Last Friday, Berkshire Hathaway announced plans to increase its investment in Chicago-based United States Gypsum (USG).  Berkshire will invest $300 million in USG convertible notes due 2018, with an $11.40 conversion price.  Fairfax Financial (FFH), a Canadian insurance company modeled on Berkshire Hathaway, will invest $100 million in this deal alongside Berkshire.

USG is a maker of wallboards, whose business has been impacted by the cyclical downtown in residential housing construction.  Berkshire first invested in USG when the company was in bankruptcy a few years ago due to asbestos related litigation.  USG placed money in a trust during these proceedings to cover any additional asbestos litigation and liabilities.  In addition, and unlike many companies in asbestos-related bankruptcy, USG’s management effectively restructured the company and invested in new plants and equipment, which one could argue gave it a cost advantage over its peers in the wallboard industry.  Basic competitive analysis suggested that as the cyclical downturn in residential construction intensified, USG’s higher cost competitors would have been forced out of the market, allowing USG to gain share.  While this may or may not be happening today (I would argue it is happening), the residential construction downturn has been so severe, that even USG had to go back to the well for more money.  It’s fortuitous that they had a partner like Berkshire that was able to put up the cash.  And for Berkshire, the terms of the deal seem like they will be somewhat favorable over the long haul.

I’ve been familiar with the other investor in the USG deal, Fairfax Financial, for years.  Fairfax is a Canadian insurance company that was modeled on Berkshire Hathaway and founded by Prem Watsa, who is often referred to as the “Warren Buffett of the North” due to his impressive long-term track record of investing.  Fairfax has been in the news a lot lately--and even Warren Buffett referred to them during the last Berkshire Hathaway shareholders meeting--as Prem correctly anticipated a blow-up in the structured finance markets, and took opposing credit default swap (CDS) positions a few years ago, that have paid-off handsomely for Fairfax shareholders.  In addition to its CDS positions, Fairfax had S&P 500 puts to hedge is equity portfolio, which I’m sure have also shown nice profits in today’s panicked market environment. Given these moves, and as Fairfax slowly realizes the gains from these positions, the Canadian insurance company could be flush with cash to make a bevy of new investments, such as its position in USG.

Please send along any questions or comments you may have.  My best wishes to you and your family for a happy and safe Thanksgiving holiday.

Justin

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author. 

A friend of mine recently emailed me an article that conjectured that the practice of value investing was going the way of the horse and buggy (and as I write, perhaps the auto makers too) because of the prevalence of “value traps” in the market.  To be sure, many investors have lost money on companies that they thought were great values.  Some companies went bankrupt, the federal government nationalized some firms, some companies are still afloat, but equity holders have been all but wiped out due to the continual dilution from capital raises.  While many of the former are incredibly extraordinary events, other very well run companies have only had their shares prices decline in the short term.

As value investors—and in this sense I write of a community of investors—we use the market to serve us, rather than instruct us.  Furthermore, as Warren Buffett and his mentor Ben Graham indicated, just because a stock price rises or declines, it doesn’t necessarily determine if you are right or wrong on an investment decision.  Rather, it is your analysis of the facts of the company or industry that will ultimately prove whether you have made a wise or poor investment choice over time.

In this current market panic, however, almost any investment decision (other than holding cash) appears to have been a poor decision in the short term.  Would investors who determined a few months ago that a company with several competitive strengths, good growth prospects, and no significant financing risk with a stock price that was trading at valuations not seen in over a decade be a good buy?  The answer is yes.  Would they also have waited to start their buying if they knew that the share price—which was already very low—would drop another 40%?  The answer again is a resounding yes!  Just because the stock price dropped another 40% in two weeks, doesn’t necessarily indicate a poor investment decision.  In fact, perhaps the long-term investment option is even more attractively priced now, and it behooves those investors to opportunistically add to their holdings at lower prices, if they have the cash available to do so.

The fallacy is that the perception of value investors is that if they can’t call the bottom of a stock or a market, they’re wrong.  Even Warren Buffett—perhaps the greatest investor of our time—wrote in his recent New York Times op-ed piece (and I paraphrase here) that he has no idea where the stock market is going to be in the next month or year, but that he sees long term value in the prices of businesses being offered by the market today.  And, to me at least, that really sums up what value investing is all about.  It’s not about calling market bottoms, but it's about buying good companies at reasonable (today they might be great) prices, and holding them for the long-term.

