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August 10, 1999

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Review of Berkshire

Author: TFoolery

Here's my Review of Berkshire one week before 2nd quarter results.

1. The business press and financial message boards are rife with cries that Berkshire Hathaway stock [BRKA, BRKB] is going down while the market is going up; Warren E. Buffett [WEB] has "lost it;" BRK's holdings in Gillette, Coca Cola, and other equities are has-been stocks and BRK is going down because Warren won't sell them; ad infinitum ad nausium. What has happened to this revered investment-grade stock after 30-some years of market-beating performance? Is this the time to get off Warren's train? Is he too old at 68 to cut the investment mustard any more? Worry, worry over succession problems that may happen sooner rather than later.

2. I read everything I can find on BRK and WEB in the financial press, monitor TheMotlyFool BRKA message board daily searching for the occasional useful bit of information, and check in at www.berkshirehathaway.com frequently. I have read the company's annual and quarterly reports for the past five years as well as the Chairman's collected letters from 1977 onward. I have studied Robert P. Miles' "101 Reasons to Own Berkshire Hathaway." I attended the annual shareholders meeting in Omaha this past May. I even monitor BBC Online and The Guardian Online daily to make sure that I don't miss any development on BRK's investment in Allied Domecq, owner of Dunkin' Donuts and Baskin Robbins which could get spun off as Allied Domecq reconstitutes itself. I get at least one GEICO ad per week in the mail from an alma mater, bank/credit union, or professional organization. I see daily GEICO ads on web pages and marvel at how thoroughly they are searching for new customers to employ their newly hired representatives moving into their new operations centers being built or enlarged with BRK's investment funds.

3. The historic price performance of Berkshire shows big ups and downs over the years. These lumpy prices aren't exactly what one would expect with such a consistently top-quality growth stock. What causes this price volatility in such a solid company? One important factor is that Berkshire is a world-renowned, high-visibility company and our Chairman is even higher profile. Another is that the company is thinly traded with about 1.52M BRKA-equivalent [or, stated another way, 45.6M BRKB-equivalent] shares outstanding - trading is 200-300 shares of A and 10,000-20,000 shares of B on a typical day - very low for a NYSE-listed company. Another is that Warren is the Sage of Omaha. When he buys, others buy the same thing as soon as they can - that's why the SEC gives him a year or so to report stock buys and sells. Warren is a market mover and when he thinks, the press tries to listen. When Warren is wheeling and dealing, and it's reported in the press, there is extreme interest and stock prices move. Price moves in BRK can be fast, if not dramatic, as in 1989, 1993, 1995, & 1998.

4. Berkshire's performance in 1995 and 1996 is interesting as an example that might aid understanding of what's been going on the last year or so. Reviewing 1995 shows the price of the stock rising from $20,400 end-of-year 1994 to $32,100 eoy 1995, a 57.4% increase. Net worth went up 45.0% [$5.3B] and per-share book value increased 43.1%. The company acquired Herzbergs Diamond Shops and R. C. Willey Home Furnishings and GEICO. Press coverage was considerable due to buying the remaining 49% of GEICO Insurance the company didn't already own. The latter transaction actually closed just after the end of 1995 but the BRK-GEICO press coverage was considerable in 1995, intense at times, with a lot about the World's Greatest Investor, et cetera, et cetera. The acquisitions were expected to double BRK's revenues in 1996 according to the Chairman. Perhaps more significantly, the company decided to issue B-Class stock [1/30th of an old BRK, now BRKA, share] to keep Wall Street scoundrels from building mutual funds on BRK's expensive shares and selling $1,000 fund shares to the public. Another reason for the B's was to allow tax-free gifts of less than $10,000 of BRK stock. Although the B-Class was issued in early 1996, much of the hoopla of the BRKB issuance occurred in 1995, increasing the press reporting and public interest in Berkshire Hathaway even more.

