Geoff Gannon January 1, 2008

And the Winner is…Me!

Value Investing News completed its first full calendar year in 2007 – and my post entitled “Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!” won the title of best value investing article and link submission for 2007.

It’s no surprise that a Berkshire (BRK.B) article received the most votes (the folks over at Value Investing News aren’t exactly Buffett haters).

However, it is surprising that the article managed to rise to the top of the 2007 heap in just two weeks of voting (it was submitted on December 16th). As George points out, this was made possible by the tremendous growth over at Value Investing News. The number of users skyrocketed over the past year.

Also, as articles were submitted at a more feverish pace, they were either voted up or lost in the shuffle a lot quicker. So, the difference between a top story and a neglected story is now determined pretty fast on Value Investing News, because the community there is so much larger and more vibrant than ever.

Apparently, I’ll be getting a trophy badge to display on my site – once George designs it. I’ll also be getting a copy of Vitaliy Katsenelson’s Active Value Investing – a book I reviewed favorably back in October.

This contest reminds me that I still have duplicate copies of some excellent value investing books and I ought to be holding some contests of my own to share the wealth. Expect them some time in early 2008.

I’d like to say the obligatory “I never expected this”, etc., etc. – but, really I can’t. I didn’t expect a free book. But, as I was writing the post, I knew it was perfect for Value Investing News. My post got circulated much more widely as a result of its exposure at Value Investing News; evidence of this fact can be seen by entering the title of the post into Google. The actual blog post on my site is far from the top result. Normally, my posts don’t get much mention in sites with higher page ranks.

So, thanks to Value Investing News for the award – and more importantly, for spreading the word. For those who frequent either Value Investing News or my blog, this post was definitely one of the highlights of 2007.

By the way, I actually enjoyed the Barron’s article – I’m glad they ran it. Barron’s is an excellent publication and my favorite weekly by far. They haven’t always been bearish on Berkshire. However, their valuation process in the article was fundamentally flawed as Berkshire has partially transformed itself from an asset based entity to an earnings based entity.

Berkshire still holds a lot of marketable securities; but, it’s as much a conglomerate as a closed-end fund these days. If you apply either a price-to-book ratio to the whole company or a price-to-earnings ratio to the whole company you’re going to end up with a very whacky intrinsic value estimate.

You have to recognize the parts for what they are and value them accordingly – marketable securities can be valued at market prices but operating businesses have to be valued on their earnings.

Berkshire’s purchases of Iscar and Marmon made it clear that Berkshire isn’t just a basket of stocks anymore. What matters to Buffett (and Berkshire shareholders) is what each dollar spent by Buffett adds to Berkshire’s market value. How much does each dollar spent buying minority stakes in public companies like Bank of America (BAC) or Burlington Northern (BNI) add to Berkshire’s market value? How much does each dollar spent by Berkshire buying majority stakes in Iscar or Marmon add to Berkshire’s market value?

If you don’t have a valuation process that can make sense of Buffett’s actions and look at a dollar spent buying part of a public company versus a dollar spent buying all of a private company – you don’t have any way of evaluating Berkshire as a whole or Buffett as Chairman. You just have a way of saying this amalgam called Berkshire once traded at a price-to-book ratio of “x”; now it trades at a price to book ratio of “y”.

That proves the relationship between Berkshire’s market price and its book value has changed. But, has the relationship between Berkshire’s intrinsic value and its book value changed as well?

If Apple (AAPL) once traded at a low P/E ratio and now trades at a high P/E ratio, wouldn’t you ask whether there had been changes in the business that justified that change in valuation? Are earnings likely to grow in the future? Has the business fundamentally changed? Is the company’s value now derived from the same products and industries, or different ones?

People see this when they write about businesses where they can add an earnings growth rate estimate to their model, but somehow they miss this when a company is undergoing a fundamental change from a marketable security heavy holding company to an operating earnings heavy holding company. I wanted to call attention to that error. That’s why I wrote the post.

Read “Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!”

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