Feb 262011

In Warren Buffett’s 2010 Letter to Shareholders released on February 26, 2011, Buffett states that he uses the “understated proxy for intrinsic value — book value” to measure Berkshire’s performance.  His annual reports every year highlight Berkshire’s annual percentage change in book value per share vs. the S&P 500 with dividends included.  He also disparages the use of income per share since Berkshire’s net income can vary greatly depending upon when he decides to realize gains or losses in Berkshire’s investment portfolio.  Therefore, instead of comparing Berkshire’s current price to earnings ratio with its historical average to determine if Berkshire is undervalued, a better comparison would focus on its  price to book value ratio.

In the table below, I show for each year from 1985 through 2010, Berkshire’s book value per share and market price per share of its class A shares, as well as its annual price to book value ratio.  From this table it can be seen that Berkshire’s 2010 yearend price to book value ratio of 1.25 is 23% below its average of 1.63 over the past 26 years, and 44% below its peak value of 2.23 achieved in 1995.  Indeed, in only two of the past 26 years has this ratio been lower than its 2010 value of 1.25.  (In 2009 the ratio equaled 1.17 as the economy was beginning to recover from the financial crisis, and in 1987 the ratio equaled 1.19 after the Stock Market Crash of 1987.)

Utilizing Warren Buffett’s preferred proxy of intrinsic value of book value per share, the yearend  price to book value per share of Berkshire indicates that it is undervalued.  (Using Berkshire’s closing price of 127,550 on February 25 and the 2010 yearend book value of 95,453, the current price to book value ratio would equal 1.34, which still represents an 18% discount from its historical average of 1.63. Of course, the current book value of Berkshire can also be assumed to exceed the 2010 yearend level, which in turn would lower this ratio.)

Year Book ValuePrice P/Book Value
2010 95,453 119,100 1.25 
2009 84,487 99,200 1.17 
2008 70,530 96,600 1.37 
2007 78,008 141,600 1.82 
2006 70,281 109,990 1.57 
2005 59,377 88,620 1.49 
2004 55,824 87,900 1.57 
2003 50,498 84,250 1.67 
2002 41,727 72,690 1.74 
2001 37,920 75,600 1.99 
2000 40,442 71,000 1.76 
1999 37,987 56,100 1.48 
1998 37,801 70,000 1.85 
1997 25,488 46,000 1.8 
1996 19,011 34,100 1.79 
1995 14,426 32,100 2.23 
1994 10,083 20,400 2.02 
1993 8,854 16,325 1.84 
1992 7,745 11,750 1.52 
1991 6,437 9,050 1.41 
1990 4,612 6,675 1.45 
1989 4,296 8,675 2.02 
1988 2,975 4,700 1.58 
1987 2,477 2,950 1.19 
1986 2,073 2,870 1.36 
1985 1,644 2,470 1.5 
      Avg. = 1.63
 Posted by at 8:06 pm
Feb 262011

This morning Warren Buffett released Berkshire Hathaway’s 2010 Letter To Shareholders.  Overall, the tone of this year’s letter is far more optimistic that of the last two years.  Buffett expects the ongoing economic recovery to benefit Berkshire’s 78 businesses, especially those that suffered during the recent financial crisis and recession.  In particular, he focussed on his February 2010 acquisition of Burlington Northern Santa Fe Railroad whose performance has exceeded Buffett’s expectations.  He states:  “owning this railroad will increase Berkshire’s “normal” earning power by nearly 40% pre-tax and by well over 30% after-tax”.

Other highlights from Buffett’s letter include:

(1) A discussion of how he calculates intrinsic value.  (He considers book value to be an “understated proxy for intrinsic value”.)  There are three components to this calculation.  The first component is the market value of Berkshire’s investments in stocks, bonds, and cash equivalents ($158 billion at yearend).  Berkshire’s insurance float (premiums paid to Berkshire that have not yet been paid out to cover claims) funds $66 billion of its investments.  Berkshire’s second component of intrinsic value is earnings that come from sources other than investments and insurance underwriting.  These earnings are delivered by Berkshire’s 68 non-insurance companies.  The third, and more subjective component to intrinsic value, is the efficacy with which retained earnings will be deployed in the future.

(2) Buffett is seeking more major acquisitions.  “We’re prepared.  Our elephant gun has been reloaded, and my trigger finger is itchy”.  ($38 billion in cash)

(3) GEICO is now the third largest auto insurer in the U.S. with a market share of 8.8%.  When Tony Nicely became CEO in 1993, its market share was only 2.0%.

