Warren Buffet
I Estimate of GEICO price I Estimate GEICO price
II Why did Berkshire Hathaway (BH) share − Use Value Line data (p. 12)
price increase upon announcement of GEICO − E(RGEICO) = 6.86% + 0.75*5.5% = 11% p.a.
acquisition? (See footnotes 15 and 32)
III Buffet’s track record − Price estimates range from $58.32-$79.85.
IV Buffet’s investment philosophy (See Excel spreadsheet)
V Prognosis
VI Summary
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II Why did Berkshire Hathaway (BH) share III Buffet’s track record
price increase upon announcement of GEICO − Berkshire Hathaway (1977-1995)
acquisition? Stock price rose from $89 to $25,400 at a return
− When Warren Buffet talks, market listens: of 36.9% p.a.
Midas's touch or modern alchemy 14.3% p.a. return for all large stocks, and
With 50.4% ownership in GEICO, Buffet knows 9.6% p.a. return on S&P 500
a lot: an insider. See Figure 1.
It makes sense to follow a buy trade of an
insider.
More importantly, his track record talks by
itself.
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• Scott & Fetzer (1986-1994) • GEICO (1976-1995)
− BW’s initial investment: $315m. − $45.7m investment in 1976 rose to $1.96b in
− Dividend from Scott & Fetzer: See Exhibit 5 1995 at a growth rate of 21.7% p.a.
− IRR of 26.7% p.a. based on no dividend growth − IRR: 28.2% p.a. at 1995 price of $55.75.
after 1994, i.e., value in 1995 is assumed at 29.5% p.a. at 1995 price of $70.
$661m = $79.3/12%. • Any mistakes?
− I use beta of BW 0.95 to arrive at 12%. − See Exhibit 3: two successes & one under water
− Cf: 12.6% return on large company stocks − See Excel for holding period return.
− An example of diversification benefits?
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IV Buffet’s investment philosophy • Scorn the use of risk-adjusted discounted rate:
• Economic, not accounting, reality Buffet discounts cash flows at a risk-free rate.
• Consider the opportunity cost − Beta is precise but wrong. (Intuition vs model)
• Focus on ‘intrinsic’ value − Maybe Buffet knows so much about a company
that the cash flows are almost risk-free. Still,
• Maximize value creation they are risk-free.
• Align interest of managers and owners, i.e., − This view is hard to reconcile with his focus on
avoid ‘agency’ problems. opportunity cost.
− Matching risk-free cash flows with a risk-free
rate is consistent with the CAPM.
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• Diversification • Top share of the “look-through” earnings:
− “Figure businesses out that you understand, − Coca-Cola: 11.26%
and concentrate.” − Wells Fargo: 7.09%
− Exhibit 1: insurance accounts for 88.5% of pre- − It does not appear that any single investment or
tax operating profit and 82.6% of assets. industry dominate BW’s earnings.
− Exhibit 2: some industry concentration − Buffet actually diversifies his portfolio (See p. 5
Insurance and footnote 8 for a list of his subsidies.)
Banking (AMEX, Freddi, PNC, Wells Fargo)
Newspaper (Gannett, Washington Post, Buffalo
News)
Consumer goods (Gillette, Coco-Cola, Candy)
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• Efficient Market Hypothesis (EMH): V Prognosis
− People believing in EMH is like playing bridge Can Buffet maintain his stellar track record?
without looking at his cards. Would the GEICO purchase help Buffet in
− EMH: stock prices fully and quickly reflects all maintaining his record?
publicly available information
• The $70 bid price doesn’t appear unreasonable
⇒ Stock price is “fair”: equal to “intrinsic” value
given our estimate of intrinsic value. The
⇒ There are no bargains to be found in the market discount rate used, however, was 11%.
EMH does not deny a group of investors with
• What if we use BW’s historical return of 28%
superior information who earn abnormal returns
as discount rate?
on their information.
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T
• To get an IRR of 28%, GEICO’s share price in VI Summary
year 2000 should be about $228. See Excel • Estimate GEICO share price based on dividend
sheet. data and using PV.
• Is GEICO purchase a good or bad move? • Estimate investment performance of BW and
compare them with some benchmarks.
• Interpret stock price response to the
announcement of GEICO acquisition.
• Examine an example of good investment
philosophy.
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