Sunday, February 27, 2011

Warren Buffett Is Tap Dancing in Omaha Again

CEO Warren Buffett was tap dancing with gusto Saturday as he reported estimate-busting earnings for Berkshire Hathaway (BRK/A).  The results were far above Wall Street estimates and 43% higher than last year.  Importantly book value (net assets per share divided by total shares) exceeded $95,000 for the Class A shares. 
As many of you know, BRK is the only non-dividend paying stock we own in our models (it's in our Capital Builder Model). We have made this dispensation for Mr. Buffett because in studying him over the years we learned of Benjamin Graham, and in getting to know Mr. Graham's theories, we came to know about the dividend meister John Burr Williams.  We have been convinced for years that Mr. Buffett is really a follower of Williams as much as Graham because of the types of companies he has acquired over the last 30 years.
The common denominator of most Buffett acquisitions, especially his publicly traded purchases, is that they have tremendous free cash flows, powerful brands or competitive advantages, and they pay generous and growing dividends.  Thus Mr. Buffett's non-dividend paying company breaks all our rules, but the underlying companies he owns fulfill them.  There is probably a good analogy here, but I can't grasp it at the moment. 
Berkshire's impressive results are good for the company but are also a great leading indicator for the US economy because of the breadth of industries in its portfolio.  Burlington Northern's results (purchased by Berkshire in 2009) were simply outstanding and make its purchase price look cheap.  But then again, hasn't Buffett always had an uncanny ability to buy the cream of the crop on the cheap?  We are convinced that his greatest legacy will be this: His courage to go on shopping sprees when everyone else is convinced that pillows and tin cans are the best place to put money. 
Another reason we have been buyers and holders of Berkshire Hathaway is that in listening to Buffett's annual lectures to the investing public, he has given many clues as to how to value his company.  We are primarily dividend investors because we believe dividend growth is a great indicator of value.  In listening to Buffett some years ago we realized that for Berkshire Hathaway, book value was the key indicator of value.
The chart above in a multiple regression of book value and United States GDP versus the price of BRK/A over the last 15 years.   As you know, the red line is the actual price and the blue bars are the model's predicted prices for each of the last 15 years.  The checkered bar at the far right is the projected value of BRK/A one year from today based on estimates of the model's inputs.
The model shows the the stock is currently modestly undervalued, and significantly undervalued based on next year's estimates.  In particular, the model is suggesting if historical patterns hold true that BRK/A's price will grow about 16% in the coming year.  Remember this is not a guarantee; it is a mathematical guess.  That would put the stock near $150,000 per share a year from now, a big climb from its current value near $128,000.
You'll note that the model's blue bars have given a good account of themselves in estimating BRK/A's value over the years.  In fact the R2 is over .85.  I'll leave it to you to Google R2 if you want an explanation of what it means.
In trying to provide an order of magnitude for how impressive BRK's 2010 earning data are, it would be like Michael Jordan scoring 60 points in his last year of play.  It is remarkable, it is out of the box, it is a testament to the nerdy kid who grew up in Omaha, Nebraska and never left.  
From an investment perspective nobody has ever done it better.  We congratulate you Mr. Buffett and all your employees.
We own Berkshire Hathaway Cl  B.  Please do use this information for investment decisions.  Please consult your investment advisor.