I thought I'd start a mini blog on Facebook. I figured I'd add to the hype about Buffett's letter.
Every year Warren Buffett writes a much anticipated shareholder letter. Since his company Berkshire Hathaway (BRKA) is my largest stock position I (along with every stock market pundit and wanta be pundit) read it with great interest. I won't comment much on the letter, but I will try to analysis the stock compared to historical levels based on the annual report.
On Feb 28, 1999 BRKA stock closed at $71,100 a share, ten years latter it closed at $78,600 a 10% gain over 10 years. Hardly a way to get rich, albeit a much better than an investment in the S&P 500 over the same period. The obvious question is BRKA a good buy now. The answer is I don't know for sure.
In fact, I should warn any FB friends that while in theory I know a fair amount about investment, my track record for the last year or two has been as bad as anybody else's down 28% in 2008 and 2009 is starting off horrible. Or to put it another way doing the opposite of what I did last year would be a pretty great way of become rich
Still I can state that Berkshire Hathaway is a heck of a lot better investment today than 10 years ago, and I think that is true of most stocks. Now this is pretty much a duh, but as the late Paul Harvey said here is the rest of the story.
Most people think Berkshire Hathaway is mutual fund run by Warren Buffett, while that used to be true. Over the last decade Berkshire has primarily become a conglomerate owning more than 70 companies with more than 250,000 employee (more than GM), the biggest is GEICO. Buffett still does lots of investing, especially over the last year. Berkshire makes money a lot of ways but one of the secrets is the use of insurance float. This is insurance premium you pay in advance for auto insurance or hurricane insurance, that Buffett and his team invest while keeping enough in reserve to pay for your future accident or Katrina. (Katrina and her sister hurricanes cost each Berkshire shareholder $2200).
Now lets see what has happened to Berkshire in the last 10 years. Probably the most important thing is that company has earned 58 Billion a tidy sum that is almost $38,000 per share. Now unlike some companies that vast majority of this money, hasn't been invested in expensive rugs, and executive retreats. Instead it has been partially invested in stocks, bonds, and preferred shares, but primarily it has been used to buy profitable companies. It is safe to say that Warren Buffett doesn't have a reputation for overpaying for things including companies. A partial list of dozens of companies acquired in the last 10 years, is Businesswire, Pampered Chief, Fruit of the Loom, Acme Brick, Shaw industries (carpets), Clayton Homes (largest mobile home supplier), XTRA (truck leasing), Johns Manfield. Two of the largest acquisitions have large oversees operations Iscar, an Israeli tool manufacturer, and PacificCorp which owns the 3rd largest electric utility in the UK and has 2+ million US customers. Now earnings can be manipulated (especially for companies with a financial component) but cash is tougher to fake, and over the last 3 years, a billion dollars a month have flowed into Omaha for Warren to invest.
Another way of looking at company is its book value (which is basically a companies net worth). Berkshire book value has increased from 58 to 109 billion (70K/share) in ten year, as Buffett explains (better than I could ever hope to see page 90-92 of the annual report), book value is a best an imprecise measure. But right now Berkshire is stock is selling for 1.1x book value, compared about 1.6 for 1999 and up to 2.0 in 2001.
2009, has been a bad year for financial stocks, and Berkshire owns large stakes in banks, this partly accounts for the stock dropping 19% this year. Berkshire has roughly $12-$13 B in Wells Fargo, American Express, US Bank and others. It has also has written insurance contracts (technically puts on stock market indexes) that expire in 2019 to 2029 and has another $35-40 billion in stock investments which have also decreased in value. Still even if we assume bank nationalization, a recession like the Japanese have gone through, it hard to justify wiping out more than 1/2 of the $56 billion in earning Berkshire has had in the last 10 years.
So simply adding the the 1999 stock price 71K to 1/2 the earning ($19K) resulted in a price of $90K. But Berkshire is much different and bigger company today than it was 10 years ago. In addition to all the companies Warren has bought, Berkshire operating companies have also grown revenues and profits, for instance GEICO is on track to become the countries largest auto insurer, and even See's has sold more candy. In aggregate Berkshire revenue have increase from 13.8 billion in 98 to 107.8 billion this year an 8 fold increase. Berkshire profits are very inconsistent due to insurance and investing returns, but if we average 3 years 98 to 2000 earnings per share are about $1650 vs. the last 3 year average of $6300 or an almost 4 fold increase. Even if the stock market was too optimistic in early 1999 about Berkshire (and clearly dot coms were beyond optimistic and well into nut levels then), the earnings potential of Berkshire is several times greater in 2008 than 1998. So in summary anyway you try value Berkshire, by book value, historical measurements, or earning potential it is significantly cheaper than it was 10 years ago, when Warren hoped to achieve a 15% return going forward.
In the 2008 letter Buffett says this
"The investment world has gone from underpricing risk to overpricing it. This change has not been
minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."
I am perfectly happy to take the risk that an investment in company like Berkshire will pay off in the long run, better than loaning my money to Uncle Sam or a bank at couple of percent. I wouldn't be surprised to see another 25% drop in the market, and I am mindful that market can remain irrational longer than you can remain insolvent, but eventually sanity will prevail.
