Guessing at Value

On August 3, 2011, Nasdaq.com published an article authored by Louis Navellier, titled “5 100 Billion Stocks Not Worth a Dime of Your Money".    Navellier wrote, “Given that future profits in the stock market are a function of profit growth, owning a $100 billion stock makes little sense.”

Navellier's original article


Berkshire Hathaway, Inc. (BRK), the conglomerate controlled by Warren Buffett, was Navellier’s top target for dissuading would-be investors.  Among other mistakes, Navellier, without elaboration or substantiation, stated that BRK should be avoided while it was selling at premium prices.  Navellier patently failed to describe his method for determining the intrinsic business value of Berkshire Hathaway; that knowledge would be necessary to wax eloquent as to whether the company was selling at a premium or at a discount.  The ensuing seven years has demonstrated that Navellier was radically wrong.

At the time of Navellier's article in 2011, BRK was selling for approximately $105,000 per share.  In the second half of 2018, BRK has generally sold above $310,000/share. Seven years and a 200% return for those investors who scoffed at Navellier, rather than BRK has been the demonstrable result.  The author was radically wrong; but what makes his assessment financially indefensible?

Analysis:

Per BRK’s 30 June 2011 financial report (10-Q) filed with the S.E.C., the book value of each Class A share of BRK stood at $98,848. As a result of the market price at publication and the most recent 10-Q at publication, one could reasonably assess that BRK was selling for approximately 106% of book value.

Navellier's article demonstrates at least three patent flaws:

 1) The reference to BRK  -- in 2011 -- as "an investment management company" was not merely outdated, but showed truly antiquated knowledge about the company.

Examining the company's 2010 10-K (most recent annual results available to Navellier's research), Berkshire Hathaway's investment management-related revenues (interest, dividends, realized capital gains, and changes in derivatives) accounted for approximately 5.5% of the enterprises total revenues of ~ $128 billion.  Even if one were to further back out all insurance premiums earned as a function directly related to investment income, BRK still generated roughly $100 billion in revenue in 2010 that was distinct from any "investment management" function.

Berkshire Hathaway's investment management, as a percentage of the enterprise's total value, was greatly reduced during the late 1990s, and the trend accelerated in the first 15 years of the new century.  Treating BRK as an investment management company in 2011 was akin to asking whether that "newfangled internet thing" would last.

2) Navellier made no reference to BRK's multi-decade relationship of its market price and book value, per share.  Historically, BRK has a multi-decade market price that averaged above 150% or more of book value.  Since the global financial crisis, the average above book has shrunk, but has continued to be in the neighborhood of 125% of book.  At publication, Navellier's reference to BRK being sold at a premium (106%) of book was grossly wrong, and demonstrated a fundamental lack of homework having been performed.

3) Navellier deigned to know the mind of Warren Buffett, despite demonstrating that he knew nothing about Berkshire Hathaway in the 21st Century.  Navellier thought that BRK was priced at such a premium in August 2011 that Mr Buffett would never buy in the shares at that price.

Less than 45 days after Navellier's article as published, Berkshire Hathaway formally stated that it would buy back shares at no more than 110% of book.  The policy was updated the following year to allow shares to be bought back for up to 120% of book.  

It would be exceptionally challenging to find a C.E.O  who has, more than Warren Buffett, first distinguished continuing shareholders and departing shareholders, and then given such weighty reflection on the need to consider both groups in the corporation's policy of buying-in shares.  For the student of Berkshire Hathaway, understanding this aspect allows one to also recognize that C.E.O. Buffett does not consider BRK to be worth the mere authorized repurchase ratio.  The reason is "margin of safety": the single most crucial term that has guided Warren Buffett's financial moves for more than 60 years.  BRK's continuing shareholders must benefit from a repurchase, and considering that intrinsic business value is not an exact science, the management puts in place a significant margin of safety when it decides what the buyback threshold should be.  The reasonable conclusion, therefore, is that Warren Buffett considered BRK shares to be worth at least 180% of Book, if not more.  He would thereby be willing to repurchase shares at a rate up to a maximum of 120% of Book, so as to ensure a "margin of safety".

Navellier's lack of understanding of BRK allowed him to compound his poor assumptions into then assuming -- astonishingly -- that he knew what Warren Buffett would or would not be willing to do with a potential repurchase of BRK shares.

Conclusion: 
The article "5 100 Billion Stocks Not Worth a Dime of Your Money" demonstrated that the author was grossly uninformed about Berkshire Hathaway concerning: 1)  basic knowledge that was at least 15 years out-of-date in 2011; 2)  an abject failure to understand how to value BRK in the 21st Century; and 3) an unimaginable hubris when it came to knowing the mind of Warren Buffett when he probably had not even read a decent article about the man. Targeting a company for derision, without performing basic homework, is financially indefensible.  

The author has continuously owned Berkshire Hathaway since 2007.