With the dramatic fall in equity prices since the Dow peaked at 14,066 on October 1, 2007, stocks have fallen to attractive price levels. The Dow closed at 7217 on Monday (down 48.7% from its peak). Given these circumstances, many think that now is the time to buy equities.
Warren Buffett, the world’s most famous investor, echoed these sentiments in his October 2008 letter to the New York Times: “I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.”
Given that Buffett is out there buying, why not buy Buffett?
Buffett’s masterpiece, Berkshire Hathaway, is one of the world’s largest holdings companies. Berkshire is made up of wholly owned subsidiaries (including Dairy Queen, GEICO, Benjamin Moore, Larson-Juhl) and shareholdings in publicly traded companies (Wells Fargo, Coca-Cola, Kraft, Procter and Gamble, etc.).
Berkshire has historically provided superior returns compared to the market. Since 1965, the company has earned an average annual return on equity of 20.3%. During that same time period, the S&P 500 index returned an average of 8.9%. Taking the compounding of interest into account, a $1000 investment in Berkshire at book value would have turned into $3.4 million 44 years later. The same investment in the S&P would have yielded a mere $42,580.
Berkshire’s 60+ operating businesses and numerous investment holdings are varied and range from carpet manufacturing to utilities to soda pop. These businesses have all been handpicked by Buffett to meet his tests of durability and ability to earn superior returns on capital.
And Buffett works virtually for free. He and vice-chairman Charlie Munger are each paid a $100k salary and do not have any stock options. Unlike a hedge fund, investors are not charged a management or performance fee. Buffett and Munger even reimburse the company for personal postage and telephone expenses.
As with any investment, there are of course some risks. Buffett and Munger are both up in years at 77 and 84, respectively. Management has outlined a transition plan for the company but it is yet untested. An official successor to Buffett has not been named though Lou Simpson, who manages subsidiary GEICO’s investments appears to be the front runner.
Due in part to Berkshire recording its worst results ever in 2008 (book value fell 9.6 percent) the stock recently hit a 5 ½ year low of $72,400 per share on March 5, 2009 ($2300 per Class B share)
From a fundamental perspective, this is the best time to buy Berkshire in many years. The business can be hard to value and analyze as it is composed of so many different pieces. Thus, I look at three high level valuation metrics in my assessment of the company: Price to Book, Price to trailing 5 year average earnings and Price to Sales.
Price to Book – Buffett uses book value as a rough gauge for measuring Berkshire’s increase in value. The range over a 10 year period to 2008 is 0.96 to 2.82. It is currently at 1.16.
Price to trailing 5 year average earnings – Using a 5 year average smooths out ups and downs (especially as insurance and investment results can be lumpy). The 10 year range has been 16.54 to 55.87. It is currently at 13.98.
Price to sales – this is a rough metric as it does not take into account the changes in businesses owned or investment holdings and it ignores changes in capital structure. Regardless it is still useful as a high level check. The 10 year range is 1.03 to 9.55. Currently it is 1.17.
I don’t know what the stock will do next week or next year, but for a long term investor this is a great buy.
Aly Mawji is the proud owner of Berkshire Hathaway’s class B shares.