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Berkshire Hathaway: Like a Kid in a Candy Store

by: Horacio Marquez August 25, 2008 | about stocks: BRK.A    

Horacio Marquez

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Berkshire Hathaway Inc. (BRK.A) with Warren Buffett at the helm has one of the greatest financial combinations investors have ever seen. The shares of the once-wheezing textile-maker-turned-investment-vehicle doubled over the past 10 years, while the broad Standard &Poor’s 500 Index returned only 18% during the same period. In the process, Buffett became the richest man on the planet, with a net worth of about $62 billion, Forbes magazine reported back in March.

Since then, however, Berkshire Hathaway’s shares have plunged 23% - the "Class A" shares closed Friday at $116,650 each, down from their 52-week high of $151,650 (the "Class B" shares represent 1/30th of the Class A shares). And Berkshire Hathaway recently reported a slight drop in its year-to-year earnings due to some weaknesses in its operating businesses, as well as some market losses in long-term derivative positions that ultimately will almost surely be very profitable.

But the long-term track record of Buffett is indisputable. His fame is such that many make a living of playing the "WWWBN Game" - "What Will Warren Buy Next."

Some analysts argue that Buffett has lost his magic touch. We dismiss this out of hand. His most-recent decisions to add into railroads, to buy shares in leading steelmaker Posco Ltd. (PKX) and 19 other South Korean companies, buying the leading Israeli industrial company and taking profits in his China holdings just before that market lost half its value were all brilliant moves and will more than compensate for any mistakes he made in timing the U.S. dollar’s weakness the year before, or more recently, in taking some mark-to-market losses in credit default swaps, where he eventually should end up making very good money.

More recently, Buffett’s Berkshire has added - either directly or indirectly - holdings in such companies as Kraft Foods Inc. (KFT), making it the foodmaker’s biggest shareholder, and GlaxoSmithKline PLC (GSK), Europe’s largest drugmaker. Berkshire also was involved in a buyout deal for chewing gum icon Wm. Wrigley Jr. Company (WWY).

And we’ll be filing periodic updates on some of his other, more-recent moves.

The bottom line: Under Buffett, Berkshire Hathaway is a like an astute and disciplined kid in a candy store.

It’s very clear that Buffett’s investment philosophy - capitalizing on value situations in companies that enjoy strong, sustainable competitive advantages in secular growth markets, and that will perform very well over the long term - has worked much more often than not.  And most of the "mistakes" that some analysts point to are actually linked overwhelmingly to short-term market movements that could easily reverse.

For instance, let’s take a look at Berkshire’s second-quarter earnings and the performance in its "troubled" insurance businesses.

For the second quarter, Berkshire’s net income declined 8% to $2.88 billion. Operating earnings declined 10% to $2.27 billion. The per-share operating earnings of $1,465 on the Class A shares actually topped Wall Street’s estimate of $1,370.

Berkshire typically derives about half of its revenue and profits from its insurance businesses. Its underwriting profit came in at $360 million, a drop of about 43%, and Berkshire said it anticipates that price competition in most of its insurance markets will reduce underwriting profits for the rest of the year.

However, Berkshire was able to post an increase in its insurance investment income to $884 million, up 3% from the $862 million reported in the year-ago quarter. That’s something that rival American International Group (AIG) was unable to accomplish.

Berkshire Hathaway’s operating profit from its non-insurance businesses advanced 4%, reaching $1.086 billion.

Some observers contend that Buffett has become too distracted with too much ukulele-playing at Berkshire Hathaway’s investor gatherings and catching the public eye with trips to China, shown live on financial cable channel CNBC. Buffet is now also intent on saving the United States from "itself" and the mountain of debt it has amassed, which is the reason for his participation (and stellar performance) in the financial documentary "I.O.U.S.A.."

And yet some argue that Buffett’s advancing age (77) brings the uncertainties of succession to the forefront and that Berkshire Hathaway, with a huge pile of cash and its massive size, is too big to find enough profitable opportunities. Think again.

The evidence is very clear that selecting the right companies for the long haul - the process developed by Buffett and his longtime partner in managing Berkshire, Charles T. Munger (84) - is solidly in place, until proven different, rather than the opposite. And while succession is a valid question, the list of capable individuals to carry on with this process inside this organization is long. And the Berkshire portfolio is very sound. 

In terms of the decline in Berkshire’s share price, most of it can be attributed to the general slowdown of the U.S. economy and the need for many investors to take their (huge) long-term profits in this stock (which means staying out of it for at least 30 days before reloading, as part of the so-called "Wash Sales Rules.").

While such key Berkshire holdings as American Express Co. (AXP), Wells Fargo & Co. (WFC) and its insurance units are temporarily suffering in different degrees from the real estate crisis and global credit downturns, these conditions will eventually abate and reverse strongly. And since stock prices have, in many cases, been pushed down much more than was warranted, this reversal could be very strong, indeed.
 This is a high-quality investment portfolio. Once it contained the very best companies in the U.S. market - such flagship brand names as The Coca-Cola Co. (KO). But Buffett has changed with the times, recognizing the powerful opportunities that globalization has brought - and will continue to bring for decades to come. In addition to the afore-mentioned move into Korea, Berkshire is engineering forays into such promising - but undervalued - markets as Germany.

Against this current market backdrop, cash is clearly king. Berkshire’s ready access to investment capital, and the shortage of investing liquidity are ready made for Buffett to exercise his well-known stock-picking prowess - creating still greater profit opportunities for Berkshire Hathaway down the road.

Our conclusion: The short-term weakness in the U.S. economy - which is reflected in the weakness of Berkshire’s stock price - makes Berkshire a bargain itself right now. And with Buffett at the helm, Berkshire will continue to be one of the most-profitable investments you’ll be able to find anywhere in the world.

