NEW YORK (
) -- There's nothing that Warren Buffett and his right hand man Charlie Munger despise more than short-term thinking about
shares. But then they shouldn't have flooded the market with the Berkshire "Baby Bs" taking Berkshire Hathaway and $100,000 Class A shares down to the level of the speculative masses.
For investors who first dabbled in Berkshire shares in the past few years, it hasn't been all that memorable. There was a big pop when Berkshire's Baby B explosion led to the stock being included in the
in early 2010, leading shares up near the $84 mark, and Berkshire was able to pass that mark early in 2011 before the markets slumped. Since then, it's been tough sledding. Berkshire has trailed the S&P 500 (through Dec. 20, down 4.6% versus an S&P 500 decline of 1.3% this year). Of course, Buffett would be the first to tell you (ad nauseum, too) that it gets harder and harder to beat the index. In fact, as he famously said earlier this year in his latest famous remark, he and his "elephant gun" are currently out searching for ways to do so.
Warren Buffett hates short-term thinking about Berkshire Hathaway shares, so others will do it for him.
Will it be the elephant gun effect in 2012, with a mega acquisition boosting Berkshire shares? There's reason to think Berkshire Hathaway shares could receive some kind of bump in 2012, putting to the side the overall global macroeconomic environment. There's more than one reason specific to the company, too, and
gathered the views of a diverse group of Berkshire Hathaway watchers to turn the tables on the Oracle of Omaha and forecast the future for his company.
The three Berkshire watchers chosen were selected because each represents a very different view of the company.
The Skeptic: Meyer Shields, Stifel analyst
Shields is the only Wall Street analyst to not rate Berkshire a buy -- he is at a hold -- (and maybe not coincidentally, the only Wall Street analyst not invited to ask Buffett questions at the 2012 annual meeting of Berkshire shareholders, the first time analysts are being afforded that privilege to muscle in on the territory of
The New York Times'
Andrew Ross Sorkin, and
Carol Loomis). Shields sees another subpar year for Berkshire in 2012, but he gave us his view on factors that could make him wrong about Berkshire being a disappointment in 2012.
The Optimist: David Rolfe, chief investment officer, Wedgewood Partners
Private wealth and mutual fund manager Wedgewood Partners only holds 20 stocks, and counts both
and Berkshire Hathaway among its holdings. The darling of the growth world and the bastion of the stock market ultra-conservative in one fund? Hard to believe? What may be even harder to believe is that Rolfe believes there is potential for a short-term pop in Berkshire shares in 2012. That kind of thinking could get Buffett to revoke Rolfe's right to own Berkshire shares.
The True Believer: Paul Lountzis, president, Lountzis Asset Management
Long-time Berkshire Hathaway shareholder Lountzis despises short-term thinking about Berkshire shares about as much as Buffett, and he weighed in on why one shouldn't weigh in on the outlook for Berkshire in 2012.
And speaking of short-term thinking: "Look at the share price history. The 'Buffett discount' only got a bump when the S&P 500 inclusion occurred. We sold a bunch into the S&P pop and then shares didn't do anything for a year. Buffett, more than anything, suffers from benign neglect," Rolfe remarked. So will 2012 be another year of market neglect or unexpected share price pop for Berkshire?
Read on to see if there will be some bang from Berkshire Hathaway shares in the opinion of the skeptic, the optimist, and the true believer.
Stifel's Meyer Shields is the skeptic. He expects another year in which Berkshire Hathaway fails to outduel the S&P 500, but the analyst did provide three short-term market factors that could upend his losing outlook for Buffett.
A domestic housing recovery.
So much of Berkshire's operations relate to housing (bricks, paint, carpets, real estate brokerage ... and that's just the beginning), that a rapid improvement would be a major positive for earnings.
Now, what's the likelihood of a major housing rebound? On Tuesday, Dec. 20, the markets expressed optimism about the housing starts rise of 9.3% in November, but the reality -- that this rise was a sign of the increase in renters and multi-family housing rather than in single family homes -- quickly threw some cold water on the excitement. On Wednesday, Dec. 21, the National Association of Realtors said sales of existing homes increased 4% from October to an annual rate of 4.42 million units. The seven-month supply of existing homes reflected in the sales pace represented the lowest since February 2007, and a sign that inventory is clearing, if slowly.
