Geoff Gannon March 27, 2007

On Buffett, Berkshire, and You

At the end of my post “On Billionaires, Their Buys, and Buffett“, I said “I will follow up with another post on this topic tomorrow. Hopefully, I can give you some idea of what you should and shouldn’t do based on news of Berkshire’s activities in specific stocks.”

This is that post. Unfortunately, before sitting down to write this post, a piece by James Altucher (author of “Trade Like Warren Buffett“) was brought to my attention. I’ll link through Value Investing News, because you should be visiting that site regularly – here’s Altucher’s article.

It’s good. However, there are still some things left for me to cover.

Altucher is right in stressing that Berkshire holds many positions that aren’t presently of interest, because the business has changed (or more usually) the stock price has changed. A rare example of the former is the Washington Post Company (WPO). If you want some idea of what the Washington Post (the stock and the business) looked like back when Buffett bought it, see Max Olson’s excellent article “Warren Buffett and the Washington Post“.

Buffett Holds

The Washington Post is a rare example of a Berkshire position that is no longer attractive because of changes in the business. In most cases, it’s a change in the stock price that disqualifies a Berkshire position from inclusion in your own portfolio. Several years ago, it was painfully obvious that Coca-Cola (KO) was one such stock.

During the Millennium Bubble, shares of Coke were priced for pluperfection. Buffett didn’t sell because he intends Coke to be a permanent holding for Berkshire. If he had been running his partnership, he would have sold. He has a different attitude at Berkshire – one he has made clear to shareholders countless times. As a result, he sometimes sacrifices better returns for Berkshire by sticking with a permanent position he knows is overpriced. Coke is probably the biggest and best known example of Buffett holding a stock he knew Berkshire would be better off selling.

But He Sells Too

However, Berkshire has many lesser known positions that it’s held for a long time. That sometimes leads people to believe that Berkshire never sells. Not true. Berkshire does sell; in fact, it has even gone as far as completely eliminating some large positions.

One recent example of such selling is H&R; Block (HRB). The company, which Berkshire once owned more than 8% of, became badly distracted with operations outside of its core tax preparation franchise. It seems clear Berkshire has eliminated its stake in H&R; Block. The company’s single minded pursuit of diversification and cross-selling is probably what turned Buffett off the stock – since Buffett bought in 2001, management has done a remarkable job of shrinking the company’s moat and scattering its eggs across many different, less secure baskets.

So, how can you avoid having a bad experience in a Berkshire stock? Don’t overpay. Even in some situations where Berkshire has only recently disclosed its stake in a company, the stock has already run up quite a bit. The first time H&R; Block appeared in Buffett’s annual letter to shareholders, the position was $255 million at cost and $715 million at market. That means the stock was up 180% from where Berkshire bought its shares.


In Buffett’s most recent annual letter, we learned that Berkshire owned 4% of the South Korean steelmaker, Posco (PKX). I wrote about this position at length in an earlier post entitled “On Posco, Berkshire, and Buffett“. In that post, I reprinted some of my comments on Posco from my quarterly newsletter where I had featured the stock in the April issue.

(NOTE: I appreciate the emails from readers who want to subscribe to the newsletter – but, I have discontinued it on account of the scarcity of compelling bargains in today’s market and I do not have plans to start it up again).

In the last issue of the newsletter (July 2006), I set my “best guess” for the intrinsic value of Posco ADRs at $124. I also suggested that beyond $190, buying Posco would be a pure speculation – i.e., the stock would have no investment merit.

My $124 a share estimate was always meant to be conservative – and, as it turns out, steel prices have held up much better than I anticipated. So, even at $124 a share, the Posco ADRs should have more investment merit than the major U.S. indices.

There’s no doubt Posco’s value to a private buyer would be substantially higher than the equivalent of $124 on the ADRs. However, I don’t see how there could possibly be a negotiated transaction for Posco – and I imagine both the company’s management and the Korean government would do everything in their power (even if it means hurting Posco’s shareholders) to prevent a foreign steel company from buying Posco.

The stock is up quite a bit. I first recommended the stock in my newsletter at $63.80. Buffett bought his shares of Posco even earlier, so he managed to get them for considerably less. Berkshire doesn’t own the ADRs; however, the equivalent cost on the ADRs for Berkshire would be closer to $45 a share – the ADRs now trade for about $100 a share.

Buffett’s annual letter showed the value of the Posco stake had already doubled by the end of last year. Shares of Posco have risen quite a bit since then; so, we are a long way from where Buffett bought into Posco. At this point, Berkshire has a nearly 125% gain on its investment in Posco.

