Buy the stock Buffett's giving away

By Michael Brush

When Warren Buffett announces plans to unload most of his own company's shares (however charitable the reason), it raises a question: Should you buy a stock that one of the world's great investors is selling?

After all, market experts will tell you it's a red flag when you see a major insider exodus from a stock -- especially by an insider who has been so crucial to the success of a company.

And few people have played so big a part in a company's success as Warren Buffett has at Berkshire Hathaway (BRK.B, news, msgs), a far-reaching global empire that has a hand in everything from insurance to furniture, jewelry to candy and Dairy Queen ice cream shops.

During the past several decades, Berkshire Hathaway shares have made more than a few investors wealthy -- thanks to Buffett's shrewd knack for making the right investments.

But now, the Oracle of Omaha is exiting 85% of his position in Berkshire Hathaway. He's giving a cool $37 billion of stock to the Bill & Melinda Gates Foundation and four other charities run by Buffett family members.

Selling, not slacking

The move announced last week left more than a few investors wondering: Does the timing say anything about what's in store for Berkshire's stock?

Not likely, say analysts who follow the company.

First off, you'd make a mistake to think that Buffett will toil any less because he won't benefit as much if Berkshire Hathaway shares rise. In a recent interview on the Charlie Rose Show, Buffett said he'll work even harder knowing that the fruits of his efforts will benefit people around the world.

That may sound like bluster, but it's hard to argue that going to work is all about the money for Buffett. Here's why. For years he's had more wealth than anyone would know what to do with. Yet his company continued to thrive thanks to his efforts -- suggesting that something else drives the man.

"For Buffett, it isn't about the Porsche, it's about the fun of the game," says Ed Walczak, a portfolio manager at Vontobel Asset Management's Phoenix Focused Value Fund (JVVAX), which holds Berkshire shares. "What matters most for him is his passion for the business, and it is 100% there. That's why I don't view this as having any importance for the stock."

A slow exit

But what about the selling pressure that will come from unwinding such a large position in a thinly traded stock? Buffett is giving away 85% of his 475,000 Class A shares, or about 25% of the overall market cap of the company. (Before the transfer, they'll be converted to Class B shares, which have virtually no voting power.)

But this probably won't push shares down much, say analysts. First, the charitable contributions are spread out over many years. The Bill & Melinda Gates Foundation will get 5% of its overall allotment each year until it runs out. That works out to about $1.5 billion a year initially, or 1% of Berkshire's market cap of $142 billion.

Next, while charities are required to spend the money within time limits, they have other funds on hand to tap if they think Berkshire Hathaway shares are a good investment, or if they are worried about depressing the stock.

"I really don't think this gradual change in ownership will impact shareholders much," says Justin Fuller, an analyst who follows Berkshire Hathaway at Morningstar (MORN, news, msgs) and has a buy rating on the stock.

If anything, it takes away fears about how aggressively Buffett's stake might have been sold off if it had moved into the hands of heirs upon his death. "You have a better idea of what is going to happen now," says Fuller.

Analysts say investors should actually buy Berkshire as Buffett sells, for two reasons.

• Ironically, the shares of the company run by the world's best-known value investor look cheap.

• Berkshire Hathaway has great growth potential ahead.

Marked down

Berkshire Hathaway Class B stock has been stuck in a trading range of about $2,700 to $3,200 since the start of 2004, yet the book value of the company has been growing at about 8% to 10% a year for the past three years, says Todd Lowenstein, co-portfolio manager of the HighMark Value Momentum Fund (HMVMX). It currently trades for about 1.5 book value and 15 time earnings, which is close to the low end of the range for this stock.

Lowenstein also calculates that under the most conservative scenario -- assuming none of Berkshire Hathaway's businesses ever grow and its enormous cash hoard of $42.8 billion is invested in bonds -- the B shares have an "intrinsic value" of $3,065. That's where they trade today. "If you buy now you are getting Warren Buffett for free, and that is an attractive value right there," says Lowenstein.

But if you assume Berkshire Hathaway successfully invests its cash for a better return, and the rest of its businesses merely grow as quickly as their peers, the stock should be worth $4,000 to $4,665. Again, that's a conservative scenario -- given the talents of Buffett and the people he has put around him. But it'll give you 25% to 30% upside if you buy today.

Morningstar's Fuller, using a conservative valuation approach, figures Berkshire Hathaway's fair value is in the same range, or $4,052 per share. He suggests buying the stock anywhere under $3,453.

Room to grow

What about the growth? First off, there's that cash hoard. "Sooner or later, the company will redeploy a lot of that cash and generate higher returns," says Lowenstein. One direction will be foreign companies. Berkshire Hathaway recently bought the Israeli company Iscar Metalworking, and analysts expect more foreign purchases.

And if we really are on the verge of an economic slowdown and a sustained bear market for stocks, Berkshire has the fire power to reward shareholders over the long term by picking up bargains in the process, says Walczak.

Next, Berkshire Hathaway owns several world-class property-and-casualty and reinsurance companies with solid credit ratings because of Berkshire's strong balance sheet.

As insurance premiums rise because other insurance companies are struggling with 2005 hurricane claims, Berkshire Hathaway can profit by picking up more lucrative business.

Life after Warren

One reason Berkshire Hathaway shares have been stuck in a trading range is investor concern over who will succeed Buffett, even though he still looks healthy at 75.

Berkshire Hathaway has put in so many highly talented and motivated managers to run its businesses, this isn't really an issue, says Fuller. Besides, they already enjoy a lot of autonomy from the man at the top. So while they would miss Buffett after he's gone, it's not because the Oracle has been looking over their shoulders and telling them what to do.

As examples of standout managers, analysts cite Tony Nicely, who is chairman and CEO at GEICO Auto Insurance, and David Sokol, chairman and CEO of the energy utility MidAmerican Energy Holdings.

Another is Ajit Jain, the head of Berkshire Hathaway's reinsurance efforts. In a recent missive to shareholders, Buffett sized up Jain's successes at the company and quipped: "Don't worry about my health, worry about his."

At the time of publication, Michael Brush did not own or control shares of companies mentioned in this column. Brush is an award-winning New York-based financial writer who has covered business and investing for the New York Times, Money magazine and the Economist Group. Brush studied at Columbia Business School in the Knight-Bagehot Fellowship program. He is the author of "Lessons From the Front Line," a book offering insights on investing and the markets based on the experiences of professional money managers.