Let me end this post with a final thought.  The great majority of people seem to think that value investing is only a subset of the investment world, and that there are all of these other types or styles of investing out there.  I propose, on the other hand, that all investing is value investing.  Value investing is purchasing businesses, securities, or other assets at prices below what they are really worth.  Why would you want to pay more for something than it is worth?

Just as classic value investors buy companies trading below net asset value, so do they buy growth companies with share prices that don’t reflect the value of the growth these companies are likely to achieve.  Value investors also buy income-producing securities, where the yield is both safe and greater than an investor can get in other instruments or securities. 

To me, at least, value investors look at the world as a set of opportunity costs, and determine where the best set of opportunities are to invest over the long-term.  It seems reasonable to conclude that value investing is a process and philosophy of evaluating the economic world, rather than just a narrowly defined investment style, as so many of today’s pundits and financial professionals would have you believe. 

I welcome dialogue with my readers, so please send me any questions or comments you may have.

Justin

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author. 

Each quarter investment conglomerate Berkshire Hathaway releases its form 13-F, which details its equity holdings.  Berkshire’s stock portfolios are managed by Chairman Warren Buffett, as well as Lou Simpson, who manages subsidiary Geico’s portfolio.  It should be noted that this filing does not include Berkshire’s international stock holdings.  In addition, it is also noteworthy that Berkshire receives exemptions from the SEC to delay the holdings of some of the stocks it is buying, in order to avoid other investors from trying to front-run the firm.  Therefore, it is possible that Berkshire could still be buying some stocks that it has yet to disclose.

The last quarter has been a busy one for Berkshire on several fronts.  Berkshire has been busy buying a lot of bonds, making acquisitions, and also taking new equity positions.  As I detailed in my analysis of Berkshire’s third quarter results below Berkshire was buying Federal Home Loan Bank discount notes as well as auction rate securities on the fixed income side.  On the acquisition front, Berkshire made a deal for Constellation Energy, at what look like very favorable terms. 

New and Augmented Equity Positions

During the third quarter, Berkshire released that it has significantly increased its stake in integrated oil company Conoco Phillips (COP).  Conoco has been a long-time holding of Berkshire, and over the past year, Berkshire has upped its stake to almost 6% of the company.  Conoco appears to be an efficiently run energy company, with several lines of business.  Given the precipitous drop in oil prices, and similarly Conoco’s share price, it isn’t overly surprising that Berkshire significantly added to it stake.

Berkshire also released that it has a new position in Cleveland-based Eaton Corporation (ETN).  Eaton is a manufacturer of electrical equipment, which supplies these products to utilities and other electric generation businesses.  Given Berkshire’s involvement in the utilities business via Mid-American energy, it was likely very familiar with this firm.  What’s more, given the focus on developing alternative sources of energy in the world today, it’s not too far of a stretch to believe that Eaton could be a benefactor of this push.

Berkshire also increased its stake in NRG Energy (NRG) this quarter.  NRG was a company that Berkshire started buying earlier in the year, and is yet another energy related holding of the conglomerate.  NRG focuses on the construction and operation of power generation facilities.

Berkshire also increased its stake in US Bancorp (USB), which is one of the most conservatively run banks in the country, and whose stock price has held up relatively well amid all the volatility in financial stocks. 

Additional positions that were not disclosed in Berkshire’s 13-F, were its augmented stake in Burlington Northern Railroad (BNI), which Berkshire disclosed on October 28, and I detailed in my blog posting below.  Also during October, Berkshire added preferred shares of General Electric (GE) and Goldman Sachs (GS).  As I noted in a previously, Berkshire also received warrants to purchase equity stakes in each of these companies.

Reduced Positions

Berkshire also reduced its stake in several companies this quarter, significantly trimming its stake in Bank of America (BAC), Carmax (KMX), Home Depot (HD),  and Lowes (LOW).  Given the cyclical downturn in both housing and autos, it isn’t overly surprising that Berkshire may have re-allocated capital away from these industries.  As for Bank of America, it is digesting both the acquisitions of Countrywide Financial as well as Merrill Lynch.  Although Bank of America is one of the best integrators of acquired companies around, digesting these two impaired financial firms could present some bumps.

Berkshire also very modestly trimmed its positions in United Healthcare (UNH), Wellpoint (WLP), and Wells Fargo (WFC).  Each of these reductions was very minimal, and I’ll note that Wells Fargo has been a longtime holding of Berkshire.

