Wednesday, May 16, 2007

Berkshire A Buy Post Buffet

Since "Woodstock For Capitalist's" weekend in Omaha is now over, a bit about Berkshire and it's leader. No one will will argue or dispute his past success and what he has done for shareholders. Nor will anyone attempt to belittle the atmosphere and honesty in which he runs the organization and the culture he created. That being said, being a former Berkshire (BRK) shareholder I would not consider purchasing shares until Buffet steps down. The reason? $40 billion in cash and no plans to spend it. Berkshire is, in essence an insurance company that pays no dividends. It's results the past two years are due to one factor, no major catastrophes.

Buffet has the ability to "buffer" shareholders against the eventual catastrophe and it's impact but refuses to part with his cash. Insurance industry profits have been at all time highs the past two years and even Buffet himself has acknowledged that this cannot continue. Berkshire earnings increases over that span have been due solely to insurance profits, not investing gains or increases in it's other operating segments. Industry pricing has already come down and we are one active hurricane season away from watching those record profits evaporate. When they do, Berkshire shares will take a hit with them.

Here is my issue, Buffet has the power to insulate shareholders from this eventuality. His recent purchase of 10% of Burlington Northern and 15% stake in USG marked the first time this century he has taken a meaningful stake in any company. In the past 6 plus years he has dabbled in shares of Wal-Mart, Home Depot, Lowe's and others without making any meaningful foray into them. When Berkshire was experiencing its meteoric rise, it was due to Buffet making huge investments in a handful of companies. Now, the definition of huge changes as your size does. $100 million to Berkshire in 1975 was significant, but today is 2% than of what Buffet has on hand to invest. That being said, Buffet still has the ability to make portfolio changing investments, he just chooses not to. Berkshire's investment portfolio today resembles a mutual fund with small positions in over 30 companies that are bought and sold regularly. In the past Buffet has said "Wait for a fat pitch and then swing for the fences". Why isn't he doing that? Considering the investment possibilities Berkshire has, his recent investing record is one of bunts, not big swings. He has also said in the past "if you would not buy the whole company, why would you buy a single share"? Using his own logic, I have to ask "Warren, if you are going to invest $160 million in Home Depot, why not $1 billion" The theory still holds, if you would not buy 100 shares why buy one share and if you would buy one share, why not a hundred of them? An investment of 4% of his available cash is not "swinging for the fences"

25% of Berkshire's current market cap is it's cash. Shares trade at a PE of 15 times earnings and given it's earnings ability and financial stability, that should be higher. The reason it isn't? People recognize that the $40 billion will be sitting there next quarter and next year and in today's low interest rate environment, money in the bank does not impress anyone. Put it to work and Berkshire's multiple will expand.

Unfortunately, that will not happen until Buffet retires and someone else runs Berkshire's investments.

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