Beyond Berkshire's Cult of Personality

Buffett wants investors to look at the entire outfit, not just his stock-picking. What they'll find are solid earnings and lots of cash

By Amey Stone

It's hard to look at Berkshire Hathaway (BRK.A , BRK.B ) and see anything but the bright, shining visage of Warren Buffett. The Oracle of Omaha wears a halo so bright that virtually everything else about the company is cast into shadow. Yet, as Buffett ages -- he's now 72 -- and the kind of hero worship he attracts looks increasingly passé in this era of corporate scrutiny, investors are focusing more on Berkshire's operating businesses. Judging by the 40% run-up in the stock price in the past year, they like what they see.

Buffett did his best to deflect investor attention away from him in his latest letter to shareholders, published Mar. 6 on the Berkshire Web site. "I think he was trying to refocus attention on the ongoing entity," says Stephen Goddard, portfolio manager of the New Market Fund (AVMIX ), which has 23% of assets invested in Berkshire. "He wants people to see the company -- not as a Buffett vehicle but as an ongoing entity after he leaves this world."

The investing guru urged his admirers to view the group as an "unfolding movie, not as a still photograph," to use one of the more poetic images in his folksy letter. Goddard took the missive as a positive sign for Berkshire's future growth.


  Buffett also included numerous plaudits in his letter for the CEOs of Berkshire subsidiaries -- execs who likely will be around after Buffett is gone. "He loves dealing with businesses and the people who run them," says Matthew Sauer, a portfolio manager of the Oak Value Fund (OAKVX ), which has Berkshire as its largest holding, about 11% of assets. Buffett still has original founders in place at many businesses. "They don't need as much [help] from him on a daily basis," Sauer says. "The company grows less dependent on Buffett every time it makes an acquisition that generates future cash flow."

Despite the success of the operating businesses, the conventional wisdom on Berkshire remains that it's a compendium of Buffett's best stock picks. But as Buffett highlights in the third paragraph of this year's 23-page letter, equity holdings have fallen to 50% of Berkshire's total net worth in recent years. That's down from a high of 114% in the 1980s (when the value of the stocks the outfit owned added up to less than the balance-sheet book value of those shares).

Berkshire investors took note of a more optimistic tone in Buffett's annual missive than they have seen recently. He certainly had better news to crow about this year. Buffett starts off his letter pointing to Berkshire's $13.6 billion jump in net worth in 2003, which amounted to a 21% gain in per-share book value, as compared to a 10% gain in 2002 and a 6% decline in 2001, when its insurance business was a major drag. "In some respects, 2003 was Berkshire's best year ever," wrote Morningstar chief of securities analysis Haywood Kelly in a Mar. 8 report.


  The Oracle of Omaha pronounced General Re, Berkshire's massive reinsurance subsidiary, which struggled with underwriting losses in prior years, as "fixed." He also highlighted a number of attractive new businesses that are subsidiaries in the portfolio, including carpetmaker Shaw Industries, building-materials provider Johns Manville, and paint company Benjamin Moore, says Sauer.

At its core, however, Berkshire remains an insurance outfit. Fully two-thirds of Berkshire's $5.4 billion in 2003 operating earnings came from its insurance subsidiaries, which include General Re, National Indemnity, and Geico, says Goddard.

Buffett's basic strategy is to take all the money garnered from premiums paid by policyholders (he calls it "float") and reinvest it. That gives him a huge advantage, says Goddard, explaining: "It's like he gets to buy on margin without having to pay for it." Plus, if Berkshire does a good job underwriting its policies, it will pay out less in claims than it collects in premiums -- which it did in 2003 -- giving it another way to earn a return.


  Not everyone thinks Berkshire will replicate last year's success. Morningstar, which has a neutral rating on the stock, values it based on three characteristics: The size of the float (now up to $44 billion, from $41 billion a year ago), how much it cost (nothing in 2003 -- it actually returned 4%), and "what Buffett does with it."

That's the big question for Berkshire's future. It has about $35 billion in cash, which Buffett admits he's looking for ways to deploy by acquiring new businesses since he finds stocks unattractive at current prices. "If the market drops and takes Berkshire shares along with it, Berkshire becomes doubly attractive," Kelly wrote. "Not only would investors get Berkshire on the cheap, but Buffett could also start putting that huge stockpile of cash to work."

Berkshire's A shares closed Mar. 9 at a cool $94,790 a piece. Most analysts are neutral on the stock at this price, and according to First Call, the median price target on the shares is $100,000 -- or just a 6.2% gain from where they are today. But Goddard believes Berkshire can keep growing earnings at a rate of 15% a year, which he thinks would justify a $120,000 stock price. At its current price, "you're paying a large discount to the market for a vehicle that's growing much more rapidly," he says. And results like that would keep Buffett's halo firmly in place for the time being.

Edited by Beth Belton

Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist

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