Unchanged Positions

Berkshire’s unchanged positions include:
•    American Express (AXP)
•    Anheuser Bush (BUD)—which is scheduled to be bought by InBev.
•    Coca-Cola (KO)
•    Comcast (CMCSA)
•    Costo (COST)
•    Gannett (GCI)
•    General Electric (GE)—not including the preferred deal in October.
•    GlaxoSmithKline (GSK)
•    Ingersoll-Rand (IR)
•    Iron Mountain (IRM)
•    Johnson & Johnson (JNJ)
•    Kraft (KFT)
•    M&T Bank (MTB)
•    Moody’s (MCO)
•    Nike (NKE)
•    Norfolk Southern (NFS)
•    Proctor & Gamble (PG)
•    Sanofi-Aventis (SNY)
•    SunTrust Banks (STI)
•    Torchmark (TMK)
•    United States Gypsum (USG)
•    Union Pacific (UNP)
•    United Parcel Service (UPS)
•    Wabco Holdings (WBC)
•    Wal-Mart (WMT)
•    Washington Post (POST)
•    Wesco Financial (WSC)—Berkshire’s 80% owned subsidiary.
 

Mr. Buffett also indicated last month that for his personal account he has been buying American stocks, and it is evident that he has clearly been doing the same for Berkshire’s portfolio.  I view each of these actions as a bullish sign for the both patient and long-term investor.

Justin 

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author.

After the market closes today, Berkshire Hathaway is scheduled to release its form 13-F, which details the conglomerate's equity holdings through September 30, 2008.  Given Berkshire's purchase of $9.5 billion of equity securities through September 30, which was detailed in the conglomerate's quarterly report last week, it will be interesting to see what positions Berkshire has augmented, and if there are any new positions revealed.  Earlier this month, Mr. Buffett wrote an op-ed piece in the New York Times, where he indicated why he is bullish on American stocks today.  Very infrequently over his career has Mr. Buffett publicly indicated his investment views, yet the times that he has voiced his opinion, it has generally been a contrarian viewpoint in the market.   But more importantly, these investment viewpoints have ultimately proved to be correct over time.  Given the enormous dislocations in the market today, it wouldn't seem unreasonable to think that Berkshire may have picked up shares in some very high quality companies with durable competitive advantages.

Check back on www.buffettologist.com later tonight for an updated analysis of the Berkshire Hathaway Portfolio.

Justin

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author. 

Investment conglomerate Berkshire Hathaway reported third quarter earnings on Friday, which were a bit of a mixed bag.  In aggregate Berkshire’s insurance businesses had lower earnings due in part to around $1 billion of hurricane losses in 2008, and also as a result of fewer new insurance policies.  To that end, Berkshire’s premiums declined about 25% this year, which was almost entirely from lower premiums in the Berkshire Hathaway Reinsurance Group.  This unit typically concentrates on writing policies with infrequent, but potentially high severity losses. In the other insurance businesses, premiums were basically flat, though auto-insurer Geico did manage to grow its topline by about 5%.

In Berkshire’s many other businesses, results were also mixed.  For example, in Shaw—Berkshire’s carpet business—revenues remained lower thanks to continued weakness in the residential construction and home improvement markets.  Several of Berkshire’s other retailing and manufacturing businesses experienced weakness, which is not overly surprising given the slowdown in economic activity.  One stronger area was the utility sector where Mid-American energy grew earnings by 9% during the quarter.

On the investing and acquisition front, Berkshire was very busy.  On the fixed income side, Berkshire made $32 billion of new purchases, some of which was likely due to sales and maturities of other fixed income securities that needed to be reinvested.  Of this amount, though, $1.7 billion was put into short-term FHLB (Federal Home Loan Bank) discount notes, and another $3.2 billion was invested in relatively short-term auction rate securities.  Berkshire put about $9.5 billion into equities, which does not include the conglomerate’s recent investments in Goldman Sachs and General Electric.  These numbers also do not include the closing of Berkshire’s $6.5 billion financing of Mars’ acquisition of Wrigley, which closed in early October.  Nor does it include Berkshire’s $65 million purchase of more Burlington Northern (BNI) stock in late October.

