I was drawn to my copy of the best-selling "One Up on Wall Street" this weekend. It really is an excellent book and completely changed my view on investing. Flicking through the pages, I came across several paragraphs on how to buy shares for less through subsidiaries. Now, at first this sounds complicated. However, it can be a great way of investing in a company for less than you would pay if you were to buy the stock directly.
Let me explain
One of the obvious examples is Altria Group (NYSE:MO) and SABMiller (OTC:SBMRY). Altria owns a near 30% stake in SABMiller, the worlds second-largest brewer, and if you want to own a share of SABMiller, it is cheaper to do so through Altria.
You see, SABMiller's primary listing is in London, where presently the company has a market capitalization of £50.5 billion, or $83 billion. Altria holds a 30% share, which is worth in the region of $25 billion. Now, according to data supplied by the Financial Times, SABMiller currently trades at a trailing-12-month P/E of 24.6, what some might call expensive. Altria, in comparison, trades at a trailing-12-month P/E of 14.4 -- relatively cheap.
The Financial Times also tells us that SABMiller earned £1.28 per share on a trailing-12-month basis--that's roughly $2.10. With 1.6 billion shares outstanding, we can estimate that Altria's share of SABMiller earned $1 billion on a trailing-12-month basis.
However, here's the exciting part -- Altria's share of SABMiller is booked on its balance sheet as being worth only $6.5 billion, indicating that you can buy SABMiller through Altria at a trailing-12 month P/E of only 6.5!
But why is Altria understating its holding in SABMiller? Well, this understatement results from the equity method of generally accepted-accounting-principles accounting. You see, as Altria's stake in SABMiller is less than 50%, and the company only has three seats on SABMiller's 11-seat board, Altria does not exercise control over SABMiller. As a result, Altria cannot fully consolidate SABMiller onto its balance sheet, and neither is the company allowed to mark the stake up to its current value. So, Altria can only record the book value of its SABMiller holding on its balance sheet, but as I covered above, this holding is actually worth much more than it first appears.
Of course, one of the best places to look for other deals of this kind is Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B). Now, Berkshire does not disclose in detail the value and earnings of its holdings, so it is difficult to figure out a valuation for each individual holding. However, using some very simple valuation metrics, it is easy to see how much value Berkshire offers.
For example, Berkshire's biggest holdings, American Express, Wells Fargo, Coca-Cola, and IBM, total a cumulative $61 billion. This is around 22% of Berkshire's current market capitalization. These four holdings trade at trailing-12-month P/E ratios of 20, 11.5, 20.9, and 12.2, respectively. So then, Berkshire's historic P/E of 14.9 looks to be about right.
But hang on, Buffett himself has mentioned that Berkshire is sitting on $40 billion of cash; strip this out of the company's valuation and you get a trailing-12-month P/E of 12.5! So, in the case of American Express and Coca-Cola, at least, it would appear that buying Berkshire stock would be a cheaper and more diversified option than buying the individual companies -- or so it would appear. Then again, in this case I must stress that this is only an estimate.
In conclusion, sometimes it is cheaper to buy companies by buying their owners, as there is often hidden value. In the case of Altria, due to the fact that the company's holding in SABMiller is only booked at $6.5 billion on the balance sheet, investors are unable to see how much this holding is really worth. Indeed, further investigation reveals that the holding is worth as much as four times more than Altria reveals.
Berkshire's low valuation and cash balance also allows investors to buy into four great companies at low prices.