Several weeks ago, I argued Berkshire Hathaway Inc. (NYSE:BRK.A) -B) offered an extraordinary Risk/Reward proposition --priced just above Warren Buffett's Buyback Price of 1.1 Times Book Value. Since then, Buffett has raised his Buyback Offer to 1.2 Times Book...and predictably the stock price sits, again, slightly above that level. Berkshire remains largely unfollowed on Wall Street, largely misunderstood on Main Street, and still deeply undervalued--poised for 2013 Outperformance.
Berkshire appears to be transitioning into a Stock Holder Value creation stage due to a confluence of factors including its large size and the possible shortage of value enhancing large business purchases (the famous "elephants").
The strengths of Berkshire are obvious: a Fort Knox Balance Sheet and a collection of Insurance Companies regarded as the best in the world. The legendary Insurance Operations generate historically cost free Float of more than $70 Billion. Invested at just 5%, that’s effectively a free $3.5 Billion dropped on Berkshire out of thin air. It’s almost unfair to give Buffett that kind of head start before he deploys a penny of Capital.
***Berkshire is significantly exposed to the recovering Housing Market offering a large cyclical bounce to Earnings. Berkshire's huge Wells Fargo & Company (NYSE:WFC) stock holding and Bank of America Corp (NYSE:BAC) Warrants benefit from rising home prices, sales, refinancings, and spreads from rising long rates. Berkshire also owns large Realtor networks, and owns many companies that benefit from rising home sales including Acme Brick, one of the country’s largest collection of furniture companies, Clayton Homes, and USG.
What are Berkshire's weaknesses? Everyone knows Buffett isn't getting any younger and he will be impossible to replace. Todd Combs and Todd Weschler have performed impressively managing small sums and should perform well handling the investment side of the business. But the Operating Companies are now the bulk of Berkshire Earnings and their operations are de-centralized. Berkshire will do very well post Buffett, but it’s true: there's only 1 Buffett.
Berkshire's size is an Anchor of Growth. Huge past growth rates are unsustainable. And Berkshire's large stock holdings have significant unrealized capital gains. Large ships are tough to turn around, and in Berkshire's case--would be very expensive to re-position via asset sales.
Opportunity: Value Creation. With $45 Billion+ in Cash and a cheap stock, the math is obvious. Buffett, for the first time ever, has pledged to buy back his stock. His pledge at buying at 1.2 Times Book is $89.37/share by my calculation. And Book is growing significantly. Now consider that Buffett recently observed that cheap money is attracting a lot more Private Equity competition for potential "Elephant" Purchases...a problem compounded by higher valuations in the stock market. It’s a real challenge to put that Cash to work buying Businesses at the right price.
Buffett also said in recent months he wants to engage shareholders in a discussion about the merits of issuing a Dividend for the first time ever.
Connect the dots. After years of strong business outperformance and a stock price that has underperformed that Business, Berkshire appears to be on a path of creating shareholder value through stock buybacks and dividend payments. We could be entering a phase where the return to shareholders outperforms the business returns (a reversal of the past decade).
**Berkshire stock has historically priced between 1.5 and 2.0 Times Book Value. It’s now just 1.25 X. But, over time, Berkshire should trade at HIGHER multiples of Book, not LOWER. That’s because in the 1990s, when Berkshire traded at 2 Times Book, the company was dominated by Investments--principally Stock Holdings. For example, when Coca Cola Stock represented a significant portion of Berkshire's Capital---investors were paying 2 Times Book for Berkshire ON TOP of the 7 Times Book Berkshire paid for Coke.