Warren E Buffett

Case 1

Buffet’s record

• Compounded increase of wealth for BH is 24% from 1965 to 2004. How do you compare it with the market return?

• How do you interpret it?

Questions

• What is the possible meaning of the changes in stock price for Berkshire Hathaway and Scottish Power plc on the day of the acquisition announcement?

• Is Buffett is overpaying for PacifiCorp?

Calculation

Is Buffett is overpaying for PacifiCorp? • Total number of stock o/s =312.18 M• Total price (Cash) paid= 5.1 BPrice per share paid to PacifCorp : $16.9 • Market value increased by 2.17BPer share increased is 2.17B/318.12M=$6.93

PV of Cash offered

• Discount rate: CAPM• 5.76+(10.5-5.76)*0.75= 9.3• Using PV formula• 5.1/(1+0.93)^1.5=$ 4.47B• Now find the price:4.47/312.18= $ 14.31 per share.(Remember,

Buffet has offered $ 16.95 per share)

Some important questions

• Decision should either/or not yes/no. Why?• Why there is no difference of buying a new share

or buying outright business?. • Who are the worst enemy of the investors?• What do you mean by momentary greed and

fear ?• “We simply attempt to be fearful when others are

greedy and to be greedy when others are fearful”. Discuss

• Buffeett’s disagreement with modern finance theory

Benefits of portfolio diversification

• Although Buffett disavows portfolio diversification, the breadth of Berkshire Hathaway’s holdings probably approaches efficient diversification.

• Case Exhibit 2 gives a breakdown of Berkshire’s diverse business segments (also described in the case);

• Case Exhibit 3 gives a listing of Berkshire’s 10 major investees. • Do you think that the portfolio looks diversified?

Market Efficiency• Discipline and rationality:

• Buffett’s quotations in the case and his acquisition philosophy in case Exhibit 8 suggest that he is looking for the market’s pricing anomalies.

• Looking for the anomalies (the rationality part) and waiting to find them (the discipline part) are not inconsistent with a market that generally prices securities efficiently.

• Indeed, one could argue that the activities of investors such as Buffett help to create the efficiency that he denies.

Market Efficiency

• Information: By virtue of Berkshire’s large stockholdings in selected firms, Buffett holds directorships and enjoys an informational advantage unavailable to outside investors.

• Information advantages are valuable in a world of only semistrong efficient markets.

Use of risk-adjusted discount rates:

• The method he uses seems rather similar to the certainty equivalent approach to valuation (i.e., discount certain cash flows at a risk-free rate).

• Although it seems doubtful that the cash flows he discounts are truly certain, the very fact that he matches riskless cash flows with a risk-free discount rate implies an approach consistent with the risk-and-return logic of the CAPM.

Other philosophy

• Economic reality, not accounting reality• Account for the cost of the lost opportunity• Focus on the time value of money• Focus on wealth creation• Invest on the basis of information and analysis• The alignment of agents and owners is

beneficial to firm value