Shareholders' patience pays off as Berkshire's stock surges

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Posted: Saturday, May 4, 2013 12:00 am

If rising stock prices make investors happy, then shareholders convening in Omaha today for Berkshire Hathaway Inc.'s annual meeting will be ecstatic about the company's stock price trajectory over the past year.

An investor who bought Berkshire stock last June has seen its price rise as much as 35 percent, outpacing even the fast-growing stock market and setting a per-share price record for the Omaha-based investment company. If you bought Berkshire shares in September 2011, the price is up two-thirds.

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Granted, CEO Warren Buffett doesn't measure Berkshire success by its stock price. “Subpar” was the word the chairman and CEO used to describe his company's 2012 performance after it missed his financial goal for the third time in four years.

His goal is for Berkshire's book value growth to exceed a stock index figure that includes dividends.

But even so, Berkshire clearly broke loose from the rest of the stock market last spring and widened the gap after Jan. 1.

It's hard to explain why Berkshire's Class A shares hit $162,904 and its Class B shares reached $108.64 Friday, both record closing prices.

Berkshire has not in the past year added a big company to its portfolio, aside from taking part in the purchase of H.J. Heinz Co. with a Brazilian investment company and this week's $2 billion purchase of the remaining 20 percent ownership of International Metalworking Cos. of Israel.

Buffett calls big acquisitions “elephants” and has bemoaned the lack of big game that has come into his acquisition-aiming sights lately. Heinz falls into that category, although it's being handled by a Brazilian investment group, and IMC already was a Berkshire division and isn't a new “elephant.”

Big acquisitions are important because they can boost the company's value significantly. Without acquisitions in the $5 billion-plus range, Berkshire's future value will grow more slowly.

For Buffett, Berkshire's cash-generating operating companies are both a blessing and a problem: They generate more than $1 billion a month, giving Berkshire a strong financial picture and “ammunition” for acquisitions.

But Buffett says cash is a terrible place to have your money at today's minuscule rates for savings, and Berkshire has about $44 billion in cash.

He keeps about $10 billion in Berkshire's cash reserves to preserve the company's top credit rating and at least $10 billion more as protection for insurance losses in natural catastrophes, and in case acquisition or investment opportunities come his way.

But without large acquisitions and investments, that cash is nearly idle.

Buffett has been wrestling with the problem for years, putting to use what he called “the gusher of cash” that Berkshire takes in. In his 2003 annual report, he said he strongly prefers owning businesses to owning stocks, especially when stocks are “expensive” in relation to their value.

“If stocks become significantly cheaper than entire businesses, we will buy them aggressively,” he told shareholders in 2003. “If selected bonds become attractive, as they did in 2002, we will again load up on these securities. Under any market or economic conditions, we will be happy to buy businesses that meet our standards.

“And, for those that do, the bigger the better. Our capital is underutilized now, but that will happen periodically. It's a painful condition to be in — but not as painful as doing something stupid. (I speak from experience.)”

So why is Berkshire's stock price up?

Buffett's announcement in September 2011 that the company might buy back its own stock prompted some investors to buy, and last December Buffett said Berkshire would pay even more for its shares if they remained undervalued.

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“That was certainly a signal that there must be a bargain here,” said Paul Schwarzbach, founder and managing member of Allied Value LLC of San Francisco. He is a Berkshire shareholder and came to Omaha this week for a panel discussion at Creighton University on value investing.

Schwarzbach said Berkshire's stock price was almost so low at one point that it covered only the company's cash and investments, with its operating companies — a railroad, insurance divisions, retail companies and the others — thrown in nearly for free.

“Mathematically, it was undervalued, and it's gone up,” he said, but it's not easy to know whether the stock remains undervalued and, if so, by how much.

Schwarzbach has attended about a dozen Berkshire meetings over the past 15 years. “At the 2009 meeting, people were quite morose,” he said, because Berkshire's stock price was down along with the rest of the stock market.

But in 2013, he said, “the shares have done well. I think this year there's a lot more spunk in the atmosphere. I think people at the meeting tend to be happier when the shares have done well, which is probably the opposite of what Mr. Buffett would counsel us.”

Buffett has said that if shareholders believe a company's value will grow, they should want a low share price so they can buy more shares.

Scott Thompson, managing director of Intrinsic Value Capital Management of Minneapolis and a Berkshire shareholder, said the key is to think of a company's intrinsic value, an elusive concept that Buffett has made popular and defines as the true, long-term value of a company, considering its future earnings capacity.

Thompson said Berkshire's recent price rise is an example of a Buffettism coming true: Market price and intrinsic value may be separate for an extended period of time, but eventually they will meet.

After more than five years of up-and-down Berkshire stock prices and no sustained gain, Thompson said, “A lot of shareholders who were patient are benefiting now.”

He said some observers estimate Berkshire's current intrinsic value at $175,000 per Class A share, a figure that grows steadily as Berkshire businesses earn profits.

“That's actually pretty conservative, if you look at the fundamentals there,” he said, and would make Berkshire's shares underpriced even after their run-up in the past year.

“A lot of shareholders have been wondering when the intrinsic value would be met by the market price,” Thompson said. “I think it finally did this year.”

Buffett himself has warned for years that Berkshire can't grow as rapidly in the future as it has in the past. “He freely admits that financial size is an anchor on performance,” Thompson said. “You can't run billions like you run millions.”

That's one of the negatives cited by Douglas Kass, the Palm Spring, Fla., money manager who will be the “Berkshire bear” during today's question-and-answer session with Buffett and Berkshire Vice Chairman Charlie Munger. Kass has pointed out other long-term problems that work against Berkshire.

Among those problems, Kass maintains, are whether Buffett's successors can continue his achievements, especially with increased competition from other investment managers looking for the same kinds of deals as Buffett.

Michael Bernard, head of investments for Korhorn Financial Group of Granger, Ind., which owns some Berkshire stock, said Berkshire has benefited from the success of its insurance companies and the high-quality stocks that it owns.

“If we don't see another credit collapse, likely that will help the company,” Bernard said.

For the future, Bernard said, “the eventual transition to the next generation (of Berkshire executives) is going to create at least jitters in this stock. Obviously, the stock is trading based on what its future will be. If Warren isn't part of that future, that's going to be an X-factor to this stock and its performance.”

The reasons for the past year's price increase may not be complicated. David Epstein, a financial adviser with Robert Baird in Milwaukee, said Buffett's timely purchases in recent years included businesses that are doing well as the economy recovers.

Berkshire's housing-related companies, including makers of bricks and carpets and real estate sales offices, benefit from the housing industry's bounce-back, Epstein said. BNSF Railway is gaining traffic by hauling petroleum and other goods.

“All of a sudden, they're starting to click.” he said, and investors are noticing.

The Omaha World-Herald Co. is owned by Berkshire Hathaway Inc.

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