Is Warren Buffett’s Berkshire Hathaway Worth More Dead or Alive?

Alive – definitely alive.

This question – more than any other – dogs every discussion of Berkshire Hathaway (BRK.B). It isn’t immediately visible to those arguing on either side (“Berkshire is overvalued”, “No! Berkshire is undervalued”) but it underlies their arguments all the same.

What do I mean when I say Berkshire Hathaway is worth more alive than dead? I mean that Berkshire as a continuing whole is more valuable than a Berkshire that is dismembered into its constituent parts this very day – a Berkshire that is cut up and dished out like a Christmas ham.

Why?

A lot of people value Berkshire as a closed-end investment fund. Peter Lynch wouldn’t make that mistake. He’d see that Berkshire fits the bill as one of his stalwarts:

“Stalwarts are companies such as Coca-Cola, Bristol-Myers, Procter and Gamble…and Colgate-Palmolive. These multibillion-dollar hulks are not exactly agile climbers, but they’re faster than slow growers…When you traffic in stalwarts, you’re more or less in the foothills: 10 to 12 percent annual growth in earnings”.

(From Lynch’s One Up On Wall Street)

That’s what Berkshire is – not a lifeless closed-end investment fund, but a living, breathing stalwart – a mega-cap company that needs to be compared to (and valued like) other mega-caps.

I tried to make this point in the comments section of an earlier post, when I wrote:

“So, now the question isn’t whether Berkshire can compete with its past (it can’t). But, whether Berkshire can compete with similarly sized public companies such as Nestle, Unilever, Google, Microsoft, General Electric, Johnson & Johnson, HSBC, AT&T;, Wal-Mart, Bank of America, and the big oil companies. Can it? I think it can. So, relative to its peers (in terms of size) Berkshire isn’t overpriced. Is it overpriced compared to the Berkshire of twenty or thirty years ago? Yes. But, so is just about every asset on planet earth. So, that’s not the right yardstick to use. You have to compare Berkshire (the stock) to other stocks you can buy today – and Berkshire the company to other companies with similar size constraints. On both counts, I think a valuation of about $140,000 a share is appropriate and fair.”

Berkshire’s value is every bit as dependent on growth as the value of those other corporate behemoths – more so, in fact, because Berkshire doesn’t pay out dividends. You need to value Berkshire based on its likely intrinsic value growth rate, because that rate will determine what the stock is worth in 3, 5, and 10 years’ time – just as it will at Microsoft and Bank of America and Wal-Mart and Google.

Berkshire is a growth stock. And how fast is it growing? Since 1995, I estimate intrinsic value has grown a little more than 15% a year. Of course, when I assign a value to Berkshire shares, I don’t assume it can keep up that kind of intrinsic value growth. Rather, I assume it could grow at a still stalwart …

Announcing the Gannon On Investing Book Store

Visit Gannon On Investing Book Store

Books are an important part of value investing and an important part of this site. They were an important part of value investing right from the beginning – when Benjamin Graham and David Dodd published Security Analysis in 1934 and they were an important part of this site right from the beginning when I reviewed that august title and others on my podcast back in early 2006. Since then, Steven Rosales of Value Blog Review has helped fill the void on this site by supplying reviews for this site’s book reviews section.

Finally, I’ve gotten around to improving the lack of good reading resources on this site.

I’ve created a Gannon On Investing Book Store.

It’s very simple. But, I think you’ll find it useful. I’ve included and categorized value investing titles in the way I thought would be most helpful. The best part of the store is probably the Gurus Section where you can find book written by Benjamin Graham, Phil Fisher, Peter Lynch, Joel Greenblatt, David Dreman, Mohnish Pabrai, Marty Whitman, John Neff, and Phil Carret.

I’ve also included a general Value Investing Section.

Then, there’s the Buffett Books Section and the Buffett Quotes Section.

I rounded out the collection with investor profiles, books that broaden your horizons, and business books – all three selected with the investor in mind. Every book in the store is investor centric.

Finally, I added a section for all the books reviewed on this site – mostly by other people.

Let me know what additional categories you’d like to see added.

As for personal picks, there will be plenty of time for that later, but for now the one book I’d recommend for anyone and everyone is Roger Lowenstein’s excellent but outdated biography Buffett: The Making of an American Capitalist.

For the true Buffett buff, the hands-down favorite is “Of Permanent Value: The Story of Warren Buffett ”. It’s basically an entire Warren Buffett museum crammed into two hardcover books – at $50 it’s an absolute steal and a beautiful book. I’m surprised Amazon still has copies.

If you have any questions about my favorite editions of certain titles, which editions of Security Analysis are canonical and which are apocryphal, and how you can find titles that can no longer be purchased new – please send me an email.

Regarding the store – comments, suggestions, and complaints are welcome.

Browse Gannon On Investing Book Store

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Happy New Year!

