Tuesday, January 30, 2007

A Reminder on American Express

I thought it would be a good time to remind readers what Joel Greenblatt had to say about American Express (AXP) last summer. Although I haven't done the valuation work yet and thus haven't invested in AXP, there are 2 things I do know: (1) American Express is one of the few really great businesses in the world; and (2) Joel Greenblatt is one of the greatest investors in the world.

At the Ira W. Sohn Investment Research Conference last year, Mr. Greenblatt presented his investment thesis for American Express. He stated that he believed the company would earn between $3.70 and $3.75 per share in 2008 and is conservatively worth 20-22 times earnings. That would give a share price 2 years out of mid-$70s to low-$80s. He also mentioned the fact that American Express only has to reinvest about 25% of its earnings for growth, so they get to give shareholders back 75% of their earnings, either through stock buybacks or dividends.

So, although AXP is up from the $51-$52 share price last summer, the recent pullback and current price of about $58 per share certainly looks like something worth taking a further look, especially since AXP is still growing its intrinsic value at a very attractive rate. Afterall, the earnings yield is pretty close to the risk free rate and if that is anywhere close to your opportunity cost, which one would you rather own?

*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.

Monday, January 29, 2007

So, What's Berkshire Worth Anyway?

It seems to be pretty clear to most value investors that Berkshire Hathaway is a bargain. But, how big of a bargain is it and how much can we expect to make over the next few years by purchasing a stake in Warren Buffett's masterpiece today?

I view the value of Berkshire as consisting of 2 parts: (1) the investments per share (which includes a massive amount of cash on hand and also includes part ownership of some of the best businesses in the world -- Coca-Cola, American Express, Washington Post, etc.), and (2) the value of the operating businesses.

So what are the 2 parts worth? Total cash and investments per share should be a little over $80,000 per share at the end of 2006, so we'll value these at the market value of $80,000. Now, pre-tax income is going to be very good in 2006 because there was very little hurricane activity. Since we are going to be putting a multiple on these earnings, it is necessary that we normalize them. If we assume that 2004 was a normal year, which I feel is conservative because this was the second worst year ever (after 2005) for hurricane losses, then normalized earnings this year should still be about $5,000 per share. So what is a conservative multiple for these earnings? I think considering the quality of the businesses producing these earnings and the current interest rate environment, a 12 multiple on the pre-tax earnings is a safe number, especially since Berkshrire is still one of the fastest growing large caps in the world. So $80,000 in investments per share + ($5,000*12) = $140,000 value per A share ($4,667 per B share).

So, if we assume investments per share grow at an average rate of 8% over the next 3 years and operating earnings grow at an average rate of 10% over the next 3-5 years (both of which I feel are very conservative -- but remember, Berkshire's growth can be a little lumpy), then we get a value 3 years out of about $180,000 per share and 5 years out of about $215,000 per share. This would yield an annual rate of return of about 15-20% per year over the next 3-5 years by purchasing shares around today's price of $108,000 per A share ($3,600 per B share).

What's the best part about this investment? No, it's not that you are getting a very attractive return and the chance to buy into a business with huge competitive advantages and a rock-solid balance sheet at a 20-30% discount to intrinsic value (although that is very nice). The best part about this investment is that you are getting that 20-30% discount without having to pay a penny in premium for the capital allocating ability of Warren Buffett. You're getting a great business, at a very good price, and you're getting "The Great One" for free.

*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.

Friday, January 26, 2007

What will this blog be about?

I suppose a logical first post on a blog would be to describe the general direction it will take. So, what will this blog be about? Will it be about investing? Of course. Will it be about value investing? Of course. Will it include a whole lot of other stuff of which I currently have no idea what that other stuff might be? Most definitely.

I hope, above all else, that this blog will represent rationality. I will ask many questions about many things and answer those in which I believe I can provide rational answers. I will discuss some of my investment ideas and research and anything else that may be of interest to me at the time. Most importantly, I will always be open to being proven wrong and to being introduced to new, better ways of thinking. My thinking heroes are, and always will be, Warren Buffett and Charlie Munger. They saved me from remaining part of the herd when it comes to conventional rationality and I could never thank them enough.