(4) Dividends from Berkshire’s common stock holdings will almost ceratinly increase in 2011.  The largest gain is likely to come from Wells Fargo.  The Federal Reserve has frozen dividend levels at major banks during the last two years.  “Wells Fargo, though consistently prospering throughout the worst of the recession and currently enjoying enormous financial strength and earning power, has therefore been forced to maintain an artificially low payout”…”At some point, probably soon, the Fed’s restrictions will cease.  Wells fargo can then reinstate the rational dividend policy that its owners deserve.”  Other companies held by Berkshire that are likely to increase dividedns this year include Coca-Cola.

(5) Lou Simpson retired at yearend at age 74 — “an age Charlie and I regard as appropriate for trainees at Berkshire”.   (Buffett is 80 years old, and Munger is 87.)

(6) With respect to the recent hiring of Todd Combs as an investment manager, Buffett was looking for someone with a good understanding and sensitivity to risk and has the “ability to anticipate the effects of economic scenarios not previously observed”.

(7) A brief discussion of some recent “terrible behavior” by general partners of hedge funds who received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with the limited partners losing back their earlier gains.  “Sometimes these same general partners  thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses.  Investors who put money with such managers should be labeled  patsies, not partners.”

(8) The reporting of net income at Berkshire is almost meaningless because that number can vary greatly depending upon when Buffett and Munger decide to sell some of their investments and realize gains or losses.

(9) Buffett and Munger believe that Black-Scholes produces “wildly inappropriate values when applied to long dated options” such as the “equity puts” that Berkshire has sold.

(10) 48 universities (selected from 200 applicants) will be sending students to Omaha this school year for a day with Buffett.  (The University of Maryland is one of the schools that has been selected.)

Buffett reported Berkshire’s largest common stock holdings (with a market value of over $1 billion) as of yearend as follows (in descending order by value):

(1) Coca-Cola ($13.2 billion)  —              21.4% of common stock holdings
(2) Wells Fargo ($11.1 billion) —            18.1%
(3) American Express ($6.5 billion)– 10.6%
(4) Procter $ Gamble  ($4.7 billion) —   7.6%
(5) Kraft Foods ($3.1 billion) —                 5.0%
(6) Munich Re ($2.9 billion) —                  4.8%
(7) Johnson & Johnson ($2.8 billion) — 4.5%
(8) U.S. Bancorp ($2.1 billion) —              3.4%
(9) Wal-Mart ($2.1 billion) —                     3.4%
(10) ConocoPhillips ($2.0 billion) —         3.2%
(11) POSCO ($1.7 billion) —                        2.8%
(12) Sanofi-Aventis ($1.7 billion)–          2.7%
(13) Tesco plc ($1.6 billion) —                    2.6%
(14) BYD ($1.2 billion) —                             1.9%
         Others ($5.0 billion) —                         8.1%
Total   ($61.5 billion)  —                             100%

Buffett’s entire Letter to Shareholders is available at:


 Posted by at 3:22 pm
Feb 152011

Berkshire Hathaway’s 13F filing with the SEC for the fourth quarter of 2010 revealed that Warren Buffett sold the remaining eight stocks that had previously been selected by Lou Simpson.   These investments were part of the GEICO portfolio supervised by Lou Simpson until his retirement on December 31.  The positions eliminated by Berkshire Hathaway totalled $1.3 billion and were in the following companies:  Bank of America, Becton Dickenson, Comcast, Fiserv, Nalco Holding, Lowes Companies,  Nestle, and Nike.  The only position that Warren Buffett added to in the fourth quarter was Wells Fargo.  An additional 6.2 million shares were purchased for about $200 million, representing a 1.8% increase in Berkshire’s stake in the company.  Berkshire is currently the largest shareholder of Wells Fargo, owning 7% of its shares.

As of December 31, 2010 the top five holdings by market value of Berkshire Hathaway were:

(1) Coca-Cola  ($13.2 billion)
(2) Wells Fargo ($10.6 billion)
(3) American Express ($6.5 billion)
(4) Procter & Gamble ($4.9 billion)
(5) Kraft Foods ($3.3 billion)

I am quoted in the following Bloomberg article (February 14, 2011) on this subject:

Berkshire Divests Stakes in Bank of America, Nike

By Andrew Frye
Feb. 14 (Bloomberg) — Berkshire Hathaway Inc. divested its stake in Bank of America Corp., the largest U.S. lender by assets, as Chairman Warren Buffett took control of the portfolio previously run by his backup stock picker, Lou Simpson.

“Any position that Buffett was uncomfortable holding on his own will have been sold in the fourth quarter” as Simpson left, said David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business.

Berkshire added to its Wells Fargo holding in the fourth quarter.

Last Updated: February 14, 2011 18:19 EST

The entire article is available at:


 Posted by at 12:53 am