Misguided Media Questions Buffet - 5 / 1 / 2009

This weekend, Warren Buffet's Berkshire Hathaway hosts its annual Shareholder's meeting. This event needs no description. A group of lovely, cash flowing companies set up booths at a local convention center and answer questions from fellow shareholders while they wait for Warren Buffet or Charles Munger sightings.

These last 12 months however have been difficult for Berkshire Hathaway's shareholders to understand. One year ago, Berkshire's bellwether shares, BRK - A, sat comfortably at $133,000.00 per share. Today the price per share sits at $94,000.00. A 30% annual loss. So the financial media has taken this opportunity to send up flares and interview investors who are asking if Buffet still has the magic touch. Or if Buffet has lost his way.

Buffet too may be feeling a bit out of his element. Beginning October 2008 he began a series of interviews with the major financial channels, wrote a few op ed's for the major news papers, and recently began comparing the share performance of the company he chairs to that of the major stock indexes. In one quote he sounds like a lowly fund manager suggesting his stock out performed the comparable markets (by virtue of a smaller annual loss).

What he should do is take the opportunity to do what he does best. Communicate his disciplined value approach to equity investments and re-educate his shareholders on his simple formula. Here it is, and readers, it really is the best way to invest.

First Berkshire only looks at companies that can show significant and consistent earnings over there most recent five year history. Next he determines the Present Value of the company, based upon the company's likelihood of maintaining its earnings growth given historic levels. He won't ever expect a company to grow its earnings by a greater percentage year over year than it has historically. Next step, he determines the return he needs his shareholders to receive on their investment annually, and compounded over the next five years, that return number is 21%. This math ensures the price he is willing to pay on his shareholders behalf is accretive or adds value to the share holder's current value (most acquisitions don't benefit shareholders because they are dilutive to the companies equity value on day one). And, he rarely moves from this model, unless he is buying insurance companies which become banks for him in that they provide a nearly free float or financing source for the company(a subject we can review another day.)

What has been created is a collection of cash flowing businesses bought at significant discount to their future value. Businesses that grow modestly, but whose values on an individual basis add significantly to the shareholders of Berkshire.

The share price also has a very favorable effect on the company's value in the market. It is much much too high to permit significant numbers of speculators from trading for a daily 1% or 2% move. So its liquidity, although growing every year, is not comparable to other companies (136,000 shares a day in the last 3 months). This share price reinforces the notion that investors need only apply. No speculators please.

But to this point of speculators, the last 15 months market crash has had an interesting effect on Berkshire's shareholder base. Fund managers searching for ways to reverse their shoddy returns, put some of their investments into Berkshire (which is a holding company with a fund manager's discipline). The result, speculators jumped in to. And these are the folks that need to be reminded by Buffet that their needs and perspective are not aligned with the Berkshire disciplined value approach. Announcements from Berkshire are few and far between. He holds one research analyst meeting a year to keep research speculation to a minimum (also a great indicator of how Buffet feels about the value added of research analysts in general). Buffet buys value, he buys cash flow and earnings, and if other's want to speculate on the value of his stock, let them. He lives only as a value investor under the same model which only acquires companies and investments that fit his criteria at a price that ensures future returns.

All this said, he does have to explain how and why his insurance groups got involved with mortgage based derivatives. He attempted this in his annual report, but the explanation wasn't very compelling.

The real point is that anyone can apply this model to their investment methodology. The key is having the patience to ignore the media and dow jones noise which will tell you that you could be making 30, 40 or 100% returns a year if you are willing to be a speculator. And if you have made those returns in a year, you are either a speculator or have been the beneficiary of other speculators. And those returns and that approach will never be sustainable.

Build Value Every Day

Brad van Siclen