Today’s teaser is a pretty short one, from the Motley Fool for their flagship Stock Advisor newsletter, but most ads from the Fool make the Gumshoe faithful perk their ears up so we’re going to cover it quickly for you today.
And I think I’ve covered more teaser picks for Motley Fool Stock Advisor than for any other single newsletter over the past ten years… so who knows, maybe it will be something we already know. The spiel is similar to the past “double down” alerts we’ve seen from the Fool — they’ve long pointed out that when founding Fool brothers Dave and Tom Gardner re-recommend a stock, those stocks do exceptionally well… only this time, it’s a “triple down” because apparently Tom Gardner is now recommending a particular “millionaire maker” stock for a third time.
So what is it?
Here’s the intro from David Hanson, one of the Fool’s analysts:
“Not to alarm you but you’re about to miss an important and rare event.
“You see, renowned investor Tom Gardner (whose investing newsletter has been reported in The Wall Street Journal as one of the best in the world*) just pounded the table and issued a THIRD BUY ALERT for this ‘millionaire maker’ stock.”
And then we get our clues about the stock in question:
“The balance sheet of Tom’s latest pick is an absolute fortress (so you can sleep easily when you invest in this company)…it generated an astounding $17.7 billion in free cash flow over the last 12 months..
“Amazingly, according to a recent report from CNBC, more than 4 in 5 American investors are ignoring this ‘millionaire maker’ stock.
“And perhaps most incredible of all…
“This stock has minted millionaire after millionaire, yet it’s still shockingly inexpensive…
“It’s only trading at 1.36 times book value!”
OK — cheap valuation and strong free cash flow? That’s enough to get me interested. What is the stock?
Thinkolator sez this is our old friend, Berkshire Hathaway (BRK.B, or BRK.A if you’re a high roller).
Heard of that one? Yep, me too. I, too, have suggested Berkshire Hathaway many times, and have owned the stock since 2005 (and bought a bunch of times since then, most recently in March).
Berkshire is currently my largest individual equity position, now that Facebook (FB) shares have fallen a few percent, and it is, obviously, a well-known conglomerate and a headline generator every Spring as Warren Buffett summons his followers to Omaha for the Annual Meeting (I’ve gone the past two years, it’s an event worth experiencing). Buffett is everyone’s favorite avuncular billionaire, and a great example of the power of disciplined thinking and patience as he’s built up his business from a failing textile mill to become one of the largest companies in the world, with a market cap of about $350 billion.
What is there to know about Berkshire that you don’t already know? Well, it’s not really ignored by most investors — it’s a substantial part of the S&P 500 index these days, so most of us own at least a small taste (that wasn’t always true, it wasn’t added to the index until they split the stock back in 2010 to make the Burlington Northern acquisition possible).
Berkshire Hathaway is certainly not a high flier, and it’s not likely to dramatically outperform the market when the market is doing well. It has become a pretty widely diversified company, with major railroad and utility operations in addition to hundreds of relatively small businesses (See’s Candy, Fruit of the Loom, Justin Boots, etc.) and a huge stock portfolio (with Berkshire’s massive holdings in companies like Wells Fargo and Coca Cola that it has held for decades), though the foundation of it all is still the large insurance operation, headlined by GEICO but also including lots of other insurance companies. Insurance helps supply “free” cash that Buffett and his lieutenants can allocate among their investments, and the conglomerate structure enables them to move the cash generated by insurance and other operations to where it’s needed as their businesses require capital investment, or to feed it to the parent company to be invested in something new by Buffett or his relatively new investment managers.
So how does one evaluate Berkshire Hathaway? Well, there are many ways to assign a value to the stock… but there are two that I prefer.
Here’s what I wrote to the Irregulars back in March when I last added to my Berkshire stake — the numbers are from 2015, so they don’t include the update for the first quarter, but the difference from that quarter would be small (the Precision Castparts acquisition is complete now, cash and investments are down a bit, and earnings are up a bit — the price/book valuation is essentially identical):
I like to look at Berkshire Hathaway’s valuation in two ways — shorthand, by using book value and calling it a “buy” whenever it gets to 1.25X book value or lower, because there’s a very strong chance that Berkshire will do substantial share buybacks if the price gets down to 1.2X book value or below. Downside at valuations like this is limited, unless you believe that many of Berkshire’s businesses (railroad, utilities, industrial companies, major positions in publicly traded stocks) will fall substantially in value at the same time. Right now, the price/book valuation is about 1.35 as the stock has been moving up with the market, so I didn’t make a major move into more shares but did bump up my position a little bit.
And the other way to think about Berkshire’s valuation is a little bit more complicated, but not terribly so — you basically take the market value of all their publicly traded stock (leaving aside the inconvenience that Berkshire would have major tax obligations if they sold them all), and add the value of all of Berkshire’s fully owned companies by taking the earnings that Berkshire reports on those companies and applying some conservative PE ratio to those earnings.
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Berkshire’s cash and investments stood at $158 billion as of the end of 2015, of which $66 billion was funded by “float” that doesn’t actually belong to Berkshire. GAAP Accounting requires that this float be considered a liability, but free access to a rolling source of funds (from new policies and renewing policies that replace existing policies, at theoretically similar underwriting cost) is also, conceptually if not accounting-wise, an asset, particularly because Be