Reader Question - Berkshire Hathaway

Here's a bonus post! A reader posed a question on a particular stock. As people ask me questions on stocks, topics, etc., I will try to post the responses on investingdecoded for the benefit of all. These 'Reader Question' posts will usually be bonus posts outside the usual topics that I'll be discussing.

However, before getting into the question, I first want to thank everyone for their support for investingdecoded. I've gotten a lot of positive feedback from many readers over the past few days, and I'd like to thank everyone. As always, let me know if you have any questions/comments/suggestions - I'd love to hear them!

So a reader asked me about a specific stock that he wanted to get my take on - Berkshire Hathaway (BRK.B). What a great stock to start with! An investing company who's genius leader, Warren Buffet, is someone that I try to emulate in my investing strategies. He's nothing short of a role model for me and many value oriented investors around the world.


What Does it Do?


First, let's take a look at what Berkshire Hathaway does. On paper, it considers itself a reinsurance company - somewhat similar to a CNA or a General Re. However, in reality, it is much more than that. It's actually more of an investment fund that buys various types of companies for long periods of time and holds them. It uses a value investing strategy when making investment decisions to buy companies that are, in Mr. Buffet's own words 'great companies at a fair price'. It then holds these companies for long periods of time. The company is a legend on wall street. Over the past 50 years, it has consistently outperformed the market and has provided superior results to its shareholders. Some of the more famous names under the Berkshire Hathaway umbrella are Dairy Queen, GEICO Insurance, and NetJets.

How is it Doing?

Being an investment company, BRK has been hit fairly hard by the economic downturn. As you can see from the chart below, it's down 25%+ over the last year (check out that spike downwards in Nov....now that's just fear selling from the Lehman fiasco)










Now seeing this graph might spook a lot of people for a few reasons:

Price - Yikes! This says the stock is about $3,000 a share! I can't afford that. Plus, even if I could, I wouldn't be able to make any money since I could only afford a few shares.
Don't fall into that trap! Warren Buffet intentionally does not split his stock (i.e. bring the price of the shares down and multiplying the number of shares available to make the price look less scary). He knows that many investors (professional and amateur) have a false understanding that an expensive stock will return less profits. These investors are exactly the type that he wants to avoid investing in his company at all, which is why the stock is at that price. The truth is, all stocks work on relative valuation - the idea that the price of a stock is dependent on factors that are measured on a per-share basis instead of an overall basis. This means that even if a stock is a million dollars a share, if it's earnings (on a per share basis) are a million dollars a share or somewhere in that magnitude, then it could be considered cheap and move higher accordingly. It doesn't really matter as much what the actual price is.

Of course, because of BRK's success, the stock has gone up substantially over the past 50 years. In fact, the $3000 a share above is not even the normal stock, it's the B-class share (shares that are still essentially the same company, but have certain restrictions that don't apply to the common stock, like voting rights). The A class shares a BRK (BRK.A) are actually running around $94,000 a share! How does that sound for success!

Downward Path - The stock is down over $25% in the last year! What's going to keep it from going down more?
It is true that BRK is facing many of the same challenges as other financial companies. And, in my opinion, these challenges have been reflected in the stock price. There is a definite downward trajectory in the earnings projections for BRK as well. But the argument can be made that many of these challenges are already priced into the stock and, when looking at a longer term chart for the company, it's apparent that a long-term outlook seems to say that BRK knows what it's doing through its consistent market outperformance.


Why You Do Want to Buy BRK.B

1. Top notch management that has a strong and unmatched track record in investing in little known, but quality companies, and turning them into gems.
2. A very strong credit rating (mainly due its strong management) that will allow to take advantage of opportunities that its competition can't - In fact, it just issued $250 Million in 10 year notes at AAA yields of 5.4%
   
3. A recent drop in the stock price making valuations much more reasonable which could provide for a great buying opportunity
4. They've done more buying in the last quarter than in any quarter in the company's history - classic Warren Buffet taking advantage of business conditions
   

Why You Don't Want to Buy BRK.B

1. The stock hasn't shown any signs of strength since the last downturn - there's no evidence of any trend changing
2. If the overall economy continues to worsen, then all this recent buying may take much longer to bear fruit
3. The company does demand a premium price compared to its competitors - merely for its brand name, so valuations get a little high. If for some reason the company loses this reputation ( e.g. several bad quarters of performance) it will likely lose that premium.

Final Thoughts


To buy the stock or not is a decisions that someone has to make base don his/her own situation. But to me, BRK is a strong name to hold if you really want to get into financials while hedging yourself from the risk brought on by some of the bank names (Do know that BRK has a large stake - I think around 9% - in Wells Fargo Bank). Actually, I hold BRK.B in one of my own portfolios since 2004. However, I do think that many of the investments its making right now will take a long time - 3-5 years - to really show some results and the stock is mainly a victim of the overall macroeconomic conditions at this point. Therefore, if you do buy it, expect to be on a roller-coaster probably for 2009. But the upside there is if you can tough out the roller coaster, there's the possibility of pretty good returns.

What do you think? BRK a buy or not? let me know and we can start a dialog!


Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.