Portfolio manager’s Letter December 2007
November was another good month with Losch Management Company’s accounts up 3% – 4% while the S&P 500 was off 4.4%. The broad market measured by the Wilshire 5000 off 4.78%, so Company’s net gain against the market was 8% – 9%, which, you can take my word for it, is definitely a good month.
Since the first of July when the Bear Stearns news broke, and the market started its correction we have beaten the market by about 20% with Losch Management Company’s accounts typically up 19% or better while the averages are down more than 1%. The year to date figures are not quite that strong, but December has started out strong and I think it likely that we will finish the year with one of our best relative annual performances.
It is not hard to figure out why the picture looks so good, Berkshire Hathaway was up 32% for the year at the end November. The problem (if there is one) is that the stock is not only beating the market, but the stock price is clearly growing faster than the company’s intrinsic value. Granted some of this is catch-up as Berkshire Hathaway’s stock price has underperformed its growth of intrinsic value for the last few years, but it is my guess that we can expect some kind of a correction soon.
The increase in the price had increased the value of the Berkshire Hathaway position in some portfolios to as high as 75%. Because, the risk level rises with the stock’s price I thought it wise to rebalance a little, and have now reduced Berkshire Hathaway to about the same percentage of total portfolio that we held when this rally began (between 55% and 60% in all portfolios).
As Berkshire Hathaway’s stock has taken flight, several of the stocks that Warren Buffett has been buying have been trading in the opposite direction. In the 3rd Quarter he purchased $770 million of Wells Fargo and $900 of US Bankcorp, both are now trading at or near 52 week lows. Burlington Northern is trading a few dollars above his purchase price, and USG which Warren Buffett was buying early in the year for $46 is now trading just above $36.
Earlier this year I did an analysis that included these stocks (see your September Letter) at the time it was my feeling that Berkshire Hathaway itself was a better value than its investees, however with the run up in its price since July this has become a much more difficult call. It may be that the best way to maintain our relative performance in 2008 will be to move money into some the above stocks.
We know that Berkshire Hathaway has sold its stake in PetroChina, and although most of the position was probably gone by the second week in October we don’t know how much of the gain was recorded in the Third Quarter, and how much is left to be recorded in the fourth quarter.
Now that we have the 3rd Quarter 13F, it is possible to make a guess about the size of the capital gain that Berkshire Hathaway will show in the Fourth Quarter. The Berkshire Hathaway Cash Flow statement from the third Quarter lists $3.699 billion of equity sales. To get the figure for PetroChina we can back out other stock sales. The following is a list those other sales, the amounts shown are estimates because the 13F does not list Berkshire Hathaway’s actual sales price.
|Ameriprise Financial||$70 million|
|Conoco Phillips||$34 million|
|First Data||$330 million|
|Northern Southern||$97 million|
|PetroChina ADR||$97 million|
|Service Master||$60 million|
|Union Pacific||$350 million|
If we Subtract $1.3 billion from $3.7 billion it would indicate that about 2.4 billion of the total equity sales in the third quarter were PetroChina H Shares. With these figures we can estimate that less than two thirds, but more than half of the H Shares went in the third quarter. This still leaves us with a nice bump to earnings for the fourth quarter. If you figure the price was a little higher that third quarter sales, the fourth quarter gain could be as high as $1.4 billion. This will probably mean that After Tax Earnings for 2007 will be in excess of $14 billion or $9500 per share, and that at $142,500 Berkshire Hathaway would be selling at 15 times earnings.
Investment gains may not be predictive, but the cash they provide is the same color as cash from “operating earnings”. Over the last 20 years Berkshire Hathaway’s after tax operating income has totaled $37.7 billion, while it’s after tax capital gains where $19.6 billion. So of the total net income for the period of $57.257 billion, capital gains amounted to 34.2 % of that. This is a figure that all by itself would have paid for most of Berkshire Hathaway’s cash acquisitions of operating companies during the 20 year period if you don’t count 2006.
In addition to the cash they will receive from investment gains in 2007, Berkshire Hathaway 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 Hathaway’s cash flow in 2007 will be in the black by something like $21 billion. Operating earnings as defined by Warren Buffett will amount to something like $10.5 billion. Somehow this hardly seems an adequate measure of the value that has been added to Berkshire Hathaway this year.
During the past 20 years Berkshire Hathaway has increased its insurance float by $49.6 billion. If, as Warren Buffett says, Float is as good as cash earnings, as long as Insurance underwriting is showing a profit, this means that the companies 20 year cash flow was $106.9 billion, and that Berkshire Hathaway’s insurance float has been a bigger factor in the companies growth that its operating earnings.