Berkshire Hathaway's Machine

If you believe recent commentaries, Berkshire Hathaway’s Warren Buffett – once considered one of the greatest investors in the world – is now “too old” for investing and is washed up, tired, and has lost his touch.  The people making these comments have clearly not taken the time to examine Berkshire’s financial statements!

In investing, timing is everything.  An undervalued investment can sometimes take months or years to begin rising in price; and, while waiting, returns will be stagnant.  Berkshire has found a way around this problem.  Berkshire is now so synonymous with safety and stability (and for being a good business partner) that it obtains exclusive deals – unavailable to anyone else - where it is actually paid to wait.

Take, for example, Berkshire’s investment in Bank of America.  BAC’s current share price is $7.07.  Berkshire bought preferred shares of BAC that earn 6%.  With this preferred share deal came warrants to purchase up to 700 million shares of BAC at $7.14 per share, and these warrants don’t expire until 2021.  In other words, any time between now and 2021, Berkshire can purchase BAC shares at $7.14 per share, even if the stock doubles or triples (or more).  While waiting, Berkshire earns 6% on the Preferred shares!

Berkshire has a similar deal with Dow Corporation.  Berkshire currently earns 8.5% on Dow Preferred Shares.  Berkshire can purchase up to 72.6 million shares of Dow at $41.32 per share with no expiry date, except the stipulation that Dow has the option to redeem the preferred shares when the stock attains stable prices of $53.72 or more!  Put more simply, this means that Berkshire will earn 8.5% from its investment in Dow for months or years, and then make at least $12.40 per share ($52.72-$41.32) when the Preferred shares are converted to common shares, for an additional profit of 900 million dollars.

Berkshire Hathaway is an incredible moneymaking machine...especially for those who have the luxury of time, and the patience to wait.

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"The most important attribute for success in value investing is patience, patience, and more patience.  The majority of investors do not possess this characteristic."

Peter Cundill

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Buffett and the Beautiful Banks

For months now, The Frost Report has been recommending the purchase of US bank stocks. For months now, US bank stocks have been dropping in price.

Earlier this week, Dick Bove of Rochdale Securities received a lot of heat after saying that people were “simply flipping out” about bank stocks, and that valuations were “ridiculous.” He pointed out, wisely, that although bank stock prices were falling, bonds prices were not.

Unlike stockholders, who tend to speculate, bondholders simply want the company to stay in business so they can collect interest and then get their money back. If a company is in danger of going bankrupt, bond prices drop. Yet, financial bond prices are holding steady, some even rising, showing that bondholders are not worried.

On Tuesday, billionaire Warren Buffett was at home taking a bath, thinking about how BofA was suffering confidence-wise and yet was solid financially. He called BofA and made them a win-win offer, and by Thursday morning (24 hours later) he owned 5 billion dollars worth of Bank of America, with warrants to purchase 700 million shares. When the news was released, BofA’s stock price rose 10% in a single day. Fortunately, I had loaded up on BofA stock just three days earlier, when it dropped after a string of rumor emails hit Wall Street claiming that the company was filing for bankruptcy.

US Banks are shouldered with large amounts of potential litigation (ie. they are being sued). They still own thousands of underwater mortgaged properties. Interest rate spreads are affecting bank profitability. Why would an investor with the stature of Warren Buffett be interested in buying bank stocks? Why would Berkshire Hathaway, Buffett’s company, be holding more than 40% of its total investments in the financial sector?

It’s simple. Great investors don’t care about rumors or fear, or whether the stock price is currently falling or rising – they just look at the facts. And, as a sound investment, the facts about banks are compelling. Bank of America is a perfect example:

Bank of America has a Mt. Everest balance sheet, with $140 billion in cash and more than twice that in securities. It actually has $13.86 in cash per share, yet the stock is trading at only $7.76. Put another way, for $7.76 you receive $13.86 in cash, $30 worth of securities, and a business that is gaining market share.

I have to admit, I have found the continuing drop in bank stocks to be both annoying (why are people still afraid?) and exciting (I can buy more!) at the same time.

Perhaps Buffett’s timely investment in Bank of America will finally make people see the light.


Update: On Monday Aug 29th, BofA announced it had successfully sold half of it's 10% stake in China Construction Bank, for a gross profit of 5.3 billion USD. A wise move if ever there was one.

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"A public-opinion poll is no substitute for thought."

Warren Buffett

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For more information, see:

Stock Market Flipping Out on US Banks

Buffett Bolsters Bank of America

BofA Sells Half of China Bank Stake, Raising $8 Billion

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