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Fool On The Hill

Thursday, July 29, 1999

FOOL ON THE HILL
An Investment Opinion
by Dale Wettlaufer

Market Musings: Coke, Berkshire, Jabil

"I'd like for Coke to get a clue, and respect its shareowners..." (sung to the tune of "I'd Like to Buy the World a Coke")

On Tuesday, I listened with interest as Rule Maker Matt Richey fought through the dense thicket of arguments put forth by Coca-Cola Co.'s (NYSE: KO) investor relations chief as to why the company holds special meetings with analysts on a regular basis and why it won't open these meetings to other investors. Now, I contend that if the company doesn't want to open to individuals the meetings attended by analysts, that's fine. There's no reason why they shouldn't have the ability to associate with whomever they want. That's a guaranteed right in this country. However, I believe that Coca-Cola is running dangerously close to breaking the letter or spirit of binding laws, namely applicable Securities and Exchange Commission rules that prohibit selective disclosure of company information.

The company says it conducts meetings with analysts on a "personal basis" and that anyone can call them and find out the same things that the analysts can find out. I'm glad to hear that, because I plan to call the company right around earnings time, before and after, and ask them the same questions that other analysts might ask. I think I'll also check in with them throughout the quarter. After all, I am a shareholder both directly, though personal holdings in Berkshire Hathaway (NYSE: BRK.A), and through the Berkshire Hathaway shares held in the portfolio I manage at the Fool. I am very interested in what's happening at the company, and I hope the company will be able to give me a full review of the quarter when I call.

I have no idea whether the company will cooperate with me on this score, but let me say this -- I will be looking at the sell-side research on Coca-Cola from now on, and I will be compiling a list of discrepancies between company-supplied information that is found in this research and what is found in company press releases and federal filings available at the time the research comes out. Both timing of disclosures and factual substance of disclosures will come under scrutiny here.

It's not that hard to figure out by looking at the sell-side research whether they've disclosed information to analysts that they do not similarly disclose to other interested parties. If a pattern of disclosure irregularities is found to exist, then all I have to say is that Coke is going to have a problem. By the way, I am initiating coverage of the company with a short-term "hold" recommendation and a long-term "attractive" rating at this time.

Speaking of selective disclosure, Berkshire Hathaway Chairman Warren Buffett had a few pertinent things to say on that score in this year's Chairman's Letter to Shareholders.

Berkshire the Mutual Fund

In a recent Stockpoint commentary, Investing for Dummies author Eric Tyson said he didn't like Berkshire (which he said is like a mutual fund because of its huge equity stakes in companies such as Coca-Cola and Gillette) because it trades at a premium to the value of the stocks it holds in its portfolio. He also said investors could buy the stocks in the portfolio, implying that's the way to coattail Buffett.

Well, hey, I guess we really should forget the fact that the company is the largest reinsurance company in North America and one of the largest in the world, the fact that it's one of the largest and most respected supercatastrophe underwriters in the world, that it owns companies such as GEICO and Executive Jet Aviation -- which you cannot buy in the open market since they're wholly owned subsidiaries -- as well as some other stuff that is critical to looking at this company in a way that is anywhere within the same neighborhood of being analytically competent.

One of these would be the fact that Berkshire last year generated revenues of $11.42 billion before realized investment gains. You would also have to add to that the revenues of its General Re subsidiary. Through Q3 1998, that's annualized revenues of $7.62 billion before realized investment gains. You'd also have to consider Berkshire's pre-tax income (before realized gains and goodwill amortization) of $1.79 billion and GenRe's annualized pre-tax earnings before realized gains and goodwill amortization of $1.37 billion.

You might also want to consider that the tens of billions of dollars of insurance float, written such that there is no cost to that capital (and there's even a negative cost of capital to the company on that money), enhances the company's spread between cost of capital (WACC) and return on invested capital (ROIC) such that it really doesn't need to show huge returns on invested capital to get into the upper echelons of the S&P 500 on its ROIC-WACC performance. Some years, Berkshire's ROIC is going to be small. Given its ultra-low cost of capital (which, even better, is achieved without lots of leverage relative to its peers in the insurance industry), in the worst investment performance years the company will not kill that much value. In the years where its investment performance is very good, you get an ROIC-WACC spread in the 2,000 basis point range. That's huge.

On the one hand, you've got a guy who's written Investing for Dummies telling you to look at the price of the company relative to only some of its assets, forgetting all other cash flows, and forgetting the cost of capital incurred by the company in supporting its assets. On the other hand, you've got a guy working for The Motley Fool saying a different thing. Strange times. You can take your pick on whomever you want to believe.

Beauty of Contract Manufacturers

They take nasty tumbles every once in a while. That's good if you're a buyer, though. Yesterday, Jabil Circuit (NYSE: JBL), the best-run electronics manufacturing services company, in my opinion, got smashed on an earnings estimate tweak by Bank of America Securities, rumor has it. Today, BancBoston Robertson Stephens' Keith Dunne upgraded his rating on the company to "buy" from "long-term attractive." According to Dunne:

"We continue to expect fourth-quarter 1999 earnings-per-share of $0.30, although sales are likely to be at the lower end of our $445 to $450 million estimates, with the offset coming from higher-interest income and a lower-tax-rate," said Dunne. "We are maintaining our earnings-per-share estimates and continue to believe the significant outsourcing trend could offer additional upside opportunities by the middle of next year."

Dunne is one of the top people on the Street that cover this company and sector. He's pretty sensitive to valuation, and I agree that Jabil wasn't that cheap coming into yesterday. Trading at 23 times Dunne's fiscal 2000 EPS estimate, being a very well-run, high return on capital outfit with a very attractive secular growth rate for the industry, I do agree that Jabil is certainly worth a look. By the way, I own this stock. And no, I am not talking up my position. I have had significant excess returns in it since buying it in late spring of 1998. I would actually prefer to see it decline some more to add it (it's not cheap enough for me to buy it again) to the Boring Portfolio here on the Fool. CS First Boston and Merrill Lynch also got behind the stock today.

Would you work for a bunch of Fools?

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