Why Warren Buffett's a genius again

By Jim Jubak

On Oct. 23, Warren Buffett's Berkshire Hathaway (BRK.A, news, msgs) hit a price of $100,000 a share. As far as I can discover, that's the highest price ever for shares of a publicly traded company. The A shares are up about 5,555 times since May 1965, when Buffett took control of what was then a modest textile company.

With that milestone behind the shares, of course, the question now is, will Berkshire Hathaway A become the first $200,000 stock?

Yes. Not a doubt. Remember that you heard it here first: Berkshire Hathaway A will be the first $200,000-per-share stock.

That doesn't mean the stock is a good investment now, however. In fact, I'm going to sell my shares out of Jubak's Picks with this column. (And I'll also sell the shares of Berkshire Hathaway A in my personal portfolio three days after this column is posted.)

Why dump a winner?

So why sell what is almost certainly going to be the world's first $200,000-a-share stock? Because time is money. The actual value to an investor of that increase from $100,000 to $200,000 a share depends on how long it will take the stock to get there. And quite frankly, the next year or so -- and maybe even longer -- doesn't look especially favorable to Buffett's company.

Simple math tells me Berkshire Hathaway will get to $200,000 a share before any other stock does. Getting to that astronomical price, after all, requires only two things.

First requirement: a steadfast refusal to split the stock. Most companies declare 2-for-1 or 3-for-1 splits whenever they think the share price is getting high enough to discourage investors from buying. Nothing actually changes, of course, since instead of one share worth $100, investors after a 2-for-1 split have two shares worth $50 each.

Not Buffett. He's on record as saying he doesn't believe in stock splits since a high stock price, he insists, discourages buying by short-term traders. The high price and the limited number of un-split shares certainly do limit trading. Typically, fewer than 1,000 A shares trade a day.

(For the past 10 years investors have also been able to buy B shares in Berkshire Hathaway New (BRK.B, news, msgs) that represent 1/30 of the A share and carry 1/200 of the voting rights of an A share.)

So it's unlikely that any other stock would climb anywhere near Berkshire Hathaway's price before management announced a stock split.

Second requirement: years of appreciation in the price of the stock. Buffett has guided Berkshire Hathaway to an average annual gain of 11% for the past 10 years. If Buffett or his successors could deliver that same appreciation in the years ahead, Berkshire Hathaway A shares would break $200,000 sometime in late 2012 or early 2013. Gosh, even if the shares gained just 5% a year, the stock would break $200,000 in about 13 years, in 2019. With inflation likely to contribute at least half that rate of appreciation, I think $200,000 by 2019 at the worst is a lock.

Nobody likes to wait

To an investor, though, there's a huge difference between $200,000 a share in six years and $200,000 in 13 years. I suspect that investors in Berkshire Hathaway would be very unhappy with a 5% annual return over the next 10 years. Look at the kind of squawking that Buffett's sluggish performance in 2004 (4.2%), 2005 (0.82%) and the first half of 2006 (3% through June 30) elicited. As I noted in my March 28, 2006, column, "OK, bash Buffett -- but buy his stock," writers such as Pulitzer Prize winner James Stewart and MSN Money's Jon Markman wondered if Buffett had lost his touch.

To understand why Buffett looked like he'd lost it in March and now looks like a genius again -- and why I'm selling my shares of Berkshire Hathaway today -- you've got to look at how Berkshire Hathaway makes its money.

I'd break down the company's earnings stream into three parts. First and foremost in investors' minds, there are the earnings from investing the huge amounts of cash thrown off by the company's insurance business. Second, there are the earnings from the insurance business itself. And, third, there are the earnings from Berkshire Hathaway's non-insurance operating businesses, such as clothing maker Russell or carpet maker Shaw Industries.

The problem recently hasn't been in that third segment, the non-insurance operating businesses, where 2005 was a good year. Earnings before taxes climbed by 27% from the third quarter of 2004 to the third quarter of 2005. And 2006 has so far been even better, with earnings before taxes from this part of Berkshire Hathaway climbing by 55% from the third quarter of 2005 to the third quarter of 2006. To be completely fair, part of the growth in the earnings of this segment comes from Berkshire Hathaway's acquisition of new operating companies with cash from its insurance operation. But I think these numbers give you an idea of where the problem isn't.

Insurance segment rebounded

Berkshire Hathaway's insurance business was one of the places, on the other hand, where the problem was in 2005. From a profit before taxes of $387 million in the third quarter of 2004, the insurance group swung to a loss of $897 million in the third quarter, sometimes called the hurricane quarter, of 2005.

And the rebound in 2006 was remarkable. That $897 million loss turned into a $2.5 billion profit.

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