I think you could do a lot worse than Posco, even at these prices. However, more selective investors should look elsewhere. Unless you’re someone who likes to hold upwards of twenty to thirty individual stocks in your portfolio, there are better bargains to be had – especially among stocks that are far too small for Berkshire.

Big Game Hunting

That brings me to the logic behind Berkshire’s investment in Posco. I think the case for Posco was pretty simple: it was big and it was cheap. Almost no (remotely healthy) company the size of Posco trades at such a ridiculously cheap price. This wasn’t a Fisher purchase. It was a Graham purchase. Usually, Buffett can’t make those kinds of investments, because Berkshire has simply gotten too big.

In fact, Buffett might have preferred to put ten times as much money to work in Posco. Berkshire doesn’t need $500 million ideas; it needs $5 billion ideas. Posco was only a $500 million idea, because although it’s a huge company, it isn’t General Electric (GE).

Posco is about a tenth the size of GE. That’s a problem, because even without ownership restrictions, it’s very difficult to acquire a third of a company in the open market. That’s roughly what Berkshire would have to do with a company the size of Posco to make it into a $5 billion idea. As Buffett says, Berkshire needs “elephants” and a public company the size of Posco isn’t big enough game.

Berkshire and You

Berkshire’s investment needs are different from yours. Berkshire needs someplace it can put billions of dollars to work. You don’t. Aside from that, Berkshire’s list of new purchases is a logical place to look for good investment ideas.

When looking at Berkshire’s new buys, you want to compare your own stock selection with Buffett’s only insofar as your stock selection includes large companies. If you’re invested in some companies with a market cap under $100 million or even $1 billion (and if you’re not you should be), it makes no sense to compare those purchases to Buffett’s most recent buys. Stocks of that size aren’t part of his investment universe. They are part of yours, because you have a lot less capital to deploy.

When looking at stocks Berkshire has recently purchased, begin by evaluating them on these three criteria:

1. Size of position relative to Berkshire’s other holdings
2. Size of Berkshire’s ownership stake
3. Degree of obviousness

The first two criteria are self-explanatory. The bigger the holding relative to Berkshire’s other positions, the more consideration you should give the stock. Likewise, the bigger the size of Berkshire’s ownership stake (i.e., the percent of the company Berkshire owns), the more consideration you should give the stock.

When the two measures are both large, it’s likely you have a winner. When Berkshire’s ownership stake is large, but the dollar value of that stake is small relative to Berkshire’s other positions, there’s still a good chance you have a winner. However, when Berkshire’s ownership stake is small, but the position is fairly large relative to Buffett’s other holdings you need to look to the third criterion.

The third criterion is “degree of obviousness”. Unlike the first two criteria, the third criterion is somewhat subjective. I thought Posco was such an obvious Buffett buy that I was surprised it hadn’t appeared in the letter a year earlier. For others, Posco might have seemed less than obvious. What’s important, however, isn’t really how obvious the stock is – it’s how obvious the business is.

The more surprised you are when you see the company’s name and Buffett’s name in the same sentence, the more likely the stock is something you want to analyze in depth. In fact, if you have a stock that is large enough to appear in Buffett’s annual letter (thus satisfying criterion #1) in which Berkshire has an ownership stake of – let’s say 3% or more (thus satisfying criterion #2) and which seems a less than obvious choice coming from Mr. Buffett – if you have all that – then, that’s the stock to start studying up on right now.

So, what recent Berkshire buys meet these criteria? The best matches are probably USG (USG), Posco, and Tesco (TSCDY). Of course, there’s also the issue of price. Can you get these stocks at prices close to what Berkshire paid?

Whether or not you can today, these are good stocks to watch in the future. At the very least, they’re companies you’ll want to be familiar with. Another name worth considering, if only for its “non-obviousness” is ConocoPhillips (COP).

Some of Buffett’s best purchases in the last few years have been in stocks that score well on these three criteria despite not being discussed as much in the press.

Don’t Dive In

If a recent Berkshire purchase is in a big, blue chip and the position doesn’t score well on these three criteria, take a moment to put things in perspective.

Buffett needs to put a lot of money to work. You shouldn’t go diving in to some big, blue chip every time Buffett dips his toe in the water. Look for the less obvious choices – and you’ll find Buffett watching can be a profitable hobby.

And One More Thing…

Wait for the fat pitch – the one stock you like, not because Buffett bought it, but for the reasons Buffett bought it. For an example, see George’s discussion of USG.

Related Reading

On Billionaires, Their Buys, and Buffett

On Posco, Berkshire, and Buffett

Column: Warren Buffett and the Washington Post

Book Review: Trade Like Warren Buffett