Warren Buffett’s cancer diagnosis is a positive for Berkshire investors. Let me explain why we think this way. Warren Buffett is the most successful portfolio manager ever. He started his career very young and didn’t really waste much money on taxes, charity, or consumption. He managed to beat the market by anywhere from 10 percentage points to 30 percentage points annually in most of his career. However, his alpha virtually disappeared over the last decade (see Warren Buffett’s alpha).
Berkshire Hathaway class A shares were trading above $120K on August 20, 2007. Today, the shares are at the same level. According to Warren Buffett’s 2011 annual letter Berkshire’s book value per share increased by 11% in 2007, declined by 9.6% in 2008, increased by 19.8% in 2009, 13% in 2010, and 4.6% in 2011. This means Berkshire’s book valued gained a cumulative of 42% since 2007, yet the stock price stayed the same. Why? You may try to blame the market conditions but S&P 500 index returned more than 15% including dividends since then. The truth is that “Warren Buffett premium” is turning into a “Warren Buffett” discount.
I am pretty sure that Warren Buffett’s Berkshire is using a pretty conservative methodology to calculate its book value. It is very likely that its true book value is 20-30% higher than what’s in the books. This means that Berkshire Hathaway’s stock actually traded at a discount to its true book value in September 2011. This prompted Warren Buffett to buy back some shares for as much as 110% of its book value. Warren Buffett knows that Berkshire’s shares are worth much more than what the market thinks.
Activist hedge funds know this too but nobody has the courage to tell the great investor Warren Buffett how to unlock the value in Berkshire. Can you imagine Whitney Tilson asking for Buffett’s resignation and calling for the break-up of the company? It is clear to use that Berkshire Hathaway is an undervalued stock but we don’t see any catalysts. Maybe Warren Buffett’s cancer diagnosis start a new trend in the company. Everybody knows what happened to Apple after Steve Jobs passed away.