Here are some of this blog’s most popular posts from 2007:

Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!
Pompous Prognostication: Irish Banks
Book Review: Active Value Investing
The Eight Best Investing Blogs
20 Questions for Clyde Milton of Cheap Stocks
The Normalized P/E Ratio Series
On Posco, Berkshire, and Buffett

Predictions

It’s something of a tradition in all financial media to do predictions at this time of year. The more predictions you make the fewer predictions people tend to remember – this can be a good or bad thing depending on your prophetic powers.

Anyway, I’ll stick to just one country and one stock. The country is Ireland and the stock is Bank of Ireland (IRE).

We’ll see how that pick does for 2008 – hopefully, I won’t look too stupid on January 1st, 2009.

Feedback

I’m planning some changes for the site. I’d appreciate any feedback about what you love or hate about this site. It should help me plan for the future. If you’ve been reading this blog for a long time – or if you remember the podcast – I’d appreciate any comments you have. Please email them to me.…

Top Financial Bloggers Face-Off: Gannon’s Picks

Asif Suria of SINLetter.com is running a stock picking contest where Top Financial Bloggers Face-Off. He invited me to join the contest, so I thought I would post my entry on this blog. The contest length is Q1 of 2008. It requires that you pick three stocks (either long or short) and a prediction for the S&P; 500 at the end of Q1 2008 (to be used only as a tiebreaker). I didn’t want to worry about the S&P; 500 prediction – so I just entered 1470 as my prediction (last: 1468.36).

All three of my picks for the contest are long. They are Bank of Ireland (IRE), NutriSystem (NTRI) and YRC Worldwide (YRCW).

Bank of Ireland (IRE) – $60.44
Irish stocks are cheap. Irish banks are even cheaper. IRE has very strong position in attractive banking market. More conservative than most large banks trading at higher price-to-earnings, price-to-book, and price-to-dividend. A competitive dividend yield should help encourage buying even if dividends don’t count toward the contest.

NutriSystem (NTRI) – $26.98
Stock shorted like a fad last year – but company isn’t a fad. Beaten down to extremely cheap levels. Should be buying back own stock at these levels. Wonderful business model with plenty of revenue from customers once acquired. Can afford to pay a lot in advertising to acquire a new customer. Program works; people actually lose weight without any unpleasant side effects. Hit hard by new diet drug. Launching a new, improved program (now) in Q1 2008. Management has shown they know how to design, market diet programs better than anyone else. But, most of all, the market has set the bar very, very low on this one.

YRC Worldwide (YRCW) – $17.09
Big, cheap trucking company. Cheap on just about every measure. Not expensive on trailing earnings; even cheaper on any sort of average, normalized earnings. High operating leverage causes extreme sensitivity to small changes in the U.S. economy – so those betting for a recession will bet against YRCW; but, in time, the price of YRCW has to move back to something approaching normalcy over a full cycle. No reason to think YRCW shares won’t improve before the industry does. Good stock at best; untimely at worst.

For the contest, the picks won’t actually be priced until after the first day of trading of 2008. So, the prices shown above are just year-end quotes on the three stocks. Contest rankings will be based on percentage changes in stock price over the course of the first quarter of 2008 – regular dividends don’t count for or against you whether long or short.

See Contest Rankings

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Steven Crist On Finding Mispriced Bets

Lincoln Minor of Reflections on Value Investing links to an excellent talk given by Steven Crist of the Daily Racing Form at the Legg Mason Capital Thought Forum.

This is a great talk. Anyone interested in investing should read the whole thing at least once.

Read Steven Crist’s Talk at Legg Mason Forum

I am here to talk about why most of what you have heard about horse racing is wrong, and why horse racing is much more similar to what you do than other forms of gambling. The general public probably thinks that for the most part, horse racing is just like the state lottery or playing craps or roulette in a casino, except that you have horses running around in circles rather than ping pong balls or a spinning wheel… The reason that you can win at poker and horse racing is the same – you are not betting against the house; you are betting against the other players. This is such a crucial and fundamental difference, and it is lost on the general public…. When the other players are setting the prices, it is an entirely different story because somewhere between frequently, occasionally and rarely, the public makes the wrong price. That is the beginning of the successful equation in horse racing…. In ten minutes I can teach anyone in this room how to pick the most likely winner of a horse race. There are data about past performance that we publish in the Daily Racing Form that correlate very strongly with the most likely winner in the race. Most horse players spend their lives thinking that if they just studied a little bit harder or got a little bit smarter, they could pick the winner of the race enough to make some money. There is no such thing. Picking the most likely winner is no great feat…. What you really want to do is determine which most-likely winners are good prices and which most-likely winners are bad prices. It is a very simple equation:

Price X Probability = Value

The entire world of investing is that simple too.

Seven Follow-Up Questions for Clyde Milton of Cheap Stocks

On April 1st, 2007 Clyde Milton of Cheap Stocks answered 20 questions. Today, he answers seven more.

Read 20 Questions for Clyde Milton of Cheap Stocks

Clyde Milton became enamored with deep value, off the beaten path investment ideas through years of fundamental research, and ultimately, as a writer/editor for a now defunct personal finance magazine.