But this is not a short-term play - or a stock for trading. It’s a long-term core holding - indeed, one of the best you’ll find. Therefore, I would buy Berkshire Hathaway in incremental stages on any weakness between now and the end of the year, as market conditions improve and tax-loss-selling on U.S. stocks abates.

ACTION TO TAKE: BUY shares of Berkshire Hathaway Inc., making your purchases in incremental stages between now and the end of this year.

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This article has 15 comments:

  •  
    Aug 25 08:09 AM
    Blah Blah Blah Blah Blah."Warren is great." Blah Blah Blah Blah Blah

    If he has "lost it" this weak article would not tell you. Who knows. If Buffet knows everything, why are profits down?
    Reply
  •  
    Aug 25 08:38 AM
    Berkshire Hathaway is down this year because it is over-exposed to the consumer. Buffet's big mistake is being optimistic on the future of the US economy as we approach an era of peak oil where worldwide oil supply will not keep pace with worldwide oil demand. In this future, many of the stocks that Buffet owns in Berkshire will continue to do poorly. I thought he and Charlie "got it" when they bought ConocoPhillips (a great stock for these times), but now I realize they don't get it as they buy a gum company and sell the COP. Their finances are great, but as Buffet himself says, don't expect past returns in the future (that is an understatement). You'd be much better off buying energy services and energy stocks than BRK.
    Reply
  •  
    Aug 25 09:20 AM
    I would bet very peopel in America ,actually practice investing like WEB and the formula in my book for berkshire has given me high double digit returns on BRK in the over 12 years owning it. The author is spot on the company at current levels is cheap with ahurricane priced in and should spike up 15-25% if we stay hurricane free
    Reply
  •  
    Aug 25 10:38 AM
    looks like we have a lot of day traders here this morning and like most of them they have no vision and lose or make nickels and dimes. That s what happens to the gamblers and then they cry because they lost their money. Thank you for all your articles Mr Marquez because some of us (long term investors ) appreciate your work. We can t wait for your next article.
    Reply
  •  
    Aug 25 11:13 AM
    It pays to soar with the Eagle(BRK)rather than to be the road kill flattened by excessive leverage. Any of the road kill worth picking up won't be missed the Eagle's sharp eye.
    Reply
  •  
    Aug 25 02:11 PM
    If Buffett had sold his COP, he wouldn't have flown out to the oil sand country. I guess someone never bothers to read the 13F-HR, but instead relies on BS from the financial media.
    Reply
  •  
    Aug 25 08:02 PM
    Saint Warren's Berkshire is too big. There are lots of better investment choices.
    Reply
  •  
    Aug 25 08:49 PM
    Buy Markel, its similar but is smaller so can grow more
    Reply
  •  
    Aug 26 02:06 PM
    Author says he just bought 20 South Korean companies. That has to mean something. What the hell is going on in S. Korea that's so great other than selling commodities to China which everyone is well aware of. I've been thinking about PKX for a while. What price did Buffett pay?

    Overall, you can't knock Buffett, period. However, I would not buy into his fund because of his age (portfolio management is all about the manager not the "process developed...") as the author mentions.

    Reply
  •  
    Aug 26 03:14 PM
    yeah, i've got a spare few million lying around so i can buy a 100 shares in incremental stages from now until the end of the year....is this guy kidding me?
    Reply
  •  
    Aug 26 05:14 PM
    Warren paid around 45 for his PKX.
    Reply
  •  
    Aug 27 06:06 PM
    "Some observers contend that Buffett has become too distracted with too much ukulele-playing at Berkshire Hathaway’s investor gatherings and catching the public eye with trips to China, shown live on financial cable channel CNBC. Buffet is now also intent on saving the United States from "itself" and the mountain of debt it has amassed, which is the reason for his participation (and stellar performance) in the financial documentary "I.O.U.S.A.."... "

    I am involved in the attempt to save America from itself also. What I would actually call it is damage control and sparing as many lives as possible very real pain. Warren Buffet is what you call a true Christian and many get confused because of organized religion. Christianity is a code of ethics, it means you are willing to put others before yourself, even to death. I know this, because he takes the time to post information here at SA. That takes time to educate others, time he could use to add some zeros to his bank account.

    Some feel this is a waste of time, to sacrifice for others when needed, but no this is not true. It actually creates some very nice investment opportunities down the line and creates trust as an honest player. If he is a kid in the candy shop then he did a great job on his paper route and save his pennies for the right time when all the other kids pissed there's away on tootsie rolls.

    In reading Warren Buffets biographies and his writings here, I come to the conclusion he learned fundamentals at an early age and lived by them. This was balanced with his Judeo-Christian belief system that America was founded on and once so prosperously lived by.

    He looks at a big picture using common sense of cause and effect and applies historical context based on repetetive human nature. A good gentleman and role model. Not a god, one who acquired wisdom from knowing God.
    Reply
  •  
    Aug 27 09:04 PM
    Sold off today part today in casegustav hits.A hurricane will make this stock a HUGE bargain.# years after Katrina I bought it for 2730 and at today's depressed price have earned 13% compunded
    Reply
  •  
    Aug 27 11:01 PM
    The columnist writes " Berkshire Hathaway's stock price has doubled,over the past ten years." Using the "rule of 72" that works out to an annual return of 7.2%. A decent return for sure, but it hardly warrants all the gushing. I think some people are just caught up in the Warren Buffet mystic and lose sight of the facts.
    Reply
  •  
    Sep 02 02:17 AM
    BRK is the only individual stock I own, and probably the only one I will ever own. I'm less enthusiastic with the current P/E, but I don't buy anything unless I'd be comfortable holding it for life. The consistent market-beating performance, low beta, and low r^2 make it an ideal core holding.
    Reply
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