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The Big, Bad Berkshire Bear

Michael Olsen, CFA
May 1, 2013

No investment clears the bar for me, without a thorough evaluation of the bear case. To turn the process on its head: Without knowing how, why, and where your investment thesis goes wrong, it's nearly impossible to assess how likely it is to be right.

Color me interested, then, at what Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) annual meeting holds. I -- along with Inside Value advisor Joe Magyer, Scott Phillips of Fool Australia, Brendan Mathews of MDP and Stock Advisor fame, and Matt Koppenheffer of -- am headed to this value-investing mecca this weekend. In an attempt to spice up the dialogue around the shareholder Q&A, Buffett has decided to appoint a "qualified bear" -- Seabreeze Partners' Doug Kass -- to shoot 10 hardball questions about Berkshire, and the stock, at The Oracle himself. The usual theatrics and sense of camaraderie aside, it adds yet another layer of enjoyment to "Woodstock for Capitalists." It's also a testament to Buffett's transparency.

In the spirit of the debate, here's my best guess at three potential Kass targets -- and, as a happy owner of Berkshire shares, I'll also offer my rebuttal.

1. Berkshire's expensive price tag
A commonly bandied-about challenge to owning Berkshire shares is its valuation. There are about 55 ways to value Berkshire and its prospects, but let's cut through the noise. Keep it simple, stupid.

For a given price, the market expects a certain performance threshold. So, let's assume that Berkshire is able to grow at just 3%. At 1.4 times book value, we can figure that out pretty easily (via the justified price-to-book) -- the market expects Berkshire to earn about 13% returns on equity, and grow its earnings at 3%, in perpetuity. A little perspective: For the 13-year period ended in May 2011, the S&P's ROE averaged 22%. Now, this measure isn't without its flaws, and it's not a perfect apples-to-apples comparison. But, with such tremendou