Boring Portfolio

<THE BORING PORTFOLIO>
Adding to Berkshire
Plus our Next Project

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (May 26, 1999) -- Let's get business out of the way first. The Boring Portfolio will add within the next five trading days four shares of Berkshire Hathaway "B" class common stock. In addition to two previous buys, on 12/31/98 and 1/12/99, this purchase will bring the total amount of the Boring Port's holdings to 12 shares of Berkshire "B" class stock. Our previous buy announcements are here:

At the current price, Berkshire meets my quantitative benchmarks, e.g., the prospect of a 15% compound annual return with the right risk/reward composite. It also exceeds all my qualitative benchmarks.

Quantitatively, my calculation of the company's value puts intrinsic value at a minimum of $77,000 per "A" share and $2,567 per "B" share. At this morning's quote, the "B" shares are selling at an equivalent of $71,190 per "A" share while the "A" shares themselves are trading at a 2.4% premium to that. Overall, the B shares are selling at an 8% discount to the value I believe will deliver a 15% annual return to the Bore Port.

Not even treating the substantial uninvested capital at Berkshire as excess capital (which for the purposes of definition, is capital that could be distributed to shareholders without damaging the company) and in treating all the liabilities of the finance and GenRe financial products business as debt, Berkshire is selling at a 14% premium of enterprise value to invested capital. I don't look at book value here or in most businesses for the purposes of assessing value for an ongoing enterprise. If we were liquidating the company, that would be a different story, but we're not. By looking at equity plus reserves, plus the current value of deferred tax liabilities, we're trying to get an idea of the financial resources the company has invested in operations. That, in turn, leads us to an estimate of how much economic value the company can generate.

So we're not buying at some arbitrary multiple to invested capital or book equity because there's some rule that a company is always a bargain at a certain multiple. The multiple has only limited use as a shorthand. The company's return on capital and the cost of capital are the important things to look at. Over the long term, I believe the company can generate a satisfactory spread between those two to justify a higher fair price for the company. And I also don't assume heroic feats. I have significant underwriting losses built into the model and the equity investment returns are quite muted, I believe. For instance, I assume a 6% compound annual return for a number of years for a significant portion of Berkshire's equity portfolio. That is, Coke and Gillette will underperform the general equity market, in my estimation, and essentially pay for some of their stellar outperformance this decade with a few years of underperformance in the coming years. So there's no stretching of the operating assumptions here.

I realize the concentration of the portfolio is probably a controversial move, so before I move on to looking at the next company on the radar, I think a short discussion is probably in order.

All over the United States, many of your friends and neighbors are very likely concentrating their economic fortunes in one enterprise. Whether they run a McDonald's franchise, a corner store, a manufacturing business, or are even salaried employees of a company with no business of their own, individuals live with concentrated economic fates every day. That academic theory suggests this is dangerous, irresponsible, or suboptimal when it comes to investment doesn't really make much sense to me, especially when this portfolio doesn't represent a cross-section of risk/reward parameters for clients. There are no widows and orphans whose capital is invested in this portfolio for whom a temporary or even sustained quotational loss of principal would be damaging. With the right company at the right price, I wouldn't hesitate to invest all the assets of this portfolio in one company, either.

When I think quantitatively of my financial future, I envision an income statement, cash flow, and balance sheet. At present, the equity investments part of the balance sheet could show one investment. But my net income in the future will hopefully be positive and the investing part of the cash flow statement in the future will also be highly negative, hopefully, for a number of years. Therefore, I'm not thinking of the balance sheet in static terms and there's nothing to say that future inflows will always be devoted to one company. When I have the free capital and find an opportunity that I believe through diligent research and understanding is undervalued and is a high quality enterprise, I don't just devote 5% of the portfolio to it. I want to make a substantial commitment to it.

The higher the quality of the company and the more undervalued it is, the bigger the commitment I want. And that depends on the quality/price intersection of the investing proposition. I try to confine everything I do to high-quality companies. Even in there, there are relative levels of quality. There aren't many companies higher than Berkshire Hathaway in the quality spectrum and I don't think any is lower in the quality/price spectrum. Coke, for instance, is high quality, but it's very high in the quality/price spectrum now. I'm sure some will point out that I am upping the Boring Portfolio's commitment to Coca-Cola Company by this very purchase. That's true, but the stock represents only around 10% of the capital under Berkshire's control even if it represents about 20% of tangible shareholders equity on an after-tax basis.

On the price that the market is serving up at any one time, I try to think as much as possible in terms of acquiring the entire company. Which gets me to the reason of why I am so price sensitive. I don't agree with the philosophy that a company is as attractive tomorrow trading up 15 points as it is today. Some people will look at stock with 400 million shares outstanding and say, that's alright, the future of this company is so golden that I will buy it even if it's up 15. To me, this sort of behavior is absolutely crazy.

If you were negotiating the purchase of the company and you came to terms with the seller to purchase it for $40 billion, and the next day they came to the table and told you, "No, now I want $46 billion," would you just say "OK, no problem?" I wouldn't. I might try to meet the seller halfway or part of the way or I might tell him or her to go blow, depending on how we got to the $40 billion negotiated value.

Three things are working there: 1) Future investment returns; 2) Margin of safety on loss of principal, and 3) Your out-of-pocket today. Each is important, but I'm not going to lay out a scorecard on the weighting of the three. Figuring out that mix falls into the art of investing, in my mind, and not the science of investing.

By the way, I'm kind of doing a draft of some of the Boring port's principles in this column and in some others, so I'm sorry that I'm not introducing anything new here today. While I've run out of time, I did want to say that I'm looking next at GM Hughes. The principal attraction there is its position as the leading direct broadcast satellite company in the United States. Current legislation to enable the delivery of local broadcast programming via satellite will increase the attractiveness of the company, but the job here is to see if that's built into the price. Another part of this analysis will be the parsing out of the valuation of the company's major divisions. We could be getting the satellite TV company at a fair price and the rest of the Hughes Electronics assets for free. I don't know any of this yet, so that's why we're putting the bird in the oven. We're nowhere near ready to carve yet.

Comments, questions, and flames are welcomed on the Boring message board. Since I don't want to mess up their mojo now, though I'm sure some could care less, I'm going to have to keep on saying "Go Sabres" through the end of the Stanley Cup playoffs or until they get knocked out. So, Go Sabres.

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05/26/99 Close
Stock Change   Bid
APCC  +3 3/16  38.19
BRKb  -24      2350.00
CSL   +  13/16 46.94
GTW   +3 13/16 60.88

                  Day     Month   Year  History
        BORING   +1.57%  -0.06%   4.85%  40.79%
        S&P:     +1.59%  -2.28%   6.46% 117.25%
        NASDAQ:  +1.94%  -4.55%  10.69% 133.17%

    Rec'd   #  Security     In At       Now    Change
  8/13/96  200 Carlisle C    26.32     46.94    78.30%
  4/20/99  230 American P    28.95     38.19    31.89%
 12/31/98    8 Berkshire   2244.00   2350.00     4.72%
   2/9/99  100 Gateway 20    72.38     60.88   -15.89%


    Rec'd   #  Security     In At     Value    Change
  8/13/96  200 Carlisle C  5264.99   9387.50  $4122.51
  4/20/99  230 American P  6659.25   8783.13  $2123.88
 12/31/98    8 Berkshire  17952.00  18800.00   $848.00
   2/9/99  100 Gateway 20  7237.50   6087.50 -$1150.00


                             CASH  $27334.40
                            TOTAL  $70392.52

</THE BORING PORTFOLIO>