FCIC Interview of Warren Buffett, May 26, 2010

“There is no staff. I make all the investment decisions and I do all my own analysis.” —Warren Buffett

FCIC Interview of Warren Buffett, May 26, 2010

On May 26th, 2010, the Financial Crisis Inquiry Commission—that was formed by Congress in 2009—interviewed Warren Buffett as part their investigation of the causes of the financial crisis, both globally and domestically, and to do a report due at the end of this year, December 15, 2010, to the President and to Congress, which we also plan to release to the American public. Tasked not only with investigating the causes of the financial crisis, but also looking at specific issues that Congress had enumerated in the Fraud Enforcement Recovery Act, which formed the Commission.

In the interview Warren Buffett is asked a few questions, and shares his views and insights, to enable the Commission to better understand the causes of the financial crisis.

Further the Commission also asks a few questions about Moody’s, since Warren Buffett was (at the time) a significant shareholder in Moody’s.

The recording of the interview, as well as a transcript of it has been made public. To listen to the interview, click here, and to read the transcript click here (for PDF) and here (for Word).

Warren Buffett: Dun and Bradstreet and Moody’s are Great Businesses

Let’s see what Warren had to say about why he thought both Dun and Bradstreet and Moody’s were such a great businesses (emphasis added).

MR. BONDI: I understand, sir, that in 1999 and in February 2000, you invested in Dun and Bradstreet.

MR. BUFFETT: That’s correct. I don’t have the dates, but that sounds right. Yes, sir.

MR. BONDI: And am I correct, sir, in saying  you made no purchases after Moody’s spun off from Dun and Bradstreet?

MR. BUFFETT: I believe that’s correct.

MR. BONDI: Okay. What kind of due diligence did you and your staff do when you first purchased Dun and Bradstreet in 1999 and then again in 2000?

MR. BUFFETT: Yes. There is no staff. I make all the investment decisions, and I do all my own analysis. And basically it was an evaluation of both Dun and Bradstreet and Moody’s, but of the economics of their business. And I never met with anybodyDun and Bradstreet had a very good business, and Moody’s had an even better business. And basically, the single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.

MR. BONDI: Now, you’ve described the importance of quality management in your investing decisions and I know your mentor, Benjamin Graham — I happen to have read his book as well –- has described the importance of management. What attracted you to the management of Moody’s when you made your initial investments?

MR. BUFFETT: I knew nothing about the management of Moody’s. The –- I’ve also said many times in reports and elsewhere that when a management with reputation for brilliance gets hooked up with a business with a reputation for bad economics, it’s the reputation of the business that remains intact.

If you’ve got a good enough business, if you have a monopoly newspaper, if you have a network television station — I’m talking of the past — you know, your idiot nephew could run it. And if you’ve got a really good business, it doesn’t make any difference.

I mean, it makes some difference maybe in capital allocation or something of the sort, but the extraordinary business does not require good management.

MR. BONDI: What interaction —

MR. BUFFETT: I’m not making any reference to Moody’s management, I don’t really know them. But it really –- you know, if you own the only newspaper in town, up until the last five years or so, you have pricing power and you didn’t have to go to the office.

MR. BONDI: And do you have any opinions, sir, of how well management of Moody’s has performed?

MR. BUFFETT: It’s hard to evaluate when you have a business that has that much pricing power. I mean, they have done very well in terms of huge returns on tangible assets, almost infinite. And they have –- they have grown along with the business that generally the capital markets became more active and all that.

So in the end –- and then raised prices –- we’re both — we’re a customer of Moody’s, too, so I see this from both sides, and -– we’re an unwilling customer, but we’re a customer nevertheless. And what I see as a customer is reflected in what’s happened in their financial record.

MR. BONDI: And I’ve seen in many places where you’ve been referred to as a passive investor in Moody’s. Is that a fair characterization, and what sort of interactions and communications have you had with the board and with management at Moody’s?

MR. BUFFETT: At the very start, there was a fellow named Cliff Alexander who was the chairman of Dun and Bradstreet while they were breaking it up.

