Client Letter Comments on Berkshire Hathaway
Berkshire Hathaway, Stock comment. - This Stock's price offers a compelling value at today's prices. Buy now. This is one decision that will last for Ten years.
Principle of Intermediate Fragmentation
On the list of Charlie's favorite books is Guns Germs, and Steel written by professor Jared Diamond. It is a book about human systems and the impact they have on history. Professor Diamond discusses the economic implications of his theories in "How to Get Rich." Professor Diamond is attempting to use history as a laboratory to identify optimal methods for business organizations, and his theories generate two fundamental conclusions.
Sit on Your Ass Investing?
Is this the time for buy and hold forever? Or should we be studying what worked in the sixties and seventies? In a roller-coaster market maybe you want to think about getting off and getting on.
Ben Laden and Berkshire Hathaway
What happens to the intrinsic value of an insurance company when it has to pay $2.2 billion in claims?
"Owner Earnings, Cash Flow and Berkshire Hathaway"
I have no clear idea how to value the float when computing intrinsic value, but I am fairly confident of two things: 1. money is going to keep pouring into Omaha, and 2. I am not sure that any future attempt to value Berkshire based solely on reported earnings will be satisfactory for me.
"Berkshire Hathaway Growth in intrinsic Value"
Buffett's $45,000 offer in 2000 was an important marker for intrinsic value, because we know that his figure must have represented a substantial discount to the intrinsic value of the stock at the time it was made. This is an attempt to adjust that price for the growth of the last three years.
"Sitting on The Sideline"
Sitting on the sideline may be no fun, but it is hardly and accurate description of what has been going on at 1440 Kiewit Plaza for the last year. I have revised my table of recent acquisition activity to include figures for Junk bond purchases and activity in the equity market (see below). If activity is the definition of fun, then Warren has been having a ball. Reading the first couple pages of the Chairman's Letter I get the impression he is tap-dancing like crazy. Certainly 72 years has not dulled his sense of humor.
"Notes from Omaha"
Saturday May 3, 2003 the Annual General Meeting of Berkshire Hathaway.
"The Power of Float"
If the present trend continues Berkshire’s after tax income this year would equal $6.9 billion up from $407 million in 1992. This means for the last 11 years Berkshire’s after-tax earnings have grown at an average annual rate of 29%.
Asset Allocation at Berkshire Hathaway
I have taken his table and added a couple of columns on the left side to cover the period that included the 1996 acquisition of GEICO. The result is a dramatic representation of Buffett's move away from the equity market. The move is very Buffett in that the shift is massive, but it was handled in such a way that unless you are really paying attention you would not notice. This table tells us better than mere words what is going on in Buffett's mind.
Having Your Cookie
Our basic market strategy evolves a large position in Berkshire because Berkshire is reasonably priced at present levels and with very solid long-term prospects. But more than this, it offers a hedge against a substantial market decline. With its huge cash positions and with Buffett to make the investment decisions, Berkshire is one stock that will get more valuable if the market declines.
Lackluster Performance
In just the last two years Buffett has realized gains of $8.2 billion in his bond and FOREX trading. Add in another $1.9 billion of unrealized gains in the junk bonds he still holds and maybe $200 to $300 million per year in interest income, and it is apparent that the chairman has enriched shareholders by about $10.5 billion with his trading skills in two years. This definitely does not meet my definition of 'lackluster performance.
The Buffett Premium
We have been hearing so long about this Buffett premium and the universal assumption has always been that there will be stock decline when he leaves. I would like to suggest, just for the sake of being argumentative, the possibility of a Buffett discount and propose a scenario where the stock price will increase in his absence.
Cheaper Elephants
One thing is different now compared to 2000. The elephants are cheaper, though not quite table-ready. They are still a lot cheaper now than they were in 2000, and another bear market like the 2000 to 2003 experience might well relieve Berkshire of a large portion of their cash problem. In 2000 Coke was selling at 43 times earnings—now it is at 22; Wells Fargo was selling at 20 times earnings whereas today it is selling at a PE of 14.8; Costco was 50 times earnings and now it is 21.7; Anheuser Busch was at 27 is now 16.7.
Berkshire Look-Through Earnings
This would mean that per-share earnings growth for the seven year period was equal to 15.2% on an annual basis for the period that includes both the purchase of General Re and 9/11. During the same period, GE has grown its per-share earnings at an annual rate of 9.8%, and Microsoft at 15.8%.
