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Buffett Watch: Should You Own Berkshire Hathaway?

This article was updated on January 20, 2010.

Warren Buffett

Wouldn't you be thrilled if your portfolio achieved the same returns as Warren Buffett's? It may seem impossible, but it's really a snap: Just own shares in his corporate alter ego, Berkshire Hathaway (BRK-B).

The price of entry for investors has come down: On January 20, shareholders approved a 50-to-1 split of the company’s B-shares, which will take the share price down from around $3,476 to about $69.

If history is an accurate guide — and there’s no guarantee it is — it’s a smart way to invest. A $1,000 stake in Berkshire at the start of 1990 would have grown to roughly $12,000 by the end of last year, crushing the broader market. Had you invested the same amount in Vanguard’s Standard & Poor’s 500 index fund (VFINX) and reinvested dividends, your stake would be worth about $4,750.

A handful of hedge fund geniuses may have produced results similar to Berkshire’s while operating from mountain aeries and using complex, opaque investment strategies. Buffett did it primarily by holding blue-chip American stocks in a publicly listed company. It doesn’t work flawlessly; Berkshire has lagged the market over the past year, returning less than 10 percent while the S&P is up more than 30 percent. But if you’re worried about such short-term horizons, don’t invest with Warren Buffett.

Buy Shares ... in Moderation

Fund managers and financial advisers say you could do a lot worse than to own Berkshire. They suggest doing it in moderation, though, because as time goes on, Berkshire’s returns are likely to, well, moderate.

“If you listen to Buffett himself, he’s pretty confident in the long-term future of the company, but he has told people not to expect returns to be as good as in the past,” said Richard Graziadei, lead equity manager for TIAA-CREF Trust Co. “No one should go in thinking it’s going to replicate its past record.”

That record has been accomplished through Buffett’s display of many traits widely recognized as the right stuff of investing. He buys into established businesses with consistent earnings, not fledgling enterprises, and he insists on paying what he deems a bargain price. That often means going against conventional thinking and buying companies relegated to Wall Street’s doghouse. After he has made a purchase — this is another sign that he is uninterested in public opinion — he has the patience to wait until it pays off or until he determines that it probably never will.

It sounds simple enough. What sets Buffett apart from his peers is not his investment strategy, his admirers say, but his ability to implement it.

“You don’t have to have the I.Q. of an M.I.T. Ph.D. in math, but you do have to have common sense” to invest wisely, said George Schwartz, chief investment officer of the Ave Maria Mutual Funds. “The problem is a lot of people don’t apply common sense, they don’t look at investment opportunities with the cold logic that he does.”

Berkshire’s chief executive “is a master of contrarian thinking,” said Schwartz, who has kept a portion of his personal money in Berkshire since 1981. “That’s how to make money. You’ve got to buy when no one else is buying. He practices that.”

In Buffett’s Portfolio

He practices another key element of solid portfolio construction: diversification. The list of Berkshire Hathaway’s holdings reads like a What’s What of corporate America, including American Express (AXP), Coca-Cola (KO), Procter & Gamble (PG), Kraft (KFT), Wells Fargo (WFC), General Electric (GE), Goldman Sachs (GS), Dow Chemical (DOW), and Conoco Phillips (COP).

Berkshire reported $57.4 billion of stock investments and $37.4 billion in government and corporate bonds at the end of September. The remaining $36 billion or so of the company’s worth was accounted for by entities in which it holds more than a 20 percent stake, making them more like operating divisions. These include Geico and other insurance subsidiaries and Burlington Northern Santa Fe, the railroad that Berkshire took complete ownership of in November.

Buffett has always held a potent mix of businesses. Anyone who made a modest outlay, say $10,000, to buy Berkshire in