He met me –- I met him in connection with something else, years earlier; and so we had a lunch at one time. But he wasn’t really an operating manager. He was there sort of to see –- oversee the breakup of the situation.

Since we really own stock in both Dun and Bradstreet and Moody’s when they got split up, I’ve never been in Moody’s office, I don’t think I’ve ever initiated a call to them. I would say that three or four times as part of a general road show, their CEO and they think they have to do that. I have no interest in it basically, and I never requested a meeting. It just –- it was part of what they thought investor relations were all about. And we don’t believe much in that.

MR. BONDI: What about any board members? Have you pressed for the election of any board member to Moody’s —

MR. BUFFETT: No, no —

MR. BONDI: — board?

MR. BUFFETT: — I have no interest in it.

MR. BONDI: And we’ve talked about just verbal communications. Have you sent any letters or submitted any memos or ideas for strategy decisions at Moody’s?

MR. BUFFETT: No.

MR. BONDI: In —

MR. BUFFETT: If I thought they needed me, I wouldn’t have bought the stock.

MR. BONDI: In 2006, Moody’s began to repurchase its shares, buying back its shares that were outstanding, and they did so from 2006 to 2008, according to our records.

Why didn’t you sell back your shares to Moody’s at that time? I know subsequent in 2009 you sold some shares, but from ‘06 to ‘09, during the buyback, did you consider selling your shares back, and if so, why didn’t you?

MR. BUFFETT: No, I thought they had an extraordinary business, and — you know, they still have an extraordinary business. It’s now subject to a different threat, which we’ll get into later, I’m sure.

MR. BONDI: Uh-huh.

MR. BUFFETT: But –- but I made a mistake in that it got to very lofty heights and we didn’t sell –- it didn’t make any difference if we were selling to them or selling in the market. But there are very few businesses that had the competitive position that Moody’s and Standard and Poor’s had. They both have the same position, essentially. There are very few businesses like that in the world. They are — it’s a natural duopoly to some extent. Now, that may get changed, but it has historically been a natural duopoly, where anybody coming in and offering to cut their price in half had no chance of success. And there’s not many businesses where someone can come in and offer to cut the price in half and somebody doesn’t think about shifting. But that’s the nature of the ratings business. And it’s a naturally obtained one.

It’s assisted by the fact that the two of them became a standard for regulators and all of that, so it’s been assisted by the governmental actions over time. But it’s a natural duopoly.

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Warren Buffett: The Reason Why I Sold Freddie Mac and Fannie Mae

MR. BONDI: Now, earlier you referenced the GSEs and it’s been reported than in 2000 you sold nearly all of your Freddie Mac and Fannie Mae shares. What persuaded you in 2000 to think that those were no longer good investments?

MR. BUFFETT: Well, I didn’t know that they weren’t going to be good investments, but I was concerned about the management at both Freddie Mac and Fannie Mae, although our holdings were concentrated in Fannie Mac.

They were trying to -– and proclaiming that they could increase earnings per share in some low double-digit range or something of the sort. And any time a large financial institution starts promising regular earnings increases, you’re going to have trouble, you know?

I mean, it isn’t given to man to be able to run a financial institution where different interest-rate scenarios will prevail on all of that so as to produce kind of smooth, regular earnings from a very large base to start with; and so if people are thinking that way, they are going to do things, maybe in accounting -– as it turns out to be the case in both Freddie and Fannie –- but also in operations that I would regard as unsound. And I don’t know when it will happen. I don’t even know for sure if it will happen. 

It will happen eventually, if they keep up that policy; and so we just decided –- or I just decided to get out.

MR. BONDI: The Washington Post reported on October 31 st , 2007, that you had provided some testimony the day before in a case against Freddie Mac’s CEO where you had indicated that you became troubled when Freddie Mac made an investment unrelated to its mission.

And you were quoted in that article as saying that you didn’t think that it made any sense at all and you were concerned about what they might be doing that I didn’t know about.

MR. BUFFETT: Yes, well, that was —

MR. BONDI: What was that investment that was unrelated to its mission?

