The Burden Of Success (BRK.A, BRK.B)

By Stephen Brown | October 18, 2006 AAA

A plethora of exegeses, articles, and analyses has been produced with Warren Buffett and Berkshire Hathaway (BRK.A, BRK.B) as the primary subject. Guess what? I'm adding another drop to this vast ocean.

Buffett and Berkshire are worthy of their attention and approbation, to be sure. Over the past 40 years, Berkshire's book value has increased from $19 per share to $59,500, producing an average (and unheard of) annual growth rate of 21.5%. In comparison, the S&P 500 Index's book value grew at an average annual rate of 10.3% during the same time.

Buffett has transformed Berkshire – a former textile mill – into a cash-generating machine buttressed by an expansive and efficient insurance operation (National Indemnity, General Re and Geico).

Berkshire pays virtually nothing for the premium float of nearly $50 billion. And at any point in time, Berkshire's balance sheet carries over $40 billion in cash and cash equivalents.

Buffett is the nonpareil allocator of Berkshire's cash. Today, Berkshire is a $150 billion (market cap) behemoth that owns over 30 private companies – clothing, furniture, jewelry and candy companies, restaurants, natural gas, and corporate jet firms – and has major investments in powerful brand names like Coca-Cola (KO), American Express (AXP), Procter & Gamble (PG), Anheuser-Busch (BUD), and Wells Fargo (WFC).

But success comes with a price. Given Berkshire's girth, bigger and bolder investments are required to materially improve the bottom line. In the past, million dollar purchases of a See's Candy or a Justin Boots would do the trick. Today, only multi-billion dollar investments will do, as witnessed by Berkshire's recent $5.1 billion acquisition of PacifiCorp and $4 billion investment for 80% of Iscar Metalworking.

What's more, the low-hanging fruit in the buyout orchard has already been picked. Economically feasible private investments are decreasing as the popularity of private-equity funds has increased. A few years ago, Buffet pooh-poohed the need to invest overseas, believing sufficient domestic opportunities existed. The recent Iscar purchase suggests that's no longer the case.

Parsing Berkshire's financial statements has also grown more difficult; something Buffett acknowledges in Berkshire's 2005 shareholder letter: "Back in 1965, when we owned only a small textile operation, the task of calculating intrinsic value was a snap. Now we own 68 distinct businesses with widely disparate operating and financial characteristics. This array of unrelated enterprises, coupled with our massive investment holdings, makes it impossible for you to simply examine our consolidated financial statements and arrive at an informed estimate of intrinsic value."

Here's my humble suggestion for mitigating Berkshire's expanding waistline: Eliminate the B-shares and split the A-shares 1,000 for one and begin paying a dividend. A split will increase liquidity for current investors and a dividend will provide capital for Berkshire investors to pursue Buffett-like investments that fly under Buffett's radar. For example, Steve Madden Shoes (SHOO), EZ Corporation (EZPW), and Ennis Business Forms (EBF).

Buffett is as sharp as ever; he would leave all but the most prescient investor in the dust on a level investing field, but the field is no longer level – it's slanted in favor of the small investor. From 1965 through 1998, a slighter, nimbler Berkshire trounced the S&P 500 every year except for 1975 and 1980, but from 1999 through 2005, a larger, less agile Berkshire was outflanked by the S&P 500 index three out of seven years. Buffet hasn't lost his touch. The economic fact is fewer investment opportunities exist for a $150 billion company than for a $150 million company.

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