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Berkshire Hathaway
BRK's Underperformance Frustrating

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By mhirschey
January 13, 2010

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It's annoying, but price and value sometimes diverge.

On Oct.16, 2008, Buffett wrote:

The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So ... I've been buying American stocks.

http://www.nytimes.com/2008/10/17/opinion/17buffett.html?_r=1

Today, BRK.A is trading at 99,776 down from 113,150 (11.8%) on Oct 16, 2008. Meanwhile, the S&P 500 trades at 1139, up from 946.43 (20.3%). Losing money over 15 months is bad enough, relative performance of -32.1% is downright discouraging. It's bad enough to get most Wall Street money managers fired; mutual fund managers would see a massive outflow of investor funds under such circumstances.

This all leads BRK shareholders to ask:

1. Has Buffett lost it? I don't think so, not by a long shot. Mentally he is shape, physically he is vigorous. I'd love to be in his shoes at 80.Moreover, recent moves in GS, SwissRe, GE, BNI and others suggest he has been prudently aggressive under the dire circumstances of late-2008, early 2009. Buffett could have done better; he could have done a lot, lot worse.

2. Is the BNI deal holding BRK back? Maybe. The yawning gap that has emerged between BRK and S&P performance has emerged in rough coincidence with the November 3, 2008 Burlington Northern Santa Fe Corporation acquisition announcement. Today, BRK.A has a market cap of roughly $105.4 billion; BRK.B has a market cap of roughly $49.3 billion. On February 11, 2010, BNI shareholders are expected to approve BRK's acquisition for $100 per share in cash and stock the remaining 77.4 percent of outstanding BNI shares not currently owned to increase its holdings to 100 percent. Based on the number of outstanding BNI shares (including shares currently owned by Berkshire) on Nov. 2, 2009, the transaction is valued at approximately $44 billion, including $10 billion of outstanding BNSF debt, making it the largest acquisition in Berkshire Hathaway history. For the $26.3 billion non-BRK shares to be acquired, $15.8 billion (60%) are to be paid for in cash and $10.5 billion (40%) are to be paid for with BRK.A or BRK.B stock. No doubt, some arbs are shorting BRK and buying BNI, but the $10.5 billion in new stock to be issued is relatively modest in light of a total BRK market cap of $154.7 billion (6.8%), so BNI arbs are probably not to blame for recent BRK underperformance.

3. Is the pending stock split to blame? No way. The Berkshire Hathaway Board has approved a 50-for-1 Class B common Stock split. According to the company, the split in Berkshire's Class B shares is being undertaken to facilitate the Burlington Northern deal by reducing the tax consequences for smaller BNI shareholders. The fact that a wider audience will be out there now for BRK.B stock also helps. Also, BRK.B would be a sensible replacement for BNI when the merger is completed and BNI is removed from the S&P 500 index. About 9-10% of the market is indexed to the S&P 500, so putting BRK.B into the S&P 500 can be expected to lead to a near-term pop in the stock. It cannot explain recent BRK weakness.

Because I can see no support for these "usual suspects," I conclude that recent BRK weakness is a simple reflection of market caution in light of BRK's economically-sensitive portfolio of wholly-owned subsidiaries, like Acme Building Brands, MidAmerican Energy Company, Benjamin Moore, Borsheim's Jewelry, Nebraska Furniture Mart, and Shaw Industries (etc.). However, as the economy continues to recover, the recovery in these businesses will eventually be recognized by the market and BRK's stock price will play catch-up.

It's tough to place an accurate value on BRK, but I like to refer to the excellent Berkshire Hathaway Intrinsivaluator http://www.creativeacademics.com/finance/IV.html. Over time, I've found that the stock price tends to track the numbers generated using "conservative" assumptions. That means that BRK is worth in the neighborhood of 122,729-a 23% premium to the current price.

In short, if you've been frustrated by BRK's recent underperformance, get in line. It's a long line. The fallout is that this appears to be an attractive time to add. Future returns look interesting.

Mark