Berkshire Hathaway Poised For Strong 2013
John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Several weeks ago, I argued Berkshire Hathaway (NYSE: BRK-B) (NYSE: BRK-A) offered an extraordinary Risk/Reward proposition --priced just above Warren Buffett's Buyback Price of 1.1 Times Book Value. Since then, Buffett has raised his Buyback Offer to 1.2 Times Book...and predictably the stock price sits, again, slightly above that level. Berkshire remains largely unfollowed on Wall Street, largely misunderstood on Main Street, and still deeply undervalued--poised for 2013 Outperformance.
Berkshire appears to be transitioning into a Stock Holder Value creation stage due to a confluence of factors including its large size and the possible shortage of value enhancing large business purchases (the famous "elephants").
The strengths of Berkshire are obvious: a Fort Knox Balance Sheet and a collection of Insurance Companies regarded as the best in the world. The legendary Insurance Operations generate historically cost free Float of more than $70 Billion. Invested at just 5%, that’s effectively a free $3.5 Billion dropped on Berkshire out of thin air. It’s almost unfair to give Buffett that kind of head start before he deploys a penny of Capital.
***Berkshire is significantly exposed to the recovering Housing Market offering a large cyclical bounce to Earnings. Berkshire's huge Wells Fargo stock holding and Bank of America Warrants benefit from rising home prices, sales, refinancings, and spreads from rising long rates. Berkshire also owns large Realtor networks, and owns many companies that benefit from rising home sales including Acme Brick, one of the country’s largest collection of furniture companies, Clayton Homes, and USG.
What are Berkshire's weaknesses? Everyone knows Buffett isn't getting any younger and he will be impossible to replace. Todd Combs and Todd Weschler have performed impressively managing small sums and should perform well handling the investment side of the business. But the Operating Companies are now the bulk of Berkshire Earnings and their operations are de-centralized. Berkshire will do very well post Buffett, but it’s true: there's only 1 Buffett.
Berkshire's size is an Anchor of Growth. Huge past growth rates are unsustainable. And Berkshire's large stock holdings have significant unrealized capital gains. Large ships are tough to turn around, and in Berkshire's case--would be very expensive to re-position via asset sales.
Opportunity: Value Creation. With $45 Billion+ in Cash and a cheap stock, the math is obvious. Buffett, for the first time ever, has pledged to buy back his stock. His pledge at buying at 1.2 Times Book is $89.37/share by my calculation. And Book is growing significantly. Now consider that Buffett recently observed that cheap money is attracting a lot more Private Equity competition for potential "Elephant" Purchases...a problem compounded by higher valuations in the stock market. It’s a real challenge to put that Cash to work buying Businesses at the right price.
Buffett also said in recent months he wants to engage shareholders in a discussion about the merits of issuing a Dividend for the first time ever.
Connect the dots. After years of strong business outperformance and a stock price that has underperformed that Business, Berkshire appears to be on a path of creating shareholder value through stock buybacks and dividend payments. We could be entering a phase where the return to shareholders outperforms the business returns (a reversal of the past decade).
**Berkshire stock has historically priced between 1.5 and 2.0 Times Book Value. It’s now just 1.25 X. But, over time, Berkshire should trade at HIGHER multiples of Book, not LOWER. That’s because in the 1990s, when Berkshire traded at 2 Times Book, the company was dominated by Investments--principally Stock Holdings. For example, when Coca Cola Stock represented a significant portion of Berkshire's Capital---investors were paying 2 Times Book for Berkshire ON TOP of the 7 Times Book Berkshire paid for Coke.
As Berkshire has evolved into a collection of OPERATING Companies, the Price to Book has CONTRACTED. This is counterintuitive. Price to Book should Expand. Burlington Northern should be selling for far more than 1.2 Times Book Value. Marmon, GEICO, the Furniture Companies..the collection of 80+ Operating Companies consistently generate cash and represent the majority of Berkshire's profits.
***Berkshire is selling at a modest premium to its Investments only. Even though Operating Companies represent the bulk of the business. Buffett recommends a 2-column method to value Berkshire (Investments + Operating Company Earnings). Investments Per Share plus a market multiple of operating earnings gets to $165,000/A, $110/B--significantly higher than today's stock price.
***Listen to Buffett: he'll guide you right on the Company he knows best. When he issued B shares --he advised the Public to NOT buy them! He said they were too expensive. In 1998, he said he wouldn't buy Berkshire stock after a big run up. And in 1999, he warned investors faced long term substandard returns in stocks due to bubble prices. Critics said Buffett was simply old and out of touch with the modern era.
Amazing, a decade later-Buffett has apparently rediscovered the Fountain of Youth: penning an Op Ed Wall Street Journal piece titled "Buy American: I Am"..an all-in recommendation to Buy Stocks when the public was puking them in disgust 4 years ago. In the last 18 months, Buffett has effectively pounded the Table on Berkshire Stock, pledging to buy back at 1.1 Times Book and upping the buyback to 1.2 times book..warning investors he could be taking advantage of them at those levels...promising such purchases would be very beneficial to long term value creation.
As we approach the May Annual Meeting....attention will turn to what Berkshire does next. Shareholder Value Creation could be at the top of that list.
Grahdodd has positions in BRK-A and BRK-B. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!