Shields, who as an insurance analyst is the first to admit he is no housing expert, didn't rate the chances of a big housing rebound highly. "I haven't heard any of our in-house guys expect dramatic improvement any time soon."
Loan loss reserves surprise
Sticking to his insurance guns, Shields thinks that a more likely short-term driver for Berkshire outperformance would be if Buffett's conservative approach to loan loss reserves turns out to be overly conservative.
"If prior-period commercial insurance and reinsurance loss reserve releases prove to be better than Berkshire's historical record implies they will, the earnings outlook would also significantly improve," Shields noted. And he thinks there's a decent chance of the reserves playing out better than expected (say, a roughly 20% chance).
Equity markets, derivative swings, stabilize
Any investor who pays attention to the quarterly results from Berkshire knows that in any given earnings report there can be a $2 billion gain, or loss, in the value of equity derivatives, especially with the recent wild market swings.
As a result, equity market recovery and stabilization could allow Berkshire to undo relatively painlessly the derivatives that Shields thinks have contributed so much to the stock's volatility since 2009.
Buffett has always stressed that when it comes to derivatives, the fluctuations in value don't matter in the long-term. They do matter to the market in the near-term, though, said Shields, and projecting that market reaction is his job as an analyst.
"If all of the relevant indices rose by, say, 25% in 2012, and Buffett unwound the derivatives positions completely, then I'd be more positive on the shares because they'd be less volatile, with a lower cost of capital, and therefore a higher valuation. I don't think it's likely," Shields said, but it is a wildcard factor.
Indeed, lots of unlikely wildcard factors that Shields outlined as being potential drivers for Berkshire to outperform the S&P, and with "unlikely" being the key word, it's another index tracking year for Buffett in the opinion of the Stifel analyst.
Buffett's elephant gun may be loaded, but for Wedgewood's Rolfe, the optimist, it won't necessarily take a big hunting trophy to move shares in 2012. In fact, if a mega-acquisition isn't on the horizon, the fund manager is looking for a major share repurchase by Berkshire to boost earnings per share.
One of the biggest Buffett announcements in 2011 was that Berkshire will consider buybacks when its shares are trading at a significant discount to intrinsic value. In the last quarter, though, the buyback activity was so minimal as to be non-existent, and that was a disappointment to some investors given the high-profile announcement.
"He bought about as much stock as his monthly steak bill," Rolfe said. That's why Rolfe has positioned 2012 as the big buy or big buyback year for Buffett: If the Oracle doesn't announce a big acquisition early in 2012, Rolfe will be expecting significant buyback activity, and that will move shares higher.
The Berkshire philosophy implies a love of cash and Buffett likes to paint a broad canvas and buy stocks, bonds and business, and the reality is that the math of buybacks makes it hard for Berkshire to boost the shares, Rolfe noted. Now, with two new hedge fund managers, Todd Combs and Ted Weschler, on board, there's probably also new requests for some of the cash hoard and great stock ideas to pile it all into. However, the hunting field is getting too small to move the needle in terms of stocks and acquisitions, and that's why Rolfe believes a big buyback would be a significant lever in 2012, especially given a macro environment that could continue to weigh on shares.
"It would be a nice surprise if he bought a bunch of stock back," Rolfe said. Berkshire as a company is generating $1 billion per month in cash and the five largest operating companies within the Berkshire enterprise will all set records for earnings this year, according to recent commentary from Buffett, with $9 billion in pretax earnings.
This cash machine and the lack of buyback activity as of yet stokes Rolfe's hopes that it's about to happen, or already is: "I hope buy orders are going in now. Buying stock here is significantly accretive," Rolfe said. He added, "It's either the elephant gun cocked on Berkshire shares or a buyback. Berkshire could be its own best acquisition in 2012, and if neither happens, then I'm disappointed. I say, 'Buy by the bucketful, not thimbleful.'"
Rolfe chimed in on some of the other potential short-term drivers for Berkshire, too, which reinforce his belief that a major buyback is the best hope for a boost in 2012.
: Simply moribund. There is so much inventory out there that it's a "thank God" situation that Berkshire has diversified enough now to the point where housing can't move the needle. Rolfe said it's better to focus on the growth in the railroad market in the next few years as a way to forget about how bad the situation in housing could remain. "Thank God Burlington is part of the mix," he said.
: Rolfe said the use of derivatives by Berkshire has been a thorn in the side of investors like him.
