Michael Brush

Company Focus9/23/2008 5:09 PM ET

The problem with Warren Buffett

Continued from page 1

To anyone who pays attention to Buffett, none of this is a surprise. In his most recent letter to shareholders, in February, Buffett warned investors that the "party is over." He told them straight out it was "a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008."

The other problem, of course, is that Buffett has collected a lot of companies with direct exposure to the housing sector. These include Shaw Industries, the world's largest carpet manufacturer, and Star Furniture, as well as Clayton Homes, Acme Building Brands, Benjamin Moore and Johns Manville, which sell manufactured homes, bricks, paint and insulation, respectively.

Buffett also has a lot of exposure to consumer-facing businesses like apparel, through companies such as Fruit of the Loom and H.H. Brown Shoe Group.

These businesses have been hit hard by weakness in the economy.

Buy or sell Buffett?

Because of the grim outlook for insurance pricing and the weak economy, analysts such as Gary Ransom of Fox-Pitt Kelton are not enthusiastic about Berkshire Hathaway's stock.

But for long-term investors, the stock looks like a good buy-and-hold and sleep-at-night investment.

"We still believe the conglomerate will do well by its shareholders for decades to come," says Morningstar's Fuller, who has a five-star rating on Berkshire Hathaway, Morningstar's highest rating.

Here are three reasons:

  • Berkshire Hathaway looks cheap. "It is trading below intrinsic value, and it always returns to intrinsic value sooner or later," says Tilson, of the Tilson Focus Fund. By tallying the value of cash per share and investments, and putting a reasonable valuation on Berkshire operating businesses, Tilson calculates intrinsic value to be as much as $160,000 per share. That suggests a potential gain of 19% just for getting back to a fair valuation for Buffett's stock.

  • Buffett has the best managers in the business. Buffett doesn't put much value on résumés. Instead, he looks for a good track record and passion. Most of the chiefs running his operating businesses no longer have any financial need to work. They sold their businesses to Buffett but continue working for him because they love it. "They have exactly the job they want for the rest of their working years. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage," Buffett told shareholders in his most recent letter to them.

  • Buffett has the cash to take advantage of the train wreck in the market. "As the markets get more and more chaotic, that works to Buffett's benefit," Tilson says. While others panic, Buffett will pick up bargains. Last week, for example, Buffett stepped up and bought Constellation Energy Group (CEG, news, msgs) after its shares swooned because of concerns about its financial strength. "It would be hard to find a better example of why this market is so perfect for Buffett," Tilson says.

Undervalued or not, a share of BRK.A at more than $130,000 may be beyond the average investor's means. The other option is BRK.B, now trading around $4,400.

6 Buffett stock picks

If you want to try your hand instead at individual holdings in the Berkshire Hathaway portfolio, consider these stocks. Three are positions that Berkshire added to during last quarter. Three others are holdings favored by value investors and Buffettologists around current levels.

Berkshire Hathaway took on one new position last quarter when it bought 3.24 million shares of NRG Energy (NRG, news, msgs), a utility. At $30 a share, NRG trades about 30% below where Berkshire probably bought last quarter.

Berkshire also added to Sanofi-Aventis (SNY, news, msgs), a pharmaceutical company with most of its sales in the U.S. and Europe, and Ingersoll-Rand (IR, news, msgs), which sells industrial equipment such as climate control and security systems. Morningstar analysts have five-star ratings on both companies. Each stock trades at or near lows for the second quarter. So if you buy now, you'll get about the same price that Berkshire Hathaway got, or even better.

Wells Fargo looks like a buy because as a financially sound survivor, it will likely benefit from the banking mess by making acquisitions or expanding, says Todd Lowenstein, a co-portfolio manager of the HighMark Value Momentum Fund (HMVMX). Wells Fargo is one of Buffett's top five holdings.

Tilson thinks American Express (AXP, news, msgs) looks "very attractive" at current levels. Fears about weak consumer spending and losses on credit card debt could hold the stock down for a while. "But they will emerge from this with a brilliant franchise intact and incredible earnings power," Tilson says. "This is one of the world's great businesses."

Just be patient, and don't expect gains right way, as there is no known near-term catalyst for the stock. American Express is also one of Buffett's top five holdings.

Another Buffett holding in the financial sector, M&T Bank (MTB, news, msgs) also looks attractive around current levels, says Ed Walczak, a portfolio manager at Vontobel Asset Management's Phoenix Focused Value Fund. The stock is weak this year with the rest of the group. But this doesn't make sense because it has "a lot less exposure to the bad stuff that is out there, like residential mortgages," Walczak says.

The faint of heart may find comfort in the fact that half of the float of M&T Bank stock is held by Buffett and other serious long-term investors, Walczak says, which means there may be "less craziness" in terms of stock price.

At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.

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