He strives to research stocks that few others will, using valuation techniques based on Ben Graham’s ideas (such as stocks trading below their net current asset value) as well as some ideas he has developed himself.

Milton freely admits that his site is written under a pseudonym; Clyde and Milton being the first names of his beloved grandfathers, to whom the site is dedicated. While Cheap Stocks was originally launched primarily to keep Milton’s research and writing skills sharp (and not as a public site) it has developed a following.

Visit Cheap Stocks

Which do you tend to invest in – high quality businesses or cheap stocks? Why?

Well, in a perfect world you’d want a hybrid: high quality businesses at cheap prices. In practice though, I tend to invest in stocks that are cheap, and honestly, they are not always high quality businesses. There is huge risk, however, if you don’t do your homework. You’ve heard it before: Stocks are often cheap for good reasons, and the art is to not fall into the value trap that you can easily become prone to.

What have your experiences with each been? What have you learned?

I’ve learned not to jump in too quickly, not to fall in love with an idea, to limit initial position sizes, to stagger purchases, and that it’s prudent to throw in the towel on a bad idea before it fails. As investors, we are all prone to behavioral biases. Some are hard to shake, others you can learn to deal with through experience…usually a bad experience.

How focused a portfolio do you tend to keep?

My current portfolio is about 20 names, and there’s definitely an asset focus toward water, land or other assets that I believe are not properly valued.

What are your views on diversification and concentration?

Diversification is a great word: it tends to disappear from investor’s vocabularies during a great bull run, then re-appears when the market tanks. But the truth is, it is imperative to be well diversified. While my stock portfolio is somewhat concentrated, and not well diversified, it is just one piece of the puzzle: My portfolio’s beta exposure comes from other sources.

Diversification is the word you did not hear in the late 90’s, and it’s made a huge comeback! I say that in jest, but it’s amazing what a bear market will do to investors. I am a huge believer in diversification, especially in the context of building a portfolio designed to meet an investor’s goals. It’s not a one size fits all proposition.

How do you deal with general market risk and specific business risks?

I’m not all that …

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 …

Nautilus Concedes Defeat; Sherborne Controls Board

Nautilus (NLS) issued the following press release yesterday:

Nautilus…and Sherborne Investors LP said today that the voting results from the December 18, 2007 special meeting of shareholders confirmed that all four Sherborne Investors nominees have been elected to the Company’s Board of Directors. The final voting results, which were certified by IVS Associates, also showed that all of Sherborne Investors’ other proposals were passed.

Effective immediately, Edward Bramson, Gerard Eastman, Michael Stein and Richard Horn will join incumbent directors Robert Falcone, Ronald Badie and Marvin Siegert on the Company’s Board. Mr. Bramson was elected as Chairman at a meeting of the Board today and Mr. Falcone will remain as President and Chief Executive Officer. Mr. Siegert will remain as Audit Committee Chairman, Mr. Stein will be Chairman of the Compensation Committee and Mr. Horn will be Chairman of the Nominating and Governance Committee. Mr. Badie will remain as Lead Independent Director.

Edward Bramson said, “We appreciate the support of our fellow shareholders and look forward to working with the new Board and management to implement an effective strategy at Nautilus to return it to profitability and establish a platform for future growth.”

“I look forward to working with our newly reconstituted Board of Directors,” said Bob Falcone. “I believe very strongly in the future of this Company and am committed to implementing the necessary actions to restore it to sustainable growth.”

Shares of Nautilus closed up $0.07 (1.44%) at $4.92. At their highest point today, shares reached $5.50.…

Letter of Resignation from Heelys Board Member

Heeelys (HLYS), which was included in Cheap Stocks list of Potential Bargains in Profitable, Cash-Rich Double Net/Nets Part II on December 8th, 2007 (last trade: $6.82/share; NCAV: $4.48/share), filed this resignation letter written by a member of the board and addressed to the company’s CEO (emphasis added):

December 17, 2007

Mike Staffaroni, President and CEO
Heelys, Inc.
3200 Belmeade Drive
Suite 100
Carrollton, TX 75006

Dear Mike:

Effective immediately, I am resigning from the board of directors of Heelys, Inc.

As you know, I strongly support your vision for the company and your strategy for realizing it. Regrettably, a majority of the directors voted at the November meeting for an ultimatum expressing dissatisfaction with your performance, an action I openly opposed (that is not reflected in the minutes) and one that I feel signals an unjustified lack of confidence in you and your strategy. I am unable and unwilling to support the majority’s alternatives and directives.

You have put together a first rate management team and led Heelys to extraordinary success. I have greatly enjoyed my association with you and wish you well.

Sincerely,

Jim Kindley…

Value Blog Review Posts Stellar Year-End Results

Steven Rosales of Value Blog Review writes most of the book reviews that appear on this site. Steven is relatively new to investing. He posted his year-end results for 2007.

Envious bloggers are hoping it’s a simple case of beginner’s luck.

See Value Blog Review Year End Results

Visit Value Blog Review…