MR. BUFFETT: As I remember, it was Phillip Morris bonds. I could be wrong. It might have been R.J. Reynolds or something. But they had made a large investment in that.

Now, they are dealing essentially with government-guaranteed credit, so we know about that and we had it ratified subsequently about what has happened.

So, here was an institution that was trying to serve two masters: Wall Street and their investors, and Congress. And they were using this power to do something that was totally unrelated to the mission. And then they gave me some half-baked explanation about how it increased liquidity, which was just nonsense.

And the truth was that they were arbitraging the government’s credit, and for something that the government really didn’t intend for them to do. And, you know, there is seldom just one cockroach in the kitchen. You know, you turn on the light and, all of sudden, they all start scurrying around. And I wasn’t –- I couldn’t find the light switch, but I had seen one.

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Berkshire Hathaway Value Update, Year-End 2014

“As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). In our 2010 annual report, however, we laid out the three elements – one of them qualitative – that we believe are the keys to a sensible estimate of Berkshire’s intrinsic value. That discussion is reproduced in full on pages 123-124.

Here is an update of the two quantitative factors: In 2014 our per-share investments increased 8.4% to $140,123, and our earnings from businesses other than insurance and investments increased 19% to $10,847 per share.”

—Berkshire Hathaway, Annual Report 2014, p. 7

Intrinsic Business Value Update

Last weekend I read the 2014 annual report from Berkshire Hathaway. As usual I enjoyed it, and even more so this year due to the extra writings from both Warren and Charlie.

Buffett himself summed up Berkshire’s 2014 in a good way in the beginning of the shareholder letter, when he said that “It was a good year for Berkshire on all major fronts, except one.” The exception was attributable to BNSF that according to Buffett “…disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.”

The table below shows some key financial data for the prior ten-year period, including an estimate of intrinsic business value (by using the so-called “two-bucket approach”).

By using this two-bucket approach and applying a pre-tax earnings per share multiple of 10 times, results in a intrinsic business value per A share of $248,593 (or $166 per B share) at the end of 2014, and increase of 12.8% year-over-year. Book value per share increased 8.3%, from $134,973 to $146,186. The biggest change was in the price per share, increasing 27.0% year-over-year, from $177,900 to $226,000.

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The 10-year average intrinsic business value (IBV) to book value (BV) was 1.65. Price to book value and price to intrinsic business value averaged 1.38 and 0.84 respectively.

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At the moment (March 6, 2015) the A share is trading at $218,986 (or $146 per B share), giving a margin of safety of 12%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Duracell: A Durable Cell Battery “Trusted Everywhere” Moves In With Berkshire

“‘I have always been impressed by Duracell, as a consumer and as a long-term investor in P&G and Gillette,’ commented Warren E. Buffett, Berkshire Hathaway chief executive officer. ‘Duracell is a leading global brand with top quality products, and it will fit well within Berkshire Hathaway.'” ―Berkshire Hathaway Inc. News Release

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SEC filing: “Berkshire Hathaway to Acquire Duracell in Exchange for P&G Shares”

“‘I have always been impressed by Duracell, as a consumer and as a long-term investor in P&G and Gillette,’ commented Warren E. Buffett, Berkshire Hathaway chief executive officer. ‘Duracell is a leading global brand with top quality products, and it will fit well within Berkshire Hathaway.’

Berkshire’s stock ownership is currently valued at approximately $4.7 billion. P&G said it expects to contribute approximately $1.8 billion in cash to the Duracell Company in the pre-transaction recapitalization.

P&G said the transaction maximizes the after-tax value of the Duracell business and is tax efficient for P&G. The value received for Duracell in the exchange is approximately 7-times fiscal year 2014 adjusted EBITDA. This equates to a cash sale valued at approximately 9-times adjusted EBITDA.”

