Monday, February 06, 2006

Why I bought Berkshire Hathaway

Actually the question might be why I didn't buy Berkshire Hathaway earlier. After all Mr. Buffett's annual letters taught me how to value businesses and inspired me to try my hand at investing in individual stocks. The basic insurance business is one of the all-time great business models. Shortly after my wife started her Pampered Chef business, Berkshire bought the company. I've known about GEICO since long before it advertised in earnest. And of course, I'm a big fan of Dairy Queen and See's Candy.

But the strange array of assets that make up the company is a bit hard to value. Thankfully other people are interested in that question as well. A little while ago, I discovered the Berkshire Hathaway Intrinsivaluator. Of course, I've substituted a complicated set of models that I don't completely understand for a business that was complicated, but explained in relatively simple terms by Mr. Buffett. But the nice thing about the models is that we have an objective judgment that extends back through the years.

Currently, the models suggest that the shares are fairly cheap, but not at "cigar butt" level. And going back in time, the intrinsic value for the various models seems to grow by fits and starts. But the price jumps all over the place—far too cheap in 1981, over valued in 1996, and everywhere in between. Lots of times, the market seems to have a handle on the value as calculated by the models.

The real problem with an accurate evaluation, is the nature of the insurance contracts Berkshire writes. Someday there will be one or more super-catastrophes that could threaten the solvency of Berkshire Hathaway if it became undisciplined. In his 2002 letter, Mr. Buffett said, "Had Gen Re remained independent, the World Trade Center attack alone would have threatened the company's existence," in reference to a recently acquired reinsurance subsidiary. But unless and until such a disaster occurs, an insurance company can use the premiums it hasn't yet needed to pay claims (called float) to invest as it sees fit.

In some ways, investing in Berkshire Hathaway is like investing in a large and sucessful mutual fund. On the one hand, the past returns look outstanding. On the other, it becomes harder and harder to find good investments for the cash that keeps rolling in. Unlike a fund manager, Warren Buffett isn't restricted by investment style or SEC restrictions on funds. He may buy whole companies—even privately held companies. And so far, he's managed to get a good return.

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