Warren Buffet Case Essay Sample

A ) What is the possible significance of the alterations in stock monetary value for GEICO and Berkshire Hathaway on the twenty-four hours of the acquisition proclamation? Specifically. what does the $ 718 million addition in Berkshire’s market value of equity imply about the intrinsic value of GEICO?

Evaluation of GEICO
Warren Buffet bought the company of GEICO for 70 $ per portion. which he estimated to an appropriate monetary value for the purchase of the company. Warren Buffet is focused on the hereafter hard currency flow that GEICO may bring forth. and utilize this to value the company before a purchase of stocks. The acquisition of GEICO shows that Warren Buffet had a large assurance in the company. which he besides mentions in the note: * Seven largest car insurance company.

* Extraordinary senior directors that may supply extra deepness to Berkshire Hathaway’s senior direction bench *the lowest-cost insurance supplier in the industry.

Warren Buffet believed that GEICO was undervalued on the stock market and that they were stronger than what the current stock monetary value said. He had besides had his eyes on the company since every bit early as 1951. when he made his first investing in the company. GEICO was a company that Buffett were comfy with and which he had followed closely for over four decennaries. which follows his investing doctrine to take for long-run investings. With the penetration in the company and the manner that GEICO performed concerns compared to other insurance companies it had performed really good antecedently. NYTimes reported on the 26th of August. 1995 that “Geico. the country’s sixth-largest auto insurance company. has been a solidly profitable company in recent old ages with a good record for low losingss and low disbursals in comparing with others in its concern. These consequences have been possible because the company bypasses agents. selling straight to the consumer. concentrating on low-risk drivers. ” Baltimore Sun reported on the same twenty-four hours sing GEICO “In the old ages since. Geico has become known as an highly finical investment banker. undercutting rivals for the concern of drivers with clean records but demanding far higher premiums from clients who have had even one driving misdemeanor.

It besides has among the lowest administrative costs in the insurance concern because it sells most policies over the phone without utilizing insurance agents. ” The intrinsic value of the company was higher than the book value that had deteriorated due to rising prices and costs. Los Angeles Times besides reference in their article the twenty-four hours after the proclamation from Buffett that analysts speculated in that by geting GEICO. Buffett tried to prepare a replacement. Warren Buffett. 65 old ages at this clip. tried to happen a stable direction squad for Berkshire Hathaway in instance of that he would hold to step down. The acquisition of GEICO was thereby non merely an investing in a company that made good net incomes. but besides an investing for Berkshire Hathaway to stay stable in the hereafter with a good direction squad. Harmonizing to the Autobiography about Warren Buffett. “The Snowball” . the payment for the stocks in GEICO was done in portions in Berkshire Hathaway. Alternatively of take downing the capital that Berkshire Hathaway had in direct hard currency. and paying with portions of his ain company. there was no direct negative hard currency flow out from Berkshire Hathaway. ( Page 747 ) Walt Disney Company:

Walt Disney Company announced three hebdomads before the Buffett proclamation that they intended to get the stocks in Capital Cities/ABC for $ 19 Billion dollars. With the 13 % ownership of the Capital Cities/ABC. the consequence was traveling to be a addition of about $ 2 billion dollars for Berkshire Hathaway that they so would be able to reinvest. The capital addition on the gross revenues of Capital Cities would more or less finance the acquisition of GEICO.

Berkshire Hathaway Stock:
The Berkshire Hathaway A stock closed on the 24th of August 1995 at $ 24. 800 and on the 25th of August at $ 25. 400. In August up to the proclamation. the Berkshire Hathaway had been shuting at an norm of $ 24. 753. This shows that the proclamation had a direct impact of the stock monetary value. The ground for the addition in the stock monetary value in Berkshire Hathaway was dependant on several factors. With the GEICO stock lifting with $ 12. 875 to $ 68. 625 on the New York Stock Exchange. Geico Hathaway gained about $ 440 million on their 34. 25 million portions in GEICO. With the addition from the approaching trade with Walt Disney Company. every bit good as the publication of the Value Line Forecast for GEICO. it is apprehensible that the Berkshire Hathaway stock rose. Another factor that besides comes into drama in this instance is the celebrated path record of Warren Buffett when it comes to puting. Decision: The addition in Berkshire Hathaway was a response from the markets rating of GEICO Company to increase. the reinvestments of the money that would be gained on the future gross revenues of Capital Cities/ABC. every bit good as the markets trust in Warren Buffett’s investings to be successful.