Source: SEC Edgar System, 2014 P&G ANALYST MEETING PRESS RELEASE

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Company History

  • 1935: P.R. Mallory founds Duracell’s predecessor company.
  • 1944: Inventor Samuel Ruben joins forces with Mallory, kicks off battery business.
  • 1966: Earnings per share hit $2.34 before falling off with recession related drop in consumer spending.
  • 1972: Sales of electrical and electronic items to industry are boosted.
  • 1978: P.R. Mallory is acquired by Dart Industries.
  • 1980: Dart merges with Kraft Inc.
  • 1986: Kraft retains Duracell portion of business after split with Dart.
  • 1988: Kohlberg Kravis Roberts takes over Duracell during leveraged buyout spree.
  • 1989: Duracell goes public.
  • 1996: The Gillette Company acquires Duracell.
  • 2005: Procter & Gamble is set to buy Gillette.
  • 2014: Berkshire Hathaway acquires Duracell from Procter & Gamble.

Sources: Referenceforbusiness.com; Wikipedia.com

The Procter & Gamble Company 2014 Analyst Meeting

Source: P&G Investor Relations

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Duracell Inc, 1996 10-K

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Source: SEC EDGAR

What Does Buffett See in Batteries?

Morningstar’s view on today’s Berkshire deal:

“We’re not sure what to make of wide-moat Berkshire Hathaway’s $4.7 billion purchase of the Duracell battery business from Procter & Gamble, another wide-moat firm. While one would have expected to see Warren Buffett use some of the more than $40 billion in excess cash on Berkshire’s books at the end of the third quarter to finance a deal of this size, the transaction has actually been structured as a tax-exempt transfers of assets, with P&G accepting Berkshire’s 52.8 million share equity stake in the consumer products firm (worth $4.7 billion at yesterday’s market close) for Duracell. That said, it remains to be seen whether P&G’s $1.8 billion pre-transaction recapitalization of the battery business will be viewed as a taxable event for Berkshire. We are leaving our fair value estimate in place.”

Source: See link to Morningstar analyst report below. 

Further Reading

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Margin of Safety: Seth Klarman on EBITDA

What Adjustments to Reported Earnings Do You Make?

“[When goodwill was required to be amortized,] we ignored amortization of goodwill and told our owners to ignore it, even though it was in GAAP [Generally Accepted Accounting Principles]. We felt that it was arbitrary.

We thought crazy pension assumptions caused people to record phantom earnings. So, we’re willing to tell you when we think there’s data that is more useful than GAAP earnings.

Not thinking of depreciation as an expense is crazy. I can think of a few businesses where one could ignore depreciation charges, but not many. Even with our gas pipelines, depreciation is real — you have to maintain them and eventually they become worthless (though this may be 100 years).

It [depreciation] is reverse float — you lay out money before you get cash. Any management that doesn’t regards depreciation as an expense is living in a dream world, but they’re encouraged to do so by bankers. Many times, this comes close to a flim flam game.

People want to send me books with EBITDA and I say fine, as long as you pay cap ex. There are very few businesses that can spend a lot less than depreciation and maintain the health of the business.

This is nonsense. It couldn’t be worse. But a whole generation of investors have been taught this. It’s not a non-cash expense — it’s a cash expense but you spend it first. It’s a delayed recording of a cash expense.

We at Berkshire are going to spend more this year on cap ex than we depreciate.

[CM: I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.]”

(Source: What adjustments to reported earnings do you make?)

BHAM1Your Thoughts on EBITDA?

“It amazes me how widespread the use of EBITDA has become. People try to dress up financial statements with it.

We won’t buy into companies where someone’s talking about EBITDA. If you look at all companies, and split them into companies that use EBITDA as a metric and those that don’t, I suspect you’ll find a lot more fraud in the former group. Look at companies like Wal-Mart, GE and Microsoft — they’ll never use EBITDA in their annual report.

People who use EBITDA are either trying to con you or they’re conning themselves. Telecoms, for example, spend every dime that’s coming in. Interest and taxes are real costs.”

(Source: Buffett FAQ: Your Thoughts on EBITDA?)

Margin of Safety

Below is an excerpt from Seth Klarman’s Margin of Safety, with a discussion about the value of EBITDA as a measure of earnings.

