WARREN BUFFETT'S BERKSHIRE HATHAWAY IS one expensive stock. But it's less expensive lately, dropping from its 52-week high to a recent $58,200. While Buffett has enjoyed great success as an investor, the fall-off demonstrates the painful limitations of his philosophy: Buy good companies he understands and hold on to them forever. His hold 'em strategy worked for 40 years, but not for the last 2.
It was always hard to believe Buffett when he proclaimed he was married for life to holdings like Coca-Cola, Gillette, the Washington Post Co. and Freddie Mac. The real reason, I thought, was his resistance to paying billions in capital gains taxes.
Well, the Treasury's loss is not Berkshire's gain. Some of his core holdings have had real rough patches. Take Coca-Cola, whose stock tumbled from its June high of 70 to 48 in early October, before recovering somewhat to a recent 64. Investors used to think that its gung-ho acquisition of bottlers and hell-bent push for global volume were magic. No longer. Japan, Latin America and Germany are showing depressed results. Recent expansions into Russia and India aren't panning out. At home, steep price hikes at supermarkets have hurt volume.
Buffett has lived the past 40 years of financial history in the trenches. So he must know that only a handful of growth stocks, decade after decade, are repeaters. But the sole stock group that has traced a 30-year record of uninterrupted growth is the pharmaceutical sector. Beyond that, the hot stocks of three decades ago aren't so hot today: JC Penney, Polaroid and Xerox, for instance.
Buffett, to his credit, didn't take positions in those ill-fated stocks. His narrowly focused approach, however, has let him miss chances to pick up great value shares. Like with drugs. When Hillary and Bill launched their federal health plan in 1993, drug stocks dipped to 14 times earnings. As a believer in the value-investing credo of his mentor, Benjamin Graham, Buffett should have gotten aboard then.
Today, properties like Bristol-Myers Squibb, Johnson & Johnson and Warner-Lambert sell at 30 times forward 12-month earnings. They're attractively priced. (Except for Pfizer, which sells near 40 times next year's numbers and is too rich.) Other enticing prospects lie with commercial finance companies that aren't overly sensitive to interest--such as Heller and CIT, both of them very cheap.
Another winner Buffett eschewed playing when it was cheaper was technology. From the market bottom of early 1991, the tech sector zoomed from 6% of the S&P 500 index to its current weighting of 25% . In the Barra growth index, tech is 37% . IBM and Computer Associates are in a buying range. Feisty Apple Computer to date is bucking the tide against computer hardware.
Any money manager who underweights tech would have had to underperform this year and last. In fact, if Buffett headed a mutual fund, he'd be looking at a second career.
Berkshire also owns a diverse array of operating companies, at whose heart are auto insurance and reinsurance. The cycle for auto insurance and reinsurance peaked last year. There is over $100 billion in redundant capital industrywide. It has led to rate-cutting and dwindling underwriting margins. Of late, auto insurance has an alarming increase in case severity and frequency.
Among auto insurers, Berkshire's Geico is the low-cost operator. Its share of market is 3% and rising on the strength of lowball premiums. This situation dredges up unhappy memories about the carrier from the 1970s. Back then, Geico pursued a comparable hard-charging scheme and came within an ace of receivership. That is when Buffett bought his first big chunk of this property for very little. For the next year or two the combination of a rising loss ratio and policy acquisition costs will depress Geico's earnings.
Then there's Buffett's worrisome reinsurance effort. General Re is stalled out in a worldwide insurance market suffering from huge overcapacity. Couple that with the mess involving the collapsed Unicover reinsurance pool for workers' compensation--and Gen Re could be hit with $200 million in additional writeoffs by year-end. Buffett's best hope is that Gen Re can restructure its investment portfolio to offset the problems with the basic business.
That's not all. Berkshire diehards need to deal with two sobering issues: Buffett's age, 69, and the company's sizable premium over after tax liquidating value. The Sage of Omaha is a great man, but he does not walk on water.
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