B ) How good has Berkshire Hathaway performed? In the sum? In its investing in Scott & A ; Fetzer? In its investings in earlier purchases of GEICO stock? In its investings in exchangeable preferable securities?

Berkshire Hathaway has a really good proven path record. due to the investings in stable companies that may supply a good hereafter hard currency flow. With the norm of a 28 % one-year addition in wealth. Note in “The Snowball ( cpt 46 note 52 ) Berkshire Hathaway one-year missive. 1985. The trade was $ 320 million in hard currency and the remainder in false debt and other costs. “Scott Fetzer Holders Clear Sale of Company. ” Wall Street Journal. December 30. 1985. In Berkshire’s 2000 one-year study. Buffett points out that BRK netted $ 1. 03 billion from its net purchase monetary value of $ 230 million. Harmonizing to Exhibit 5 we can gauge returns on stock for each twelvemonth from 1986 to 1994 and one-year growing rate on net incomes per portion.

Scott and Fetzer|
Stock retun| Growth on earnings|
23 % | 0|
55 % | 121 % |
61 % | 119 % |
49 % | 101 % |
58 % | 105 % |
46 % | 100 % |
58 % | 115 % |
70 % | 110 % |
87 % | 102 % |
avarage growth| 109 % |
growing since 1986| 197 % |

This gives us truly good Numberss to specify company’s public presentation in geting of Scott’s and Fetzer stocks with mean return on portion of 56 % and mean growing rate of 109 % with a entire growing from 1986 to 1994 of 197 % . With the GEICO stock lifting with $ 12. 875 to $ 68. 625 on the New York Stock Exchange. Geico Hathaway gained about $ 440 million on their 34. 25 million portions in GEICO. During the period from 1976 to 1980 GEICO stock monetary value was earnestly damaged by rising prices and assorted other factors. In 1995 original interest of 45. 7 million grew to 1. 9 billion dollars which is. GEICO paid increased dividends per portion from 1976 to 1994 with mean return on stock of 13. 5 % . Concerning preferable securities. we estimated return on securities throughout their retention period boulder clay 1995 when most of those stocks would be converted into common portions or redeemed by issuers with contracted ransomed monetary value: Corp| Preferred Stock Return|

CIP| 39 % |
First Empire| 184 % |
Gillette| 326 % |
Salomon| 13 % |
USAir Grp| -31 % |

Harmonizing to these Numberss Berkshire’s investings on norm made 106 % before 1995 when exchangeable portion work stoppages in. Valuing return after 1995 is a inquiry of timeserving cost determination.

D ) Based on Value Line’s prognosis information. what is the scope of possible intrinsic values for GEICO? What inquiries might you hold about this estimated scope?

Cost of equity of 11

1996| $ 1. 16| PV=1. 16/ ( 1. 11 ) =1. 05|
1997| $ 1. 25| PV=1. 25/1. 112=1. 01|
1998| $ 1. 34| 0. 98|
1999| $ 1. 44| 0. 95|
2000| $ 1. 55| 0. 92|
Forecast Stock monetary value | $ 90| 53. 41|

Current Stock Value=
1. 05+1. 01+0. 98+0. 95+0. 92+53. 41= $ 58. 32
1996| $ 1. 16| PV=1. 05|
1997| $ 1. 34| PV=1. 09|
1998| $ 1. 55| 1. 13|
1999| $ 1. 79| 1. 18|
2000| $ 2. 07| 1. 23|
Forecast stock monetary value | $ 125| 74. 18|