MOS2“A Flawed Definition of Cash Flow, EBITDA, Leads to Overvaluation

Investors in public companies have historically evaluated them on reported earnings. By contrast, private buyers of entire companies have valued them on free cash flow. In the latter half the 1980s entire businesses were bought and sold almost as readily as securities, and it was not unreasonable for investors in securities to start thinking more like buyers and sellers of entire businesses. There is, of course, nothing wrong with reexamining an old analytical tool for continued validity or with replacing one that has become outmoded. Thus, in a radical departure from the historical norm, many stock and junk-bond buyers in the latter half of the 1980s replaced earnings with cash flow as the analytical measure of value.

In their haste to analyze free cash flow, investors in the 1980s‘ sought a simple calculation, a single number that would quantify a company‘s cash-generating ability. The cash-flow calculation the great majority of investors settled upon was EBITDA (earnings before interest, taxes, depreciation and amortization). Virtually all analyses of highly leveraged firms relied on EBITDA as a principal determinant of value, sometimes as the only determinant. Even nonleveraged firms came to be analyzed in this way since virtually every company in the late 1980s was deemed a potential takeover candidate. Unfortunately EBITDA was analytically flawed and resulted in the chronic overvaluation of businesses.

How should cash flow be measured? Before the junk-bond era investors looked at two components: after-tax earnings, that is, the profit of a business; plus depreciation and amortization minus capital expenditures, that is, the net investment or disinvestment in the fixed assets of a business. The availability of large amounts of nonrecourse financing changed things. Since interest expense is tax deductible, pre-tax, not after-tax earnings are available to pay interest on debt; money that would have gone to pay taxes goes instead to lenders. A highly leveraged company thus has more available cash flow than the same business utilizing less leverage.

Notwithstanding, EBIT (earnings before interest and taxes) is not necessarily all freely available cash. If interest expense consumes all of EBIT, no income taxes are owed. If interest expense is low, however, taxes consume an appreciable portion of EBIT. At the height of the junk-bond boom, companies could borrow an amount so great that all of EBIT (or more than all of EBIT) was frequently required for paying interest. In a less frothy lending environment companies cannot become so highly leveraged at will. EBIT is therefore not a reasonable approximation of cash flow for them. After-tax income plus that portion of EBIT going to pay interest expense is a company‘s true cash flow derived from the ongoing income stream.

Cash flow, as mentioned, also results from the excess of depreciation and amortization expenses over capital expenditures. It is important to understand why this is so. When a company buys a machine, it is required under generally accepted accounting principles (GAAP) to expense that machine over its useful life, a procedure known in accounting parlance as depreciation. Depreciation is a noncash expense that reduces reported profits but not cash. Depreciation allowances contribute to cash but must eventually be used to fund capital expenditures that are necessary to replace worn-out plant and equipment. Capital expenditures are thus a direct offset to depreciation allowance; the former is as certain a use of cash as the latter is a source. The timing may differ: a company may invest heavily in plant and equipment at one point and afterward generate depreciation allowances well in excess of current capital spending. Whenever the plant and equipment need to be replaced, however, cash must be available. If capital spending is less than depreciation over a long period of time, a company is undergoing gradual liquidation.

Amortization of goodwill is also a noncash charge but, conversely, is more of an accounting fiction than a real business expense. When a company is purchased for more than its tangible book value, accounting rules require the buyer to create an intangible balance sheet asset known as goodwill to make up for the difference, and then to amortize that goodwill over forty years. Amortization of goodwill is thus a charge that does not necessarily reflect a real decline in economic value and that likely not be spent in the future to preserve the business. Charges for goodwill amortization usually do represent free cash flow.

It is not clear why investors suddenly came to accept EBITDA as a measure of corporate cash flow. EBIT did not accurately measure the cash flow from a company‘s ongoing income stream. Adding back 100% of depreciation and amortization to arrive at EBITDA rendered it even less meaningful. Those who used EBITDA as a cash-flow proxy, for example. Either ignored capital expenditures or assumed that businesses would not make any, perhaps believing that plant and equipment do not wear out. In fact, many leveraged takeovers of the 1980s forecast steadily rising cash flows resulting partly from anticipated sharp reductions in capital expenditures. Yet the reality is that if adequate capital expenditures are not made, a corporation is extremely unlikely to enjoy a steadily increasing cash flow and will instead almost certainly face declining results.

