Three Tables

Presented here are three tables comparing the value of Berkshire Hathaway with some of Buffett’s recent purchases. Also, included for the sake of comparisons are some of the stocks of Berkshire’s long term holdings. All three tables show Operating Income, the ratio of current operating earnings divided by the stock’s price as of July 1, 2007, the forward price earnings ratio on July 1, 2007, and the company’s growth rate for the 5 years ending June 30.

On Table One the stocks have sorted by the forward PE ratio, with the cheapest stock at the top of the list. On this basis Conoco Phillips is the cheapest with a PE of 8.4. Burlington Northern is about the middle of the list with a PE of a little over 15, and generally the stocks as a group appear reasonably priced if not cheap with about half of the list showing a PE of less than 15.  All of Buffett's recent buys carry a lower PE than the S&P 500, and keep in mind that the PE of S&P 500 is about half of what it was seven years ago.

For Table Two the stocks are sorted on the basis of their operating income divided by the per share price on July 1. This is sometimes a better indication of value than the PE ratio, because it is not as affected by one-time items and other games. By this measure the recent purchases appear even cheaper, with 16 out of the 27 stocks at or below Buffett’s preferred value of 10 times operating earnings or less. Looking at this list it is not hard to understand why Buffett has been able to spend $21.1 billion in new stock purchases since 2005.

Table Three sorts the stocks according to Annual earnings growth for the last five years. Note that the rate shown for Berkshire is actually for revenue growth not Earnings growth. The revenue figure was used because in 2001 Berkshire’s earnings were depressed by losses at the World Trade Center, so any comparison starting with that year gives an unrealistic growth rate for earnings. On this basis, Berkshire Places number three on this list in terms of the rate of growth.

The only companies showing more rapid earnings growth are USG with 78.3% and Conoco Phillips at 57%, two cyclical companies ridding the tail end of their growth cycle; neither of which is likely to be able to beat Berkshire’s growth rate long term. This leaves us with the impression that Berkshire will be able to sustain its growth at a higher rate the than the companies Buffett has been buying. As of the date that this table was prepared Berkshire was selling at 8.5 times operating earnings, and cheap as this appears it includes nothing for the operating earnings of Berkshire’s investees.

I did not try to estimate undistributed pre tax operating earnings of Berkshire’s investees, but the undistributed after tax earnings of Berkshire’s investees have been increasing rapidly in the last couple of years because of Buffett’s equity purchases. Last year this figure increased 33% to $1,222 per “A” share, and with another $9.1 billion in equity purchases in the first two quarters of 2007 the increase this year may be larger than in 2006. This $1,222 figure is after subtracting all dividends actually paid to Berkshire and includes only the undistributed, and after tax portion of investee earnings. If we add this figure to Berkshire’s after tax trailing 12 month earnings it drops the PE ratio to 12.9, and would result in a similar drop operating earnings ratio.

These tables help to explain Buffett’s recent purchases, the values are cheap particularly if you look at Operating Earnings, and in view of Buffett's stated preference for companies selling at 10 times operating earnings or less.

I do not think there is any question that Buffett’s recent purchases represent good traditional value, and that the current market represents a complete switch from the market of 2000 where large cap American companies were overvalued, and small cap American and all foreign stocks where undervalued, to one where pretty much the opposite is true.

For the value investor, a question remains, whether to buy the stocks that Buffett is buying or to add to positions in Berkshire where the value is as good as any of his recent purchases, and the growth potential is probably higher.

The advantage of adding to the Berkshire position is that you can participate in the best value sectors of the current market though Buffett’s purchases, but also benefit from the leverage added by Berkshire’s huge float, and receive the protection of the hedge provided by Berkshire’s cash position and Buffett’s derivative trading.

In view of the above, plus the fact that Berkshire's stock price has underperformed the S&P 500 in the last five years while the company's operating earnings have increased by 74% per year, leave me with no set of circumstances I can conceive of, where I could recommend the purchase on an index fund.