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Thursday, March 11, 1999

An Investment Opinion
by Dale Wettlaufer

Berkshire Reports on Saturday

As a longtime fan of Berkshire Hathaway (NYSE: BRK.A), a shareholder, and one of the guys at the controls of The Motley Fool's Boring Portfolio where Berkshire comprises 30% of the assets, I will be very interested in the release of the company's annual report this Saturday morning at 8:00 a.m. eastern time. In advance of the release, I thought I would review some things to be looking for in the report.

First, Berkshire Hathaway is a company in transition following some major deal-making activity in 1998. The largest deal was the merger of Berkshire with reinsurer General Re Corp. (NYSE: GRN), which expanded the company's trailing twelve month revenues (not including realized investment gains) through the third quarter of 1998 to $18.48 billion from $10.73 billion on a stand-alone basis. The GenRe merger also expands the balance sheet from $50.1 billion in assets to $95.1 billion in assets and from shareholders' equity of $26.9 billion to $34.4 billion (all net of goodwill as of the end of Q3 1998). Berkshire is also now the largest publicly traded insurer in the world, measured by equity capital, and the third-largest global reinsurer as of August 1998, according to Business Insurance.

I express the company's market position in terms of capital rather than gross written premiums because the reinsurance units at Berkshire Hathaway don't go for market share or premium growth for the sake of those things. They will take on business that provides an economic return. The reason this may be a point of discussion is that topline growth at Berkshire's insurance units outside of GEICO and some of the specialty lines isn't really the feature one should be looking at. It's the quality of underwriting that is the key feature of Berkshire that makes the company different.

Within an industry that is facing intense price competition, it's not market share points that you want. For instance, the competition between Compaq (NYSE: CPQ) and Dell Computer (Nasdaq: DELL) is often expressed in terms of market share, but the real cash flow economics of the companies are independent of market share. At Berkshire's GEICO auto insurance unit, the company only has between 3-4% of the U.S. auto insurance market, but accounts for much more than that in underwriting profits and certainly in return on assets arising from float. Being a market share pipsqueak isn't prima facie evidence that the company is an economic pipsqueak.

Expect substantial discussion of the GEICO unit -- this year it grew voluntary policies in force by nearly 21%. Last year, The New York Times warned that Berkshire Chairman and CEO Warren Buffett had said in last year's 10-K that the company's profitability is subject to severe price competition. That certainly is true, but you can quote a lot of stuff from the Bible to prove a lot of points just as you can overemphasize one thing that Warren Buffett says to attempt to prove a hypothesis on Berkshire Hathaway. GEICO is going for increased market share and is lowering its prices, but it's still ridiculously profitable. The problem with GEICO is that it's too profitable. Berkshire wants to deliver more value to the customer, gain market share, and use the insurance float for investment.

Tomorrow I'll discuss the implications of insurance "float" and some of the other interesting issues you should watch for in Saturday's report.

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