It is not easy to determine the required level of capital expenditures for a given business. Businesses invest in physical plant and equipment for many reasons: to remain in business, to compete, to grow, and to diversify. Expenditures to stay in business and to compete are absolutely necessary. Capital expenditures required for growth are important but not usually essential, while expenditures made for diversification are often not necessary at all. Identifying the necessary expenditures requires intimate knowledge of a company, information typically available only to insiders. Since detailed capital-spending information was not readily available to investors, perhaps they simply chose to disregard it.

Some analysts and investors adopted the view that it was not necessary to subtract capital expenditures from EBITDA because all the capital expenditures of a business could be financed externally (through lease financing, equipment trusts, nonrecourse debt, etc.). One hundred percent of EBITDA would thus be free pre-tax cash flow available to service debt; no money would be required for reinvestment in the business. This view was flawed, of course. Leasehold improvements and parts of a machine are not typically financeable for any company. Companies experiencing financial distress, moreover, will have limited access to external financing for any purpose. An overleveraged company that has spent its depreciation allowances on debt service may be unable to replace worn-out plant and equipment and eventually be forced into bankruptcy or liquidation.

EBITDA may have been used as a valuation tool because no other valuation method could have justified the high takeover prices prevalent at the time. This would be a clear case of circular reasoning. Without the high-priced takeovers there were no upfront investment banking fees, no underwriting fees on new junk-bond issues, and no management fees on junk-bond portfolios. This would not be the first time on Wall Street that the means were adapted to justify an end. If a historically accepted investment yardstick proves to be overly restrictive, the path of least resistance is to invent a new standard.

EBITDA Analysis Obscures the Difference between Good and Bad Businesses

EBITDA, in addition to being a flawed measure of cash flow, also masks the relative importance of the several components of corporate cash flow. Pretax earnings and deprecation allowance comprise a company’s pretax cash flow; earnings are the return on the capital invested in a business, while depreciation is essentially a return of the capital invested in a business. To illustrate the confusion caused by EBITDA analysis, consider the example portrayed in exhibit 1.

MOS1Investors relying on EBITDA as their only analytical tool would value these two businesses equally. At equal prices, however, most investors would prefer to own Company X, which earns $20 million, rather than Company Y, which earns nothing. Although these businesses have identical EBITDA, they are clearly not equally valuable. Company X could be a service business that owns no depreciable assets. Company Y could be a manufacturing business in a competitive industry. Company Y must be prepared to reinvest its depreciation allowance (or possible more, due to inflation) in order to replace its worn-out machinery. It has no free cash flow over time. Company X, by contrast, has no capital-spending requirements and thus has substantial cumulative free cash flow over time.

Anyone who purchased Company Y on a leveraged basis would be in trouble. To the extent that any of the annual $20 million in EBITDA were used to pay cash interest expense, there would be a shortage of funds for capital spending when plant and equipment needed to be replaced. Company Y could eventually go bankrupt, unable both to service its debt and maintain its business. Company X, by contrast, might be an attractive buyout candidate. The shifts in investor focus from after-tax earnings to EBIT and then to EBITDA masked important differences between businesses, leading to losses for many investors.”

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Chapter 8 of Berkshire Beyond Buffett: Free Download

Berkshire Beyond Buffett: The Enduring Value of Values

BBB1Lawrence A. Cunningham is out with a new book titled Berkshire Beyond Buffett: The Enduring Value of Values.

At ValueWalk.com I found a link to a free download of chapter 8 of this book.

I have not read the book myself yet, but it’s on my reading list.

Even though I haven’t read it, I thought I’d share the link for everyone to have a look. Just go here for a free download of chapter 8.

For some information about the book, here is the book description from Amazon.com (same link as above).

“Berkshire Hathaway, the $300 billion conglomerate that Warren Buffett built, is among the world’s largest and most famous corporations. Yet, for all its power and celebrity, few people understand Berkshire, and many assume it cannot survive without Buffett. This book proves that assumption wrong.

