Value Hiding in Plain Sight?


I want to highlight one deal still available on the market hiding in plain sight, Wells Fargo.  So often we think we have to search the outer reaches of the magical stock market kingdom to find value.  Today we'll look at how Wells Fargo offers outstanding value and significant upside.  Secondly, I will keep this short and sweet.  I have been recommending Wells Fargo to a number of people and today I will spell out why it's a great deal.  

Wells Fargo - A Fantastic Business

Since I want to get directly to the valuation of the company, I wont waste much time singing the praises of the company.  Wells Fargo is truly is a fantastic business.  It has a huge deposit base that is very, very low cost and it has among the largest net interest margin of all the large banks.  You can think of net interest margin as the gross margin for a bank.  I tell people it's the difference between the interest rate on a loan (loan interest rate) and the funding interest rate (deposit interest rate).  This is because of the community banking focus.  

As I have said before, during financial crisis of 2008, Wells Fargo would have been the last bank standing.  The credit default swaps barely moved compared to the much riskier banks.  Also during the credit crunch they were also able to pick up Wachovia on the cheap.  (Don't take my word for it read the takeover proxy yourself) 

Wells Fargo - A Fantastic Valuation

As for valuation, the company is selling for roughly $23.50 ($23.36 Friday's close).  The trailing 12 months earnings per share is $2.58, giving it a trailing P/E ratio of 8.7 times.  That is a 11.5% earnings yield (earnings per share divided by the share price).  Now we must stop here and make a few comments.  This is one of the truly outstanding companies in the USA.  As an owner you are effectively getting a very good return on your capital today, in the rear view mirror, not some pie in the sky future estimate.  Lastly, the company is operating in some very difficult conditions given the recent recession and very weak loan growth.  The company does has money to lend to credit worth borrowers.  If the company were to pay out the historic rate of 45% of earnings as dividends, you would be earning a 5.1% dividend yield, today not tomorrow.  You also benefit from the large amount of retained earnings to fund future growth. 

Now lets stop and take a look into the future.   I have done my own analysis and believe the company will earn approx $4.10/shr in 2013.  You may rightly suggest that I am am only an "armchair" analyst, what do I really know?  Well to calm the critics, let see what First Call has to say about the analysts who cover Wells Fargo.  A polling of 27 analysts estimate the company will earn $3.49/shr in 2012 and $4.05/shr in 2013.  Let's all be pessimistic and agree on $4.00 per share of earnings in 2013. 

What does that mean for a valuation?   Well in two years time the company will be good for a 17% earnings yield.  Again, if they pay out 45% in dividends that will be good for a 7.7% dividend yield.  Plus you will also benefit from the growth provided by the retained earnings.  By 2013 the company will be more than able to pay out a much large percentage of earnings as they will have enough capital to meet Basil III requirements. 


Summary

Today you can use the "recession fear" to become an owner of one of the best banks in the USA for approx. $23.50/shr.  Profits for this year will come in at around $2.80/share.  Under normal circumstances (not raising capital) that would be good for over a 5% dividend yield.  This is not pie in the sky but actual money they are earning TODAY.  In two years profits are estimated to be up 44% to $4/shr, and dividends will be approximately $1.80/shr, giving a 7.7% dividend yield (based on today’s price). 

By 2013 I would expect two things to happen.  First, as already mentioned, the company will be earning closer to $4/shr (44% growth), and the P/E multiple should expand from the current 8.7 times to a more normal 14 times earnings (55% growth).  This would place the value of the common stock at around $56/shr, giving dividend yield of 3.1% ($1.80/shr dividend divided by $56/shr price). 

Lets be conservative and say the share price only gets to $50 per share (~12 times earnings) in 2013, that would mean you double your investment in around two years.  That works out to be a 42% annual return excluding dividends.  Let’s just say even if I am wrong and wrong by a lot, Wells Fargo is very cheap.

The funny thing is, none of this is private information.  It’s easily accessible to anyone with a computer and half a brain. 


Conclusion

I don’t find it surprising the Warren Buffett was buying more Wells Fargo in the second quarter.  The cheapest Wells Fargo reached during the second quarter was approximately $25.36/shr.  Today you have an opportunity to buy Wells Fargo 10% cheaper than Mr. Buffett was recently buying it for. 

Wells Fargo is Warren Buffett’s second largest holding, behind Coca-Cola.  Do you want to wager a guess about what he things about the company and it’s future prospects?  Don't bother fretting over the current macro problems, and focus on doing one thing... Buying Stocks Cheap. 



Best Regards,

Kevin Graham

Disclosure – I've been adding to WFC recently.   

Friday, August 19, 2011

Gold Bubble? You be the Judge!

An interesting chart of the day.  Gold is definitely going parabolic.  For what it's worth I think it has a way to run (but who really knows, right?)





We all know how the internet bubble ended.  Here is a refresher for those that have forgotten.  (Click on the picture to make it larger)




Best Regards,

Kevin Graham

Disclosure - I have added GLL to my watch list.  Gold may have a way to run but I will profit from the folly someday.

Monday, August 8, 2011

MARKET ALERT - TIME TO BUY

We’ll it’s finally time for another blog post.  I don't know about you but I've been having a great summer and we've enjoyed more days at the lake this year than I can remember.  Things definitely got a little spicy this weekend with the S&P downgrade of US debt.  All it did was add a little more fear to the fire. 

Well if are looking for attractive securities I would suggest randomly hitting letters keys on your keyboard.  The market is finally repriced and now offers decent value.  Lets try a few random letters. 

WMT – Yep, it’s a winner.  Walmart is cheaper today than during the darkest days of the recession. 

BRK – Close enough… BRK.A/BRK.B are at a new 52 week low and the company is so cheap they have to be considering a share buyback, although Buffett doesn’t like taking out his so called “partners” for cheap.  That said they have $40 billion in cash and I would bet Buffett is putting some to work as I write this. 

WFC – New 52 week low today, awesome deal.   Wells Fargo is the safest and best run bank in the USA.  They will be earning over $4 per share within 2 years.  At $23/share that’s a 17% earnings yield (P/E of 5.75).  If you can handle the stench, BAC offers even better value.   

MSFT – Wow another winner.  Microsoft is minting cash at a rate of $2 billion every month and has a comfortable $51 billion of liquid assets but who’s counting.  The company has averaged 14 billion of free cash flow for the past several years.  Microsoft even has a higher credit rating than the US government according to S&P.

GS – Short and sweet.  Goldman Sachs is selling for less than tangible book value and these guys know how to make money better than any other on Wall Street.   

JNJ – Well Johnson and Johnson produces 14 billion in free cash on 60 billion in revenue… can you say fantastic business!  Today’s valuation is compelling with the company offering a 3.7% dividend.  Sit back and get paid to be an owner. 

Beyond those, I like almost anything in the DOW.  Almost all of the companies have a license to print money and offer outstanding value.

As for the next few days I would look for a rebound.  I noted on a couple of other blogs that the VIX is reaching new highs (a measure of volatility).  Secondly, the VIX relative to the ten year treasury is as high as it’s been since the failure of Lehman Brothers.  That means if the tomorrow is a great time to buy if you have any cash available.   Looking backward, stocks have rebound strongly (90% of the time) over the following three month these levels were reached before.   

I am lucky I have the bulk of my funds in three stocks that have held up well (PEY, BRK.B, FFH).  My BAC and WFC are taking it on the chin today, but I know in the long run they will be fine. 

Much of the issues in the financial sector in 2008 was related to mark to market losses on mortgage backed securities.  Once these securities became illiquid their value was anyone’s guess.  Today banks have lots of liquidity, the Federal Reserve holds the bulk of the risky assets, and the banks rely very little on the short-term repo market (or at least they should have learn this lesson). 

I used to tell a coworker back during the darkest days of 2008 that in a couple of years we would both look back at this downturn as a blip on radar.  The same is still true today.  I just talked to a doctor friend of mine and he said a number of patients came in today and said they sold everything.  I told him to start buying every time he has a day like today with his patients selling out. 

Be greedy when others are fearful and fearful when others are gready.”  Warren Buffett

It’s gready time.    


 
Good Luck,
Kevin

Disclosure: I am long everything except WMT, which I may purchase over the next couple days.