Has the Buffett premium been replaced by a Buffett penalty?
Warren Buffett's disclosure that he has prostate cancer has again raised the question of who will eventually succeed the world's most successful investor at Berkshire Hathaway Inc. The 81-year-old, who said he will begin radiation treatment for early stage prostate cancer in July, has steadfastly refused to provide a clear succession plan at the company he controls.
But the revelation has had little effect on the stock – perhaps because investors no longer pay a premium for Mr. Buffett's presence. The stock now trades at less than 1.2 times its book value, a rough guide to what the company's net assets are worth. As recently as late 2008, shares traded at 1.8 times book value.
"[Berkshire's]attractive valuation just outweighs succession risks at this time," said Tom Lewandowski, an analyst with Edward Jones & Co.
While Mr. Lewandowski doesn't like the lack of details about who might take over from Mr. Buffett, he says Berkshire's wide swath of businesses, which range from insurance to railways, generate enough cash to justify a share price considerably higher than it is now. The shares could easily trade at a multiple of 1.3 or 1.4 times book value, he says.
Mr. Buffett himself clearly believes the shares represent a good deal. When the price-to-book value of the stock dipped below one last September, he launched the first formal share buyback plan in the company's history. He vowed to repurchase the company's shares at a price of up to 1.1 times book value. The move quickly boosted the shares, and the company spent only $67-million (U.S.) buying back shares before the price advanced beyond the ceiling Mr. Buffett had set.
Whitney Tilson, managing partner of T2 Partners LLC in New York and a long-time Berkshire shareholder, believes the market is heavily discounting the company's true worth. In a February report, he calculated that Berkshire trades 33 per cent below its intrinsic value, which he defined as the sum of the company's investments per share plus 12-times its pretax earnings per share.
He estimates that the A class stock is worth $178,400 a share, compared with a market price of $119,750 as of Wednesday's close.
Numerous factors make Mr. Buffett "irreplaceable," including his experience, track record and reputation, which means deals come to him at prices unavailable to anyone else, Mr. Tilson noted. But the hedge fund manager concluded that he wasn't overly worried about succession plans for two reasons: First, Mr. Buffett could realistically run the company for years yet, and second, the discount on the stock is too good to ignore.
Although Mr. Buffett has been candid about the importance of picking his successor, he has been deliberately vague about the details.
"The primary job of a board of directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow," Mr. Buffett said in his annual letter to shareholders in February.
He went on to say that the board had in fact selected the successor, and two backups, but did not publicly identify who they are.
Every time the succession issue is raised, Berkshire stock dips, Meyer Shields of Stifel Nicolaus & Co. said in a note to clients on Tuesday. He is the only one of the four analysts following the company not to rate the shares a buy.
"Succession-related uncertainty remains one of the primary concerns underlying our hold rating, but we don't think today's news makes these concerns significantly more imminent," he wrote.
The late Steve Jobs similarly frustrated investors by not producing a succession plan at Apple Inc. Many investors feared that the company's stock would slump without the iconic leader at the helm. But shares of Apple have risen by almost 50 per cent since Mr. Jobs died in October at 56.
Mr. Buffett has received widespread praise for being forthright about his illness, something that Mr. Jobs chose not to do. But some say that without Mr. Buffett's leadership, Berkshire's stock would likely decline, at least in the short term.
"The market is going to want to weigh in on who ultimately is going to be in that role," Mr. Lewandowski said. He doesn't expect Mr. Buffett's illness will lead him to publicly announce his successor.
"He controls 37 per cent of the company. It's his decision at the end of the day," he said.