5 Reasons Why the Bears Are Wrong About Berkshire Hathaway
Jessica is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) growth over the last year would be impressive, at least, if you ignored the upward drift of the Dow Jones Industrial Average. However, taken together with the massive run up in the rest of the market, Berkshire's prospects look less rosy. In fact, Berkshire-favored stocks like DaVita HealthCare Partners (NYSE: DVA) and Chicago Bridge & Iron (NYSE: CBI) have given back most of their gains from Spring.
On May 13, Michael Price of MFP Investors gave a slide presentation at London Value Conference arguing that the fair value of Berkshire Hathaway's stock should be roughly 20% lower than it is today.
So are the bears right about Berkshire? Here's five reasons why I believe the answer is an emphatic “No.”
Berkshire has better accounting practices than 95% of U.S.-listed companies. Buffett generally avoids loopholes in GAAP accounting, which means that Berkshire's businesses and partnerships have an inherently higher intrinsic value relative to the market.
Most companies believe in aggressive accounting practices that rely on shifty measurements of “accounting goodwill” (not genuine economic goodwill, but rabbit-out-a-hat valuations attached to things like jingles or the name recognition of also-ran products without the benefit of a durable competitive advantage). In the event of a major financial crisis, scandal or plain vanilla recession, such "aggressive" accounting tricks can be an investors worst nightmare.
Ownership in Berkshire confers a tremendous, if often under-appreciated, advantage, in that Buffett's accounting practices favor owners over management. Berkshire's subsidiaries are proven outperformers that would be likely worth considerably more than Berkshire's book value alone would suggest. How many companies can you say that about?
Heinz is likely to surprise. Berkshire's Heinz acquisition has largely dropped off of investor's radar, but there's every reason to assume that 3G Capital and new Heinz CEO, Bernardo Hees have big plans for the company. Both 3G and Hees have a track record for cutting costs, with some estimates putting the figure as high as $225 million over the next 3 years.
Burlington Northern Sante Fe has a lock on US shale oil transportation. BNSF has 1,000 miles of rail line in place and 8 originating terminals in the Williston basin. At present, BNSF serves 30% of US oil refineries and commands 80% of the crude-on-rail market. Delivering crude via tank cars costs about $3 more per barrel than moving by pipeline, and the gap is actually shrinking as bigger storage terminals are built to meet demand.
Berkshire's entry into the commercial underwriting market will dramatically increase the company's float. Two months ago, Bloomberg News reported that Berkshire was, in Warren Buffett's words, “...getting into commercial-insurance very big time.” At the time, many investors wondered why Buffett would bother. Berkshire already owned Geico, along with half a dozen other insurance subsidiaries, and Hurricane Sandy had dealt commercial underwriters massive losses. Why would Buffett want to double down?
One of the key insights that Buffett realized early on was that an insurance company's float, or the premiums that business owners pay to insure their property against loss, would provide him with a massive war chest at essentially zero or even negative rates of interest. By getting into commercial insurance, Berkshire is looking at a massive injection of cheap, imminently investable liquidity over the next few years – more than enough, in fact, to fund half a dozen more “elephant-sized” deals like Heinz.
Buffett's protégés are a chip off the old block. You may have noticed that Buffett's acquisitions and stock picks over the past decade follow the same amusing pattern. It goes something like this:
- Buffett buys something.
- Market gurus immediately hit the air waves with one of three story arcs:
- “Warren Buffett bought Company X! We have absolutely no idea why, but we're going to bloviate over it anyway because it's either that or dead air.”
- “Warren Buffett bought Company X? That stock is BORING. He must really be losing it in his old age.”
- “Well, of course Warren Buffett bought Company X. Company X is the most wonderful thing since sliced bread! What do they make, again?”
- Three months and 10,000 pages of analysis later, investors realize that Company X has some outstanding competitive advantage that everyone overlooked before.
- 6-18 months after that, investors realize that Company X exploits several well-known and documented demographic and/or policy shifts. This information was widely available to the investing public at the time but its importance was downplayed by the market.
- Everyone agrees that Warren Buffett a raving genius until his next big purchase, after which the cycle then repeats itself.
As it happens, the picks of Buffett's protégés exhibit many of the same attributes.
Take Chicago Bridge & Iron, for example: US regulators are preparing to approve as many as 20 liquefied natural gas plants for exporting LNG to more profitable markets abroad. This ruling has been anticipated for some time, though you wouldn't know it from the analyst coverage. Berkshire now owns 6.1% of the company.
Or take Ted Weschler's pick, DaVita Healthcare Partners. Growing obesity rates have been trumpeted non-stop by the media for decades. In 2012, the issue took center stage in Washington with the report that 27% of 17-24 year olds could not pass an army physical due to weight concerns. Yet, few investors drew the obvious connection between America's obesity problem and diabetes and from diabetes to dialysis. DaVita is currently Berkshire's fastest growing equity position.
These picks aren't so much a display of dazzling insight as a willingness to disagree with the consensus opinion on prospects that already exist.
Evaluating Berkshire's intrinsic value according to Ben Graham principles without taking into account how Warren Buffett has refined and expanded Graham's theories is like looking at Einstein's General Theory of Relativity from a Newtonian point of view. For decades, many physicists did exactly that, only to be proven exactly wrong. Such intellectual fossilization deserves a standing ovation from Berkshire shareholders. Without it, we might be back to the bad old days of the Buffett Premium.
And then where would we be?
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Jessica McCann has no position in any stocks mentioned. 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!