When I learned yesterday that Berkshire Hathaway had just reported its biggest book value loss in 44 years (indeed, it has only even had a loss once in that 44 year period), I said to my wife “dammit, Mabel, it’s time to buy.” But Mabel wouldn’t listen. Her theory is that everyone is investing in Berkshire Hathaway because of Buffett, but at 78 years old, he won’t be around forever. Since proving each other wrong is the cornerstone of every marriage, I decided to measure the premium that Buffett adds to Berkshire Hathaway.
There are two ways to do this:
- the way that is technically correct, and
- the way of a blogger rushing to dinner
So I’m going to apply the most blunt instrument I know…price to earnings ratio. The idea is to take the PE of Berkshire Hathaway and compare it to the weighted average of the largest stocks in the Berkshire Hathaway portfolio:
- American Express
- Coca-Cola
- Johnson & Johnson
- Kraft
- Procter & Gamble
- Sanofi-Aventis
- Tesco
- US Bancorp
- Wal-Mart
- The Washington Post
- Wells Fargo
If Berkshire Hathaway’s PE (which is 15.56) is higher than the weighted PE of the component stocks, than my Mabel is right: investors are overpaying. I say if because I haven’t run the number yet (I thought that would keep things interesting for both of us). And I’ve changed the name of my wife to Mabel in this story to protect her from the overwhelming public embarrassment of being proven wrong. So give me a few moments to crank this into excel.
…
…
Wow.
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Maybe I should listen to that Mabel. The weighted average PE ratio came to 14.58, about 6% less than the Berkshire Hathaway PE. For a $121.77 billion company, that translates into a personality premium of about $7.65 billion.
Now, I could point out all the flaws in this method (earnings are a blunt instrument, these holdings account for less than half of the market value of Berkshire-Hathaway’s holdings, yada yada yada), but I won’t be a sore loser.
The larger point is, that even after a tumultuous couple weeks, Berkshire Hathaway is still trading at a premium to a portfolio of some of its component stocks. And if you’re better at picking stocks than Warren Buffett, why pay that premium?
Of course, none of us is better at picking stocks than the Oracle of Omaha. To the extent that we’re half-way decent at picking stocks, it’s because we learned everything we know from Warren. So, even if my wife won’t let me entrust our savings to the greatest investor of all time, I’m at least going to let him take me to school once again this year.
Here’s what I learned today in his annual letter to shareholders (all quotes below are Buffet’s):
Don’t invest in Munis this year:
Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.
Double-down on oil?
I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.
Don’t stick it in your mattress
Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.
I hope someone out there in the blogosphere will give me a good argument as I hash this out with my wife. (comment below…please) The best I can do is this: Buffett and Munger aren’t the only ones at the helm of Berkshire Hathaway, and even if they were, Berkshire Hathaway isn’t the only company with an aging leadership. But the counter-argument, of course, is that America seems to value Buffett’s aged wisdom very highly, and all those other CEOs are valued as so much dead wood.
Undervalued stocks
Value Cruncher
Whether one sides in this argument with you or with Mabel comes down to whether one believes WB to be a “Clock Builder” or a “Time Teller”.
BH and other companies face this same question as their founders / gurus wind down their careers. Corporate boards and stockholders nervously try to forecast the result of a famous founder leaving the company he created. According to the ‘94 book “Built to Last” , companies that endure across generations were built by Clock Builders; whereas those that shine briefly, then fizzle are run by Time Tellers.
Clock builders install built-to-last mechanisms that can keep going no matter who’s in charge: Sam Walton, GE’s 1st CEO Charles Coffin, Intel’s Andy Grove – and the U.S.A.’s founding fathers were CB’s.
Time tellers, on the other hand, are CEO’s with vision and charisma to whom everyone looks for answers – they can tell time – but no one else there can nor do they ever learn how. Once the old man leaves, the company is left ill-equipped and descends into chaos: Juan Trippe of Pan Am, Walt Disney, and (many suspect) Steve Jobs are examples of Time Tellers whose companies suffered in the wake of their absence.
I think I’ve heard this referred to as “Key Man” syndrome in a different context.
At any rate – I believe WB’s investment judgment is inherently rational and that it therefore can be codified and taught and perpetuated once he’s gone. I also have gotten the impression over the years that WB is a teacher and an engaging person – one who would want to pass along his wisdom vs. some crotchety, scary wizard in a tower (like john simon: creepy king of black box quants). BH can survive because its past success wasn’t pulled from a crystal ball – it was the result of sound reasoning and precise execution: it should run like a clock for years to come.
full disclosure: I pulled what i said in my last post from this article in Portfolio Magazine’s current issue:
http://www.portfolio.com/executives/features/2009/02/11/Analysis-of-Jobs-Leave-of-Absence
it’s titled “Apple After Jobs: What the iconic company can learn from Walt Disney and Sam Walton”
Dude. you so need a blog.
Douglas Kass is a guy who shorted WB & BH stock through his domestic dedicated short fund Seabreeze Partners Mgmt.
Doug has been called “the Anti Cramer”, which of course contrasts his short bias with Jim Cramer’s “strong long” outlook. Both men write columns for thestreet.com
below is an excerpt from a 5/18/08 Barron’s interview with Kass. What he said then sounds pretty smart now:
Barron’s: “You’re short Berkshire Hathaway [BRK.A]. Betting against Warren Buffett in the past was a costly move, as evidenced by Berkshire’s stellar performance since the 1960s. Why do so now?
Kass: “No. 1, there will never be another Warren Buffett. I respect and admire him considerably, but in part because of the lucrative compensation set-up in the hedge-fund industry, the investment landscape now is inhabited by a lot more smart and aggressive managers who comb for value — far more than there were 10, 20 or 30 years ago. Berkshire Hathaway ’s outperformance versus the market has been narrowing in the last decade, and I expect that will continue. Investors are going to dump the shares if Buffett is no longer at the helm, though I’m not signaling that he plans to step down anytime soon.
What else concerns you about Berkshire?
More than anything, I’m short Berkshire because of Buffett’s recent investment-style drift. In the past five years, Buffett frequently called derivatives “financial weapons of mass destruction.” Yet, very much out of character, he immersed himself in several large and thus far unprofitable derivative transactions, leading to an unrealized $1.6 billion pretax loss in the first quarter. I’m also short Berkshire because the salad days for insurance, which is the cornerstone of Berkshire’s business, are over. Also, Berkshire’s premium valuation seemingly has been a byproduct of the credit crisis, and the perception of the company as a safe haven. Berkshire’s shares might underperform as some of the deflated financial companies regain their footing. And Buffett is substantially exposed not only to financials — he owns large positions in Wells Fargo [WFC], Bank of America [BAC] and American Express [AXP] — but also to a weakening housing market through his ownership of Clayton Homes.
Kass sides with Mabel on this one.
I’m putting out a fatwa on Kass. May the Allah of capitalism strike him down!