Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: jhg_in_kc who wrote (987)	1/11/1999 2:13:00 PM
From: Thomas M.	Read Replies (1) \| Respond to of 4691

forbes.com Buffett and Cheap Oil Don't Mix By Martin Sosnoff A GALLON OF GASOLINE is cheaper than a liter of Coca-Cola. This is bad news for Coke, bearish for Berkshire Hathaway, specifically, and generally a worldwide depressant. It doesn't help banks and brokers dealing in emerging market bonds, either. Oil below $10 a barrel is biting into Mexico, Venezuela, Indonesia and all the Middle East oil producers, also Norway. Their 1998 budgets were based on $17 oil. Ten-dollar oil spells deficits in the billions, weakening currencies and more geopolitical risk for everyone. It's hard to find even an energy security analyst who thinks an early recovery is in the cards. This is also bad news for Warren Buffett. Buffett stands today immobilized by his own successes in franchise-based equities like Coca-Cola, American Express, Geico, Washington Post Co., Disneyland and Gillette. Berkshire's equity portfolio, overweighted with almost $13 billion in Coca-Cola out of $31 billion in specified equities, underperformed the S&P 500 by 20 percentage points in 1998. Coke performed particularly poorly relative to other pricey securities, like Pfizer, Microsoft and Lucent, which virtually doubled in 1998 and are not so dependent on emerging markets. Unless you believe worldwide reflation is coming soon, it's hard to see 1999, either, as a vintage year for Berkshire Hathaway. There is a strategic problem with Berkshire's portfolio of insurance operating companies. After an eight-year bull market, the capital-to-surplus ratios of most fire-and-casualty underwriters is woefully underleveraged. Normally, the premium-to-surplus ratio for underwriters is closer to 2-to-1. Today it's almost 1-to-1. This has caused everyone to shave premium rates, but it is also topping out the investment income line, which is where the carriers make their money. The same goes for re- insurance worldwide. Gen Re runs a 1-to-1 premium-to-surplus ratio, with little growth on its premium revenue line. The company is too smart to take bigger risks for lower rates, and is determined to maintain its combined ratio of losses and expenses at 100 or below. Aside from capital gains on its portfolio, which is heavily weighted in bonds and municipals, earnings are flattening out. To get going, Buffett needs to make a timely entry into equities with as much as $10 billion to $15 billion of Gen Re's investment portfolio, plus $5 billion or more of Berkshire's cash. Where is he going to put the money in a market priced at 24 times forward 12-month earnings? Being fully invested regardless of price isn't Buffett's style. I like what he's doing with Geico. Going for market share against State Farm and Allstate makes sense. I can see Geico picking up market share points over the next three years, but only 15% of the total market is available for switching. Allstate retains over 90% of its customers with good service, and the industry's 15% that switches is not the highest-quality business. So Geico will grow its cash flow at 15% or better, but this will penalize near-term earnings. That's vintage Buffett: He'll take cash flow over earnings anytime. But put it all together and what do you have? Berkshire Hathaway as a stock peaked at $89,000 last year and trades closer to $60,000 currently. For Berkshire to see $89,000 again, Buffett's going to need the following: worldwide reflation to lift Coca-Cola; a chance to reinvest his cash, some $25 billion of Gen Re's portfolio and growth in Gen Re's premiums in a soft worldwide reinsurance market. All this suggests Buffett is likely to press for another big acquisition before long in order to get some growth. If Warren Buffett has to scramble to make money in these conditions, what does this say for the average investor? It says that if he or she owns 30-year zero Treasury bonds, he or she is in good shape for the new year.