As such, Berkshire’s $28 billion reported cash balance would have to be adjusted by the $6.5 billion Wrigley deal, and the combined $8.1 billion it committed Goldman, GE, and Burlington Northern.  Thus, Berkshire’s cash balance after these investments looks like it is around $13 billion, which is significant because Berkshire typically keeps around $10 billion of cash on hand for insurance regulatory purposes.  It is further significant because Berkshire has committed about $3 billion to help Dow Chemical finance its Rohm & Hass acquisition, and has also committed $4.7 billion for its Mid-American subsidiary to purchase Constellation Energy.  Even, though I’ll note that Berkshire generates cash fairly quickly—at least in its insurance businesses--I think it is also reasonable to opine, that Berkshire is almost fully invested today.  What’s more, it is likely planting some great investment seeds for the future.

On the topic of investment seeds for the future, it also appears as though one of the investment managers that Berkshire indicated it had identified to eventually take the reins, could potentially be already working with the company.  Berkshire’s 10-Q report indicated that all portfolios are managed by Warren Buffett, except for some portfolios at Geico and General Re.  Lou Simpson has long been the manager at Geico, so it could be possible that there is perhaps a new manager handling a part of the General Re portfolio.  The filing didn’t give any guidance, but it could be an interesting note about the eventual succession plans at the company.

Finally, Berkshire’s earnings were impacted by some losses on its derivatives portfolio.  Berkshire’s derivatives portfolio consists of a basket of equity index put options and some credit default swaps.  On the former, they are held to maturity, and won’t come due for more than 13 years.  On the latter, a credit default swap is essentially an insurance contract, and given this, Berkshire gets the cash for writing these upfront.  That means that there is effectively no credit risk to these derivatives, and that Berkshire can also invest the “premiums” for its own account until an event triggers the contract or it eventually expires.  What is more, it is interesting to note that Berkshire recently wrote some more credit default swaps which expire in 2013.  Given that prices for credit protection were likely very high over the last couple of months, its not surprising that Berkshire became a player in this market.

All in all, it was an interesting—there was a lot going on—but mixed quarter for Berkshire.  It was clear to me at least, though, that Mr. Buffett was very busy trying to plant investment seeds for the future.

Justin

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author.

While most of you are familiar with Berkshire Hathaway, a less well-known insurance company that was modeled on Berkshire Hathaway reported earnings today.  Richmond, Va. based Markel (MKL) is a specialty insurance company with a very attractive long-term track record of creating wealth for owners.  Over its more than 25 year life as a public company, Markel's growth in book value per share has, on average, exceeded 20% per year---truly outstanding results.

How does Markel do it, you might ask?  Like any great business or idea, Markel's approach is simple.  It underwrites insurance policies with incentives in place to ensure that it will make an underwriting profit in most years, and then it invests these insurance premiums in both bonds and stocks that are held for the long term.

If this sounds like such a simple strategy, why is it that so few companies are successful at executing it?   Put bluntly, pursuing a strategy like this requires patience, discipline, and emotional stability in all market environments.  And unfortunately, these are qualities that most management teams just don't seem to have, or perhaps more kindly, they just don't operate under an incentive structure that encourages this behavior.

Markel’s managers, on the other hand, are owners of the business.  Each of them has a substantial component of their net wealth in the stock of the company.  As such, they are compelled to act prudently, to not mortgage the farm on any one idea, and to think long-term. 

As for this quarter’s earnings, like most financial companies, Markel’s results this quarter were marred by losses from this year’s hurricanes as well as write-downs on some of the stocks and bonds in Markel’s investment portfolio.  While it’s never pleasing to see hurricane losses, it is bound to happen from time to time, and it is part of Markel’s business.  And even with the hurricane losses, Markel’s combined ratio through the first nine months of the year was still only 104%, which is a far cry from the 88% last year, but still not bad given the losses.  In addition, Markel also took losses on its investment portfolio which helped to cause book value to fall 11% to $235.72 per share.

Given these dismal results--at least by Markel standards--it’s easy feel uneasy about the long-term prospects of the company. And perhaps this is the appropriate feeling to have.  That said, if one also considers that the financial meltdown of the past few months has depleted capital from the insurance industry, pricing could increase, which would improve Markel’s underwriting results.  In addition, one could also argue that Markel holds a bevy of undervalued securities in its equity portfolio that could improve in value over time.  Taken together, these factors could make Markel an intriguing idea for the long-term.

Justin

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way.  This content is intended solely for the entertainment of the reader, and the author.