The next recovery should be almost ideal for Buffett's Berkshire Hathaway.
money.cnn.com
By Michael Sivy
NEW YORK (CNNmoney) - Achetez aux canons, vendez aux clairons -- Buy on the cannons, sell on the trumpets.
The old saying that investors should buy on the sound of cannon fire, often attributed to one of the Rothschilds, is actually a statement about risk, not about war. The real meaning is that investors undervalue stocks in times of danger and overvalue them in the celebration that follows victory. But it's also true that unless a military conflict turns into a complete fiasco, it's usually good for the stock market.
I'm certainly not going to try to predict the outcome of "America's New War," as CNN calls it. But the key elements are in place for a strong market rally starting sometime in the next few months. The Sept. 11th attacks pushed the economy into recession, caused multibillion-dollar losses for some industries and created a climate of enormous uncertainty. But all that is now fully reflected in today's deeply depressed stock prices.
The Federal Reserve's interest-rate cuts and the federal government's spending on rebuilding and defense will almost certainly stimulate the economy. And even partial progress in dismantling the terrorist network will greatly boost investor confidence, as long as there are no further major attacks.
Times change
The war on terrorism is different, however, from any previous war this country has fought. And the current bear market is like no other bear market. So before you start adding stocks to your portfolio, it's worth thinking about the precise ways that the stock market is likely to change over the next year or two.
For starters, I wouldn't necessarily start loading up on defense stocks, many of which have climbed to 52-week highs since Sept. 11. The long-term outlook for the industry is good, because defense spending is slated to rise -- but that was also true before the recent runup. If you want to buy these stocks, wait until they're not the focus of attention.
I think big, world-class tech stocks will rebound strongly once an economic recovery actually begins. But the market over the next 10 years won't be the same as that of the past decade. Non-tech growth stocks, like the ones superstar investor Warren Buffett owns, are likely to perform much better than they have over the past few years.
Berkshire Hathaway, Buffett's holding company, has all the qualities needed to prosper in this environment. Berkshire is an unusual entity, consisting of operating companies, large equity stakes in big-cap stocks and enormous holdings in bonds. Each of these three elements has to be considered separately.
What all of Berkshire's assets have in common is a minimal exposure to high technology. The operating companies include candy manufacturing, retailing and jewelry, but the most important are property and casualty insurers, particularly the reinsurer General Re.
Berkshire's insurance divisions will suffer a one-time loss of $2.2 billion from the attacks' damage. But the long-term effect of Sept. 11th will be to boost business for major reinsurers, companies that insure individual insurance companies that need to lay off some of their risk.
Buffett's holdings
Berkshire's stock portfolio is loaded up with financial and consumer products companies, including American Express, Coca-Cola, Gillette and Wells Fargo. Those are exactly the sorts of stocks likely to prosper in an economic recovery marked by low short-term interest rates. Buffett always said his investment style doesn't work very well in a tech-driven market, and Berkshire Hathaway's sales price is still below its 1998 high.
Now, however, it looks as though we're moving into a Warren Buffett market, where Berkshire could recover its historical growth rate of more than 20 percent a year. And in addition to high core growth and diversification, Buffett has another strength -- liquidity: Berkshire's balance sheet includes more than $38 billion in bonds and cash.
Buffett doesn't believe in splitting Berkshire (BRK.B: up $15.00 to $2415.00, Research, Estimates) stock, so a single share currently trades at $72,500. Fortunately, class B shares, equal to one-thirtieth of a regular share, go for a more reasonable $2,415.
Valuing Berkshire has always been extremely difficult because of the company's extensive stock and bond holdings. Those investments, however, are worth more than $40,000 per share. After allowing for other liquid assets, Berkshire's operating businesses are going for less than $30,000 per share. Excluding third-quarter insurance losses, Berkshire will have operating earnings of more than $1,000 a share this year and is projected to top $1,700 next year.
At the current price, Berkshire is trading at less than 20 times next year's projected operating earnings. A company with Berkshire's growth record could easily justify an operating P/E as high as 30.
So after deducting the value of Berkshire's stocks and bonds, the operating businesses are at least mildly undervalued. Moreover, a broad market recovery will substantially boost the value of Berkshire's investing holdings, giving investors a chance for a double play. |