5. The annual price performance of Berkshire in 1996, the year following the bang-up +57% stock gain of 1995, was a sorry 6.2% increase to $34,100. Net worth was up 36.1% [$6.2B] and per-share book value increased by 31.8% --- both above BRK's 32-year averages of those measurands up to that time but apparently unrecognized by Mister Market. What happened? For one, the B-Class issue was more auspicious than anticipated by management, great public interest and demand continued to push the stock up rapidly in early 1996. WEB and Charlie then jawboned the prices down by making public comments like, "We wouldn't but the stock at these prices," and "We wouldn't recommend the stock to our friends at these prices," et cetera. So, after the initial run-up to annual high of $38,000 and fallback to a low of $29,800, 1996 turned into a pretty flat $32,000 - $34,000 year. Starting to sound familiar?

6. Looking at last year [1998] shows the price of the stock rising from $46,000 end-of-year 1997 to $70,000 eoy 1998, a healthy 52.2% increase. Net worth went up 45.0% [$25.9B] and per-share book value increased 48.3%, a very good performance considering that per-share book value has grown at a rate of 24.7% [from $19 to $37,801] over the last 34 years, compounded annually. There was a lot of press coverage triggered by the acquisition of Executive Jet and General Re and the stock went up to a high of $84,000 during the 2nd quarter. The latter part of the year, market uncertainties over the eventual General Re takeover and the S&P Index effect weakened BRK stock prices, with BRKA dipping as low as $57,000 in both the 3rd and 4th quarters. The removal of General Re [GRN] from the S&P 500 Index contributed to the fall in Berkshire market prices as the S&P Index and the index emulator funds divested themselves of GRN which was, by that time, tied by a fixed ratio to BRK stock. These effects showed in the drops and volitility in August through December. In spite of all this, 1998 ended favorably at $70,000 per BRKA share.

7. The General Re acquisition was a very large undertaking and some Gen Re holders don't appreciate Berkshire Hathaway. Shares worth $22 billion [June 1998 agreement valuation] were issued to consummate the transaction and Berkshire increased its stock outstanding by 23% to 1,518,548 equivalent A shares [BRKA increased 12.7% to 1,349,535 and BRKB increased 366% to 5,070,379 shares]. These shares mostly went to General Re stockholders after the closing of the transaction on 21 December 1998 and were distributed through March 1999. Many Gen Re stockholders didn't want Berkshire stock and sold as soon as they got the shares so prices dropped into the low $60s in January. Some held on awhile but, after a first half with no price appreciation and mediocre 1st quarter earnings, are deciding to divest themselves of their BRKA and B. Who can blame them -- some need dividend income, some need to see steady quarterly earnings growth, some need some kind of reassurance they feel they don't get with Berkshire. There will probably be continuing BRK sales from these holders until they're all gone or converted to the Berkshire Hathaway way.

8. General Re has some warts. One is a very lucrative off-balance-sheet stock-option program that is being converted to payroll entries that will impact earnings until a WEB-style incentive program is functional. Another is lack of underwriting profit since Berkshire acquired the company? Another is the "unexpected" loss by a General Re subsidiary in workmans compensation insurance.

9. What's the bottom line of the Gen Re acquisition? At the May stockowners meeting, in response to a question from the floor, WEB said that we may expect to see some positive results on the balance sheet from Gen Re in a year or two. That means for sure in 2001, maybe in 2000, but not in 1999.

10. So what's going to happen to BRKA and B in the future? Naturally I don't know for sure but would expect to see more of the roller-coaster price moves that have occurred over recent years. The shock of ingesting General Re that started in mid-1998 could be expected to have played out by mid-2000. But we might not notice it since by then WEB will most probably have made more acquisitions so there will be new shocks to dampen [read 'wait' or 'ride'] out. U. S. News reports that MARS Candy may be up for grabs - the size and franchise are right? When is Berkshire added to the S&P 500 because of brute size or whatever? If past is any prologue, BRKA should reach six figures in 2000, never to return to five figures again by the year 2002. Succession jitters or not, Mr. Buffett has created a capitalist juggernaut -- it will roll on and on, smooth road or rough. The ride is nothing if not interesting and I'm enjoying it immensely.

/s/ Tom