In a comprehensive portrait of the distinct corporate culture that unites and sustains Berkshire’s fifty direct subsidiaries, Lawrence A. Cunningham unearths the traits that assure the conglomerate’s perpetual prosperity. Riveting stories recount each subsidiary’s origins, triumphs, and journey to Berkshire and reveal the strategies managers use to generate economic value from intangible values, such as thrift, integrity, entrepreneurship, autonomy, and a sense of permanence.
Rich with lessons for those wishing to profit from the Berkshire model, this engaging book is a valuable read for entrepreneurs, business owners, managers, and investors, and it makes an important resource for scholars of corporate stewardship. General readers will enjoy learning how an iconoclastic businessman transformed a struggling textile company into a corporate fortress destined to be his lasting legacy.”

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. This article is informational and is in my own personal opinion.

Berkshire Hathaway: Intrinsic Value (Part 4)

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A last look at Berkshire’s intrinsic value

From earlier post, part 1 to 3, the following values for the Berkshire A-share have been calculated:

  • Post 1: Book value per share – $138,426 (as of Q1 2014)
  • Post 2: Adjusted book value per share – $205,604 (as of Q1 2014)
  • Post 3: Two-bucket approach – $220,413 (as of Q4 2014)

See chart below for a summary of historical values for the three different metrics above.

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From the calculations in earlier posts an intrinsic value in the range of $200,000 to $225,000 seems reasonable.

Price per A-share as of today is approximately $191,750, implying a margin of safety in the range of 4%-17% depending of where in the value range you look. A fair price, but not a bargain at the moment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Berkshire Hathaway: Intrinsic Value (Part 1)

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Intrinsic value of Berkshire Hathaway – Today and Tomorrow

I thought I would take a look at Berkshire Hathaway and its intrinsic value to be able to compare it to the current stock price to see if there is any difference between them. The analysis of Berkshire’s intrinsic value will be divided into the following three parts:

  • Book value per share
  • Adjusted book value per share
  • Two-bucket approach

Book value per share

Warren has many times emphasized the change in book value as a proxy for the change in intrinsic value. For example, in his letter to shareholders in 2012 Warren wrote that “It’s our job to increase intrinsic business value – for which we use book value as a significantly understated proxy – at a faster rate than the market gains of the S&P.”

So, if this holds true, i.e., that book value is a significantly understated proxy of intrinsic business value, we can look to the change in book value to try to get a sense of the possible change in intrinsic value. From Berkshire Hathaway’s officially published annual reports – you find them here – book value per share in the last 10 years has been as follows in the table below. Percentage shows the change in book value per share from year to year.

BVPS2

Book value per share in 2003 was $50 498 compared to $134 973 at year-end 2013, a gain of 167.3% or a 10-year compounded annual growth rate of 10.3%.

BVPS1

Book value per share can be seen as another measure for a conservative estimate of intrinsic value. Remember this, and the words “a conservative one.” In the shareholder letter from 2012 Warren wrote that “The value of our float is one reason – a huge reason – why we believe Berkshire’s intrinsic business value substantially exceeds its book value.”

Book value per share at the end of the first quarter 2014 was $138,426.

This seems like a conservative measure, considering the fact that Warren is willing to buy back stock at prices of 120% of book value. Calculated from the $138,426 at the end of the first quarter 2014 120% gives a target buy back price level per share of $166,111.2.

Current stock price

Right now Berkshire, according to Google Finance, is trading at a price per share of $189,724.

Currently the Berkshire stock trades at a price to book multiple of 1.37, i.e., the stock price exceeds book value per share with 37% at the moment.

Compared to the 120% above book value where Warren is ready to buy back Berkshire stock, the current stock price is exceeding this target level with 14.2%.

Looking at the downside the current stock price would have to drop with 12.4% before Warren steps in and starts to buy back Berkshire stocks. In other words, there seems to be a pretty good downside protection at the moment.

Having looked at the book value per share and the downside scenario, in the next post I will take a look at an adjusted book value per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.