I am Happy I Bought More Berkshire Hathaway

Introduction

I do not have buyer's remorse from adding more shares of Berkshire Hathaway (NYSE: BRK-A), currently priced at about $120,000 per share, to my private financial services fund. At the end of each year I make an effort to invest any spare cash that has accumulated in this portfolio; Berkshire was one of the three stocks I purchased at that time.

The ‘Buffett Discount’

For the last few years, along with my wife, one of my sons and good friends, I have attended the Berkshire Hathaway shareholder meeting in Omaha, one of the world’s largest such gatherings. After last year’s meeting, I wrote about the “Buffett Discount” in my blog entitled Observations from Omaha. Normally, stock prices pay a premium for a history of successful management, sometimes too much. In my opinion, last year the reverse was true. The uncertainties as to who would, in time, replace Warren Buffett and Charlie Munger, weighed on the price of the shares. This was a concern for a number of years, but last year became a headline event when the presumed CEO replacement left the company under trying circumstances.

The last Saturday in February is the usual time that Berkshire publishes its annual report, including a much anticipated letter from Mr. Buffett. On Saturday, like many portfolio managers and other investors, I devoted a number of hours poring over the document. While there was additional, welcome, detail on the progress of the company, there was very little of new information that would have changed my mind at year end, when I decided to increase our investment. What was news was the disclosure that the next CEO and two backups is known to the board, but not yet revealed to the other shareholders. For some investors this may close the Buffett discount, but I was confident that it would happen one way or another relatively soon.

My rationale for buying more

Our most recent purchase of BRK-A is already up 4.6%. (I mention this to our blog community and fellow shareholders only because we bought in the midst of what was considered by many as a troubling stock market.) Below is a brief outline of my thinking.

1. We bought at a small (15%) premium to a very much understated book value. The company itself has a policy of only paying 110% of book when buying back stock. The book value of Berkshire's operating assets is essentially its purchase price, but after acquisition earnings. As many of these acquisitions were made years ago and at bargain prices, I am guessing a multiple of book is a more appropriate measure. (This might suggest that the return on investment would be lower, based on the higher augmented book value.)
   
   
2. The Buffett discount mentioned in my prior Berkshire blog is being addressed. There is now an undisclosed CEO, with two backups in reserve. In addition, two value-focused investment managers have been hired.
   
   
3. The five largest operating subsidiaries are reporting record operating income.
   
   
4. “Float” production remains ample, aided by nine years of underwriting profits (even if there is an occasional loss year).
   
   
5. Recognition of past mistakes is acknowledged by management, both in terms of acquisitions and portfolio decisions. This is comforting compared with many CEOs and portfolio managers.
   
   
6. Berkshire benefits from others providing leverage for its regulated activities. Operationally, Berkshire is leveraged to housing, which appears to be getting better.
   
   
7. As the company is primarily US-based, after much of its US business is improving, our multi-year outlook is encouraging.
   
   
8. Averaging up at a lower valuation is generally a good thing.
   

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When Warren Buffett Speaks About Investing, the Wealthy Should Listen

Is this you?

The really wealthy are those that have liquid investment capital in excess of their perceived needs. All the rest are enslaved to their circumstances and lack the flexibility to be the masters of their investment future. This blog is directed to the wealthy; whether they are ultra high net worth counting their portfolios in the tens of millions or those that are merely wealthy, who have a spare few dollars to invest.

My Saturday Chore

Approximately 60 days before the annual meeting of Berkshire Hathaway (BRK.A), Warren Buffett publishes his letter to shareholders. He times the release for a Saturday morning. I have two reasons for reading this year’s nineteen page letter. First, thankfully I have been a shareholder personally for many years and the stock is also in the hedge fund I manage. The second reason I read the letter intently is that it is an excellent investment primer, particularly for those who can think of themselves as wealthy as described above. This year, with one of my sons, I plan to attend the annual meeting, known to some as “the Woodstock of Capitalism.”