"It is what it is, but with all the volatility of this period we are in it would be nice if the earnings were clean, where we wouldn't have to say 'By the way, derivatives ... don't put weight in them.'" Rolfe added that most investors can look past the quarter- to-quarter swings, but it's still an issue of market perception.
Loan loss reserve positive surprise
: Buffet is a broken record on reserves, and if somehow Berkshire has over-reserved, it's not something an investor can model. "It would be a pleasant surprise and the philosophy of Buffet is to be Scrooge-like conservative in this area, but most surprises in the insurance business are negative," Rolfe said.
The mere suggestion to long-time Berkshire Hathaway shareholder and true believer Lountzis that there are short-term drivers for Buffett's business worth paying attention to set off a chain reaction and counter-stream of Buffett philosophy rivaling any length that Ayn Rand went to in espousing her ideas, and ideals.
Housing. Buybacks. Derivatives. Loan loss reserves. Any of these issues could certainly impact Berkshire's stock price next year, or any year, according to Lountzis, but the bigger question is Berkshire over the next two decades.
Nevertheless, he was willing to provide a little color on these topics for the Berkshire Hathaway investor.
: The derivatives exposure at Berkshire is not well understood by most investors, in Lountzis' opinion. Berkshire has no counter-party risk unlike most derivatives as the payment is made in advance when the contracts began. In typical Berkshire fashion, risk is reduced as the obligations have been put up ahead of time and Berkshire has use of the funds for as long as the contract runs. At year-end 2010, Berkshire had $4.2 billion of derivatives float to invest. The derivatives do create volatility in Berkshire's quarterly results but for investors that understand them it should not be a meaningful concern.
Would an equity market recovery help the quarterly volatility that has been a negative with the derivatives portfolio? Yes, but that is not a core focus for Lountzis and should not be for investors.
"The derivatives will work out fine over time," he said. "Risk is always present but I feel very comfortable that they will work out well over the life of the contracts. This is not where I am focused on Berkshire's value creation."
: Lountzis speculates that housing could begin to turn when new housing starts start rise closer to 800,000 to 1 million, up from 400,000 to 500,000 that has been more typical lately (in November the number was 685,000, though multi-family was the driver; single family starts was at 443,000).
"When that will happen I have no idea but that would certainly help
, real estate brokerage, the furniture companies and some of the companies in the
to post far better results," Lountzis said. But even if a housing rebound doesn't happen soon, Lountzis said that given Berkshire's financial strength now is a time for each of these businesses to continue to invest when appropriate for the hopeful inevitable recovery. "Perhaps bolt-on acquisitions are available as many competitors are stressed and lack the financial strength to survive," he said.
Loan loss reserves
: Another short term focus, and while it's accurate to say that it could drive short-term performance investors should not ascribe great value to the loss reserve releases over short periods. "They could have a meaningful impact in any given year, but I view loss reserves over long periods of time seeking companies that have done a conservative and solid job over decades," the Berkshire investor said.
What issues should Berkshire investors pay attention to, in the opinion of Lountzis?
The much-discussed anchor of size and how Buffett will continue to move the needle with both private and public investments going forward.
Forget about the Buffett succession risk for a moment:
The purchase of private, often family-run businesses with which Buffett has made deals, many from decades ago, creates an important issue to monitor in years to come: How management succession is handled in each subsidiary company if no family member or team is in place to provide continuity.
Growing operating earnings
The best opportunities for Berkshire are to continue to grow its operating earnings from the stable of owned businesses and continuing to add to those over the next two decades. Purchasing bolt-on acquisitions for existing companies and finding new investments around the globe that would fit into the Berkshire family.
The Combs and Weschler hires were great additions in 2011, but simply cannot move the needle for a company like Berkshire, Lountzis said. "The more Berkshire can continue to build long-term earnings power that is predictable and growing the better it will be reflected in the stock price over time. Many of Berkshire's results -- reinsurance, one-off deals, public stock investments, the derivatives investments -- are variable and the results can be large additions or reductions in any given year.
"The long term earning power of the diverse companies he owns is what I believe will continue to drive Berkshire forward and the stronger, more predictable and growing those earnings streams are the better for Berkshire in the decades ahead," Lountzis said.
Spoken like a true Berkshire investor.
-- Written by Eric Rosenbaum from New York.
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