Current Stock Value= 1. 05+1. 09+1. 13+1. 18+74. 18= $ 79. 85
Questions:
1. What premise did they do in calculating dividends and growing rate? 2. Why even after the publication of the study. the stock monetary value did non alter? Estimated growing rates from table 1. Value line Projection ;

1. 55/1. 16= ( 1+g ) 4
g= 7. 5 % ( low -end )
2. 07/1. 16= ( 1+g ) 4
g= 15. 58 % ( high-end )
g= k- D/p
g= 11 % – 1. 16/55. 75
g= 8. 91 % ( market growing rate )
g= 11 % -1. 55 * ( 1+0. 0751 ) /90= 9. 15 %
g= 11 % -2. 07* ( 1+0. 1558 ) /125=0. 0908*100=9. 08 %
Buffett’s ground for making this investing is that most likely he expected a growing rate of more than 9 % .

Tocopherol ) Please critically assess Buffett’s investing doctrine. and fix to place points where you agree and disagree with him.

1. Economic world. non accounting world
* In a really elegant manner. Warren Buffet is right in his premise. Accounting criterions are designed to take an otherwise unsurmountable volume of information of every company. and convey it in a concise and rapidly digestible format. By definition. this procedure must give some grade of informational truth and dept. 2. The cost of the lost chance

* Warren Buffet agrees with a long standing economic dogma that states: “rational picks are made by comparing the result to the chance cost of the following best alternative” . This is consistent with a logical and rational determination doing procedure. 3. Value creative activity: clip is money

* The basis to cardinal analysis is the Net Present Value of the discounted hard currency flow for a company. The pros are that it is a simple and easy to understand step of economic public presentation. and besides conveys what the present value is of what the concern proprietor can anticipate to gain. The negative side to this measuring is that it is extremely subjective. Whoever is making the measuring must basically do conjectures about the size and continuance of future growing rates. taking to a extremely subjective “touch and feel” Net Present Value solution. 4. Measure public presentation by addition in intrinsic value. non accounting net income * Intrinsic value vs. accounting net income is a really strong analytical tool. Nominal values are merely utile when considered what the options are. or existent values. A 10 % return is merely valuable so long as the market is acquiring & lt ; 10 % return. and frailty versa. 5. Hazard and price reduction rates/Diversification

* It is true that the more an investor knows about a company. the more certain that investor can be about that companies future. However. Warren Buffet argues that extinguishing idiosyncratic hazard through in-depth research into a individual company is a stronger tool than variegation. If every investor had the entree to information that Warren Buffet does. through sitting on the board of managers or holding close relationships with cardinal determination shapers. so a stronger instance could be made. Unfortunately this is non the instance. Diversification can still be used as a tool to protect an investor ; a force majeure can non be predicted through company research merely as macroeconomic hazards can non be deduced no affair how good an investor understands a individual company. 6. Investing should be done through analyses. non hunch

* Any rational determination shaper will strongly hold with this statement. Warren buffet nevertheless goes on to call on the carpet the efficient market hypothesis and market timing. which is contestable. While both have defects. they have been proven in instances as utile tools. Statistical techniques for placing market tendencies are by and large extremely profitable before being revealed to the remainder of the market. and dollar cost averaging can be used to extenuate trading hazard. Ironically. many of these tools are used through logical analysis instead than intuition. 7. Alliance of agents and proprietors

* The pros to alining agents and proprietors are in answerability. Agents are given a disincentive to gain at the cost of the proprietors. since they are themselves the proprietors. Warrant Buffet’s wage is merely 100k for functioning as CEO. so the bulk of his compensation is straight tied to public presentation of Berkshire Hathaway. This is an elegant tool to turn to the moral jeopardy between ownership and control. The downside is that the proprietors are capable to the penchants to those in control. preventing a trough from providing to an proprietor who may keep a divergent involvement.