Everything Warren Buffett: INVESTTERMS.COM: Berkshire Hathaway (BRK-A) Is Oversold

Thursday, February 19, 2009

INVESTTERMS.COM: Berkshire Hathaway (BRK-A) Is Oversold

Berkshire Hathaway Inc. (NYSE: BRK-A) shares are a few hours away from one of their lowest closing prices since late 2005 – hovering above $80,000 for class-a shares and $2,640 for the more attainable class-b shares – after losing more than 40% of their value over the last 12-months and another 4% today.

Warren Buffett’s company is now outperformed by the S&P500, Dow Jones Industrial Average, and Nasdaq over the last 12-months and year-to-date. Is Berkshire Hathaway oversold or are investors finally recognize that the company is in a precarious position?

The drop in Berkshire Hathaway’s share price is presumably tied to 3 concerns: (1) the end of the “party” in the insurance business that is at the core of Berkshire Hathaway’s operations; (2) Berkshire Hathaway’s equity loses in blue-chips like Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC) and others; and (3) unexplored derivative risk that Berkshire Hathaway has despite Warren Buffett’s outspokenness against the “financial weapons of mass destruction.”

Addressing these concerns briefly:

(1) Though the insurance business that is Berkshire Hathaway’s bread-and-better may not offer the outsized returns it did over the last few years – as Buffett himself readily admits – I haven’t seen any convincing arguments as to why the industry is decimated. Berkshire Hathaway is well-positioned to take advantage of even a less attractive insurance landscape, and I can’t see why this would justify such a precipitous price-drop.

(2) Here is a list of Berkshire Hathaway’s largest stock-holdings by dollar value:

Coca-Cola - $8.5 billion
Procter & Gamble - $4.8 billion
Burlington Northern Santa Fe - $4.8 billion
Wells Fargo & Co. - $3.7 billion
ConocoPhillips - $3.3 billion
Kraft Foods - $3.3 billion
American Express - $2 billion
Johnson & Johnson - $1.5 billion
Wesco Fin Corp. - $1.5 billion
Moody’s Corporation - $1 billion

Certainly the equity portfolio has taken a significant hit as the market has sharply declined, but Berkshire Hathaway’s portfolio has few major problem holdings. Yes, it has a position in Bank of America (NYSE: BAC) that, as people rightly noted, might become THE Bank of America through nationalization – but Berkshire Hathaway only holds 5 million shares of the company, a drop-in-the-bucket relative to Berkshire Hathaway’s market capitalization.

Of its major holdings, American Express Company (NYSE: AXP) and Wells Fargo (NYSE: WFC) have had their share prices collapse, but how much more downside is there on these holdings, especially when Berkshire Hathaway lost some $5+ billion in market capitalization just today – basically as if the market decided its American Express and Wells Fargo holdings were both worth nothing and re-priced Berkshire Hathaway accordingly.

(3) Much was made a few months ago about Buffett’s selling put options on four stock indexes, especially in light of his calling derivatives “financial weapons of mass destruction.” First, these put options are pretty unsophisticated and not the kind of terribly complicated derivatives that so many firms took-on without understanding their full exposure. Nonetheless, Buffett’s play needs explaining. But explain it he has:

These puts had original terms of either 15 or 20 years and were struck at the market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of $4.6 billion. The puts in these contracts are exercisable only at the expiration dates, which occur between 2019 and 2027, and Berkshire will then need to make payment only if the index in question is quoted at a level below that existing on the day the put was written…I believe these contracts, in aggregate, will be profitable and that we will, in addition, receive substantial income from our investment of the premiums we hold during the 15-or-20 year period… in all cases we hold the money, which means we have no counterparty risk.

Unless something more sinister lurks beneath Buffett's explanation - which would be completely out of character with decades of behavoir as a guide - the derivative exposure argument also fails to explain market reaction.

Overall, I have admittedly done a very cursory evaluation of a $124 billion company in a very complicated industry – but even so I have yet to find the seeds of a convincing reason or set of reasons for the magnitude of drop in Berkshire Hathaway’s price. It seems from where I am sitting that Berkshire Hathaway is a value right now.

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