Saturday, November 12, 2011

Investment Idea - Berkshire Hathaway

Yesterday I gave you a number of quotes from the Oracle of Omaha, Warren Buffett.  The last quote was the following:

Your goal as an investor should be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.

So I got thinking to myself, are there investments available today that meet Mr. Buffett's criteria.  I was originally going to post on another company that is significantly undervalued and will most likely be taken out at a premium over the next year or two for reasons that would become clear upon investigation.  I had come to the decision that I wasn't going to invest but the stock has recently gotten cheaper and I do some buying.  The stock isn't overly liquid but the company is fairly large.  Anyone want to make a guess? 

Upon further reflection the best example that I could think of today that meets Mr. Buffett's criteria is his own company, Berkshire Hathaway.  Today Berkshire Hathaway represents a very asymmetric investment opportunity.  The downside is very, very low and the upside is very, very significant.  My argument for investment won't rely on any facts or figures but simply a statement recently issued by the company itself. 

It stated, "Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10 premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise."

So what we have is hat tip from Mr. Buffett who is clearly signaling that he believes his stock is cheap.  Not only does he believe it is cheap, but worth considerably more than a 10% premium to book value.  The 10% premium is likely to reflect the fact that they don't believe a significant portion of their principally deferred income taxes, listed as a liability, is really a liability.  Some other minor balance sheet modifications could also be made. 

Secondly, downside is limited to 110% of book value or currently $71/share (Class 'B' share).  So, for the sake of argument, let's assume Berkshire is worth 1.75 times book value or about $115/share.  So at recent prices you have around 8% downside and 50% upside making this opportunity very asymmetric.  Besides the very attractive risk/reward scenario you are buying a business that owns a number of fantastic businesses from Dairy Queen (a personal favorite) to GEICO.  They also have some fantastic equity investments in growing companies like Coca-Cola and Wells Fargo.  Nearly all of the Berkshire companies earn exceptional returns on equity. 

So lets run down the checklist from Mr. Buffett's quote above: 

1) Rational Price?

Check - Mr. Buffett has told us it's not only undervalued, but significantly undervalued.

2) Easily Understandable Business?

Check - Although Berkshire is a complex conglomerate of many businesses and equity investments, most all of these businesses are quite simple and provide valuable goods and services that people use everyday. 

3) Are the earnings are virtually certain to be materially higher five, ten and twenty years from now?

Check - Wholly owned business have increased per share earnings by 20% annually for the past decade.  Those companies will be providing the same goods and services 20 years from now as they are today (very low technology risk).  Examples would be bricks, carpet, insurance, ice cream, razors, soft drinks & candy.

4) Would Berkshire be a good company to own for the next ten years?

Check - I can't think of another company I would be more happy to own for the next ten years.


What does Mr. Buffett recommend you do when you find a company that meets all of his requirements and is available at a reasonable price?  You should buy a significant amount of stock.  Enough said, the writing is on the wall. 

My recommendation is to buy some Berkshire and forget about it for at least ten years.  When you check it again, it will be worth much more than what you paid.  No need to get a daily stock quote or read every single news update out of Europe.

Lastly, by investing in Berkshire, you will benefit not only from earnings per share growth but also from a market that will value the company in a more optimistic mood in the future.  In the short term if the stock does get cheaper realize that is in your best interest for Berkshire to buy back as many shares as possible.  Just remember to use Mr. Buffett's assessment of fair value and ignore what the market says.

Best Regards,

Kevin Graham

Disclosure - I am long BRK.b

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