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In Search of Warren Wisdom, Part 3

Editor's Note: This is the last part in Jeff Bronchick's discussion of the Berkshire Hathaway (BRK.A) annual meeting. Part 1 appeared Monday, Part 2 Tuesday.

The Insurance Racket

Warren Buffett made it clear that he considers insurance a good business for Berkshire, but a generally lousy business for most middle-of-the-road insurance companies. He also made an interesting comment about acquisitions: He would rather have or acquire $20 billion of new "float" with a cost of 1% or 2% (meaning a combined ratio of 101 or 102) than he would $100 million of float generated by a combined ratio of 93. What's the "float?"

Float is, of course, the oldest temptation in the insurance industry: CEO's are infamous for saying "just another point of cost will get me x billion of float" until they are drowning in underwriting losses. While Berkshire will always have its own insurance problems from time to time, I don't think anyone is really sweating out that the problems stem from the greed to buy another dollar of business.

The D&B Opportunity

Berkshire Vice-Chairman Charlie Munger was unusually vocal about a holding of mine, Dun and Bradstreet (DNB), in which I believe Berkshire is up to nearly a 15% position. That's one of the largest percentages that I have ever seen Berkshire take in the past decade, and the reason is Moody's. Buffett and Munger talked about "buying business castles with the widest moats" -- the moat metaphor indicating an impregnable business position -- and it does seem that Moody's would be a lovely fit within the Berkshire financial empire. The credit reporting business was duly noted as a tougher piece to value, but in my humble valuation opinion, Moody's is worth $25 or so per Dun & Bradstreet share, leaving the core credit business valued at next to nothing. Go Berkshire.

In thinking back about the meeting, it was almost surreal to see how Buffett talked about his businesses, in contrast with the quarterly nonsense drill conducted by most management teams. So if the world is a competitive place -- and great ideas are repeated by others -- there seems to be a giant disconnect here: Many of the management practices of Berkshire are not adopted by the rest of corporate America, and in fact are going the other way.

Berkshire's Early Days

Buffett also related an interesting story as to how Berkshire was really founded and I don't think it is in any of the Buffett books. Berkshire was a cheap and dodgy textile company that used to tender for its stock regularly as part of a buyback. Buffett used to buy stock and then tender, making some nice arbitrage-like profits. The then-chairman of Berkshire asked at what price Buffett would sell his stock at tender, and Buffett came back to him with the answer: 11 3/8. Some time later, Berkshire announced a tender at 11 1/4.

Buffett took it personally. He didn't tender his stock, and instead bought more and eventually seized control of the company. Not a great investment decision -- but a fun story. Although he seems like a wonderful grandfather figure, he can clearly be tough. He also ripped the plastic wrapper off his post-lunch Dilly Bar fiercely with his teeth, sending a shiver through the crowd.

Buffett and Munger's snack tally for the meeting, incidentally, was two cherry Cokes, 2 Dilly Bars, and what had to be an entire box of peanut brittle.

My Recommendation

So was it fun and worth going to? A 100% "Yes." I look at it as the equivalent of going to see Babe Ruth play at Yankee stadium. You were stupid if you lived in New York, cared about baseball and didn't bother to go and see arguably the greatest practitioner of the sport.

See Also
A Personal Take on the Buffett Love-Fest

Did I really learn anything additional about Berkshire Hathaway and its investment merits? No. Was it intellectually helpful as a long-term value investor to sit for five hours, listen to The Boss, think about your own investment decisions, style, holdings, etc.? I think yes.

Am I going to go every year? No. I think it would begin to bore me to tears and frankly, buying jewelry at Borsheim's would kill me on an annual basis. Would I love to sit in a room with Buffett and Munger and a small group of informed shareholders and shoot the breeze about business? Sign me up.

So What's It Worth?

I still stick to my core valuation of roughly $54,000. Add to this the embedded value of the growth of a giant tax deferral and you get a stock that is somewhere around fair value at current levels.

But before I get a number of emails from the true believers, be aware; I've looked at the really high valuations generated by using the currently low discount rate and projecting 15% investment returns forever into the future on a portfolio that is less than 50% in stocks. My two cents is that they are too high. (Disagree? Shoot me an e-mail !)

You do have rock-solid protection on the downside given the fortress-like balance sheet. You also have the possibility of a very big stock if there truly ever is a major turn in insurance pricing. I think what is more likely is that Berkshire will be a steady compounding machine with mid-teens in annualized returns, which, if one's memory goes back a bit, should still be considered a pretty good investment.

Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Fund. At time of publication, RCB was long Berkshire Hathaway and Dun & Bradstreet, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at jbronchick@rcbinvest.com.

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