The Berkshire Hathaway Annual Report
Despite four hurricanes and an almost one billion dollar loss to their foreign currency position, Berkshire still had a pretty good year.
Berkshire's Growth Rate
Total pretax Operating Income has grown from $329 million in 1987 to $7.5 Billion in 2005. The growth for the 19 year period works out to annual rate of 19% which is not bad for a company the size of Berkshire, but what is more interesting to me is that the rate for the last ten years is 24%. Better yet the growth rate for the last 5 years is also 24%.
Berkshire's Second Quarter
Buffett says that lumpy earnings do not brother him, and it’s a good thing because Berkshire’s earnings are lumpier than a sack full of cats. While this is not a problem for Buffett it clearly is a problem for Mr. Market. This poor soul, obviously to busy to read Berkshire’s financial statements, has no clue, earnings are up or earnings are down but what does it mean? With all those lumps?
Hurricane Synergy
This I suspect is part of what we will call Buffett's hurricane synergy, the idea that if Berkshire can buy enough companies in the building materials, construction, and a manufactured housing industries. Then, when its the insurance companies are paying insurance claims for catastrophic damage due to hurricanes and earthquakes, Berkshire as a company will just be transferring money from one pocket to another.
Berkshire's Third Quarter
Using this guess (let me emphasize the word guess) we arrive at a pre tax operating profit of $4.111 billion for the insurance and the non-insurance operating companies. Estimating a tax rate of 36% would deduct $1.5 billion and leave us with an after-tax operating profit of 2.6 billion of the third quarter compared to $2.05 billion in the Second quarter, $1.8 billion in the first quarter of 2006 and $100 million in the third quarter of last year.
Equitas
Also helping to push Berkshire’s stock north was the recent announcement of a $15 billion deal with Equitas a trust formed by Lloyds of London to handle their asbestos and environment liabilities. This is a huge deal that will provide $9 billion in new insurance float when the deal closes, and maybe as much as $7 billion more over the life of the contract. This float comes from asbestos claims that will eventually have to be paid.
Berkshire Hathaway's Annual Report
Berkshire’s 2006 earnings were spectacular. For the year net earnings were $11 billion or $7,144 per share. This was up 29% from last years $5,538 per share. It was up from $4,753 per share in 2004 and $2,795 per share in 2002 for a 4 year annual growth rate of per share earnings of 26.4%.
Berkshire's First Quarter
I think it likely that 1st quarter earnings at Berkshire will again offer a positive surprise. Emboldened buy lucky guesses last year and being too stupid to quit while ahead, I will attempt the impossible (predict Berkshire’s first quarter)
Berkshire as a Hedge Fund
The main reason we have such a large position in Berkshire is for protection in a down market so at least for the moment our hedge is working. One big advantage of using Berkshire is that it can also outperform when the market is going up, as it did in 2006.
Berkshire's Third Quarter
In the Second Quarter Berkshire’s after tax net was $3.1 billion, so the Petro sales may well push Third Quarter bottom line to over $4.5 billion. This compares to last years $2.77 billion for the quarter, so the quarter to quarter comparison may exceed plus 60%
Omaha Cash Flow
In addition to the cash they will receive from investment gains in 2007, Berkshire will see a big cash infusion from a jump in the float of its insurance businesses because of the Equitas transaction. Add the $6.9 billion from Equitas to an after tax profit in the area of $14 billion, and Berkshire’s cash flow in 2007 will be in the black by something like $21 billion.
More on Omaha Cash Flow
This is an attempt to establish the importance of insurance float in any attempt to Value Berkshire Hathaway; we will use Buffett’s two column approach to attempt to understand the company’s current value.
Hurricane Insurance
It should come as no surprise then that Berkshire Hathaway has jumped with both feet into the market for insuring Wall Street and other financial institutions against financial hurricanes.
Berkshire's Preferreds
Berkshire’s Goldman Sacks warrants that were part of the $5 billion in preferred stock deal are in the money (profitable) by $754 per “A” share at the moment, total $1152 per share pretax. That's quite a lot in around 9 months, and as Goldman is nice the Swiss Re Purchase is sweeter.
Beach Reading
For your light summer reading I have included the annual update of some of our Berkshire financial tables. Please ignore the sex and violence.