May 2 (Bloomberg) -- This weekend, 40,000 or so Berkshire Hathaway shareholders gathering in Omaha for the conglomerate’s annual meeting will spend plenty of time strolling through the mall of Buffett: a 194,300 square foot retail space set up to ply sundry products produced by Berkshire’s subsidiaries, including See’s Candies, Justin Brands western boots and Quickut (Ginsu) knives.
For deep-discount value seekers among the shopping crowd, the company stock is what merits a look-see.
Although shares of Berkshire Hathaway have failed to keep pace with the Standard & Poor’s 500 index over the past three years, money managers with skin in Berkshire say they are unfazed and see a compelling risk/reward story ahead.
David Rolfe, chief investment officer at Wedgewood Partners, has 7.7 percent of client money invested in Berkshire. He acknowledges the “opportunity cost” to owning Berkshire shares the past few years, but he says that’s pretty much par for the course with Berkshire in strong markets -- a point Buffett has repeatedly made. Rolfe estimates that shares are trading at a 40 percent discount to their intrinsic value. “It’s hard to find a more undervalued investment of such quality,” he says.
Tim Hartch, co-manager of the $1.8 billion BBH Core Select fund, which has nearly 6 percent of fund assets riding on Berkshire Hathaway (the fund’s largest holding), calculates that the recent $120,000 price for the A shares is a sizable 30 percent discount to the per-share intrinsic value of the firm’s business. (Berkshire’s B shares, with limited voting rights, trade at $80 a share.) “All companies and all shares lag from time to time,” says Hartch. “We’re focused on the underlying businesses and they are doing quite well.” Besides, he adds, “as a long-term investor what you want is a low price.”
That’s exactly a point Buffett took time to lay out for shareholders in this year’s shareholder letter: "Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply."
Buffett has long said the goal for Berkshire is for its per-share gain in intrinsic value to outperform the S&P 500 over time. Calculating intrinsic value is more art than science, so Buffett uses the more knowable book value (the net value of a company once liabilities are subtracted from assets) as a conservative proxy. In last year’s annual report, Buffett pointed out that in the 42 rolling five-year periods since he took over the company, Berkshire’s book value has in fact outpaced the S&P 500 every time. That streak held up last year as well.
Plan to Repurchase Shares
Investing pros are also bullish on the decision last fall by Berkshire’s board to greenlight a repurchase plan that will consider buying company stock when it trades below 110 percent of book value. That’s well below the 150 percent median valuation for the past decade.
The stock currently trades at 120 percent of book value, in spitting distance of when Berkshire will consider buying back shares, a move that increases the per-share earnings of remaining shares. “For someone who purchases today, the company is saying it will step in and repurchase shares at just 10 percent below its current level,” notes David Kass, who teaches finance at the Robert Smith School of Business at the University of Maryland and closely follows Berkshire.
Wedgewood’s Rolfe dryly notes that with the stock trading so close to a price at which one of the world’s great investors says he will consider buying, “I don’t want to be on the other side of that trade.”
David Winters, manager of the $1.6 billion Wintergreen value fund, says the stock repurchase plan was a factor in his recent decision to increase his fund’s Berkshire stake from about 3 percent of assets to 4.5 percent.
“You’ve got a company that is continuing to grow, with a stock price that has done nothing for a few years, and now the company has said it will repurchase at about 10 percent below today’s price,” says Winters. “There’s almost no downside with what we think is considerable upside. That’s what we call a special situation.” Winters says his conservative intrinsic value for the A shares is $160,000. “And I can get to $180,000 without pushing very hard.”
Buffett’s Succession Plan
Apart from the “we always lag in strong markets” and “we only care about long-term performance” explanations for the stock’s recent underperformance, there is also the matter of what happens after Buffett, 81, ceases to run the show.
To be sure, no one expects the next chairman to be able to pick up the phone and make near-instantaneous sweetheart deals, such as Buffett’s $5 billion investment in Goldman Sachs that paid Berkshire a 10 percent interest rate in the depths of the 2008 financial crisis, or last year’s $5 billion investment in Bank of America preferred shares, with a yield of 6 percent, plus warrants to purchase $700 million in common stock.
Pat Dorsey, president of Sanibel Captiva Investment Advisers, acknowledges that concern about Berkshire’s next generation leadership are “not immaterial,” but he says all the attention on Buffett’s age and potential successors obscures the fact that Buffett has spent the past decade repositioning the company to keep chugging along after he stops being in charge.
Berkshire is now much less dependent on the performance of its investment portfolio and more reliant on the operations of its wholly owned subsidiaries.
It’s a point Buffett has been cheerleading. In last year’s annual report, he observed that the 10-year compounded annual per-share growth in investments averaged less than 7 percent through 2010, compared to more than 20 percent in the 1980s, ‘90s and ‘00s. Meanwhile the annual compound growth in per-share pretax earnings of Berkshire’s non-insurance businesses increased more than 20 percent during the decade ending in 2010.
“Buffett has transformed Berkshire from a closed-end fund to a giant operating company,” says Dorsey, adding that those wholly-owned subsidiaries won’t stop churning out earnings once Buffett is no longer at the helm of the holding company. University of Maryland's Kass also points out that Buffett has long known what to look for when it he goes shopping. “He bought companies with durable competitive edges,” says Kass. “That doesn’t disappear overnight.”
Moreover, Dorsey sees a further potential masterstroke in Buffett’s recent acquisition of capital-intensive businesses, something Buffett has always disliked when making minority investments in other companies’ stock. The ongoing capital investments needed in railroads (BNSF) and utilities (MidAmerican Energy) are effective sponges for some of the hefty cash being generated by all the subsidiaries, further reducing the company’s reliance on annual decisions as to how to deploy capital. “That limits the scope of the successor to screw things up,” says Dorsey. “For Berkshire shareholders, the next 20 years will be less dependent on the guy in charge than the last 20 years.”
(Carla Fried is a freelance writer based in California.)
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