THE LESSONS:

Liquidity is a good defense

The first lesson is to lose less on the inevitable downturns. Buffett’s direct quote is, “Our defense has been better than our offense.” When you examine the Berkshire portfolio, you can see that in many years there is an excess of short term cash instruments (wealthy people have cash). Part of Buffett’s business strategy is to use a large amount of cash generation owned by others (float). He uses this float to replenish the cash he uses for investment. Wealthy people also have a positive cash flow which allows them to have spare ammunition to be able to shoot at attractive targets during down turns. Perhaps more importantly, with a pile of cash on the sideline, the wealthy don’t panic and sell at depressed prices. Liquidity is a good thing to own or control at all times, but particularly in rough periods. The low return on liquidity in ebullient periods is a tolerable insurance premium.

Invest in what you know

Warren Buffett at age 79 and Charlie Munger at 86 only invest in those companies that they think they understand and whose future they can predict with some degree of certainty. They are not comfortable investing on the basis of new products, no matter how exciting they may be. (Remember that Bill Gates of Microsoft is not only a director of the company, but he and his wife will direct the vast bulk of Buffett’s charitable estate.) Berkshire’s caution on new products did not prevent them from investing $3 billion in wind generation for a controlled utility in a monopoly position.

Investors bring their own needs to an investment

With its long term need to find productive places to invest its continuous cash flow, Berkshire has found that Burlington Northern Santa Fe (BNSF), a railroad serving many of its customers, will continually need cash for capital investments. Berkshire views positively the railroad’s need for additional capital every year. Berkshire’s willingness to supply long-term capital trumped a price that an ordinary buyer would pay for this stock. The lesson here is that a particular need of an investor leads to an investment decision that others do not perceive when one is buying the whole company. This is similar to a property owner buying adjacent land to prevent any construction on the site.

We can all make investment mistakes

Over the last forty years, one of the attributes of all the great investment managers that I have known is that they admit their mistakes. Privately, they are like fishermen: they talk about the one that got away. With Berkshire Hathaway, Mr. Buffett dwells on mistakes of commission. Buffett publicly admits it was his personal mistake that drove GEICO, one of their owned companies, into the sub prime credit card business.

In their publicly traded portfolio, Berkshire Hathaway has thirteen positions each with a market value of $1 billion or more. Many of these have been great long term successes: American Express (AXP), Coca Cola (KO) and Procter & Gamble (PG). One of the thirteen is ConocoPhilips (COP), which they have been selling, but still have a book loss remaining of some $ 800 million. The reason that I find this holding so interesting is that I have noted a similar position in a number of value-oriented funds with great long term records. This stock has been a great value trap. As good as Warren Buffet is, it shows even he can make a mistake, particularly when a position in the larger Exxon (XOM) would have produced better results.

Think Global, even in US Investments

An additional insight from looking at the baker’s dozen billion dollar holdings is that there are two foreign stocks; BYD,the Chinese battery manufacturer and Tesco, a British retailer. But when you look further into the other companies one can speculate that at least half of their underlying earnings power comes from overseas. Thus, in truth Berkshire is increasingly becoming a global investment vehicle despite the high profile railroad investment (which also has some foreign trade elements).

Berkshire’s Liquidity Advantage

The final lesson that I choose to highlight relates back to the first, but in this case pertains to good companies when they have a need for liquidity. Taking advantage of those needs, Berkshire purchased the non-traded securities of Dow Chemical, GE, Goldman Sachs, Swiss Re and Wrigley. All these holdings produce dividends and interest which pay Berkshire roughly 10% on its investment plus an additional equity kicker. From time to time good companies have poor liquidity and are willing to pay a big price for it. Thus, one can use one’s own liquidity to help others for an outsized return. But like a good US Marine Corps Division, as soon as one commits a reserve, one needs to reestablish a new reserve so that one can fight another day.

What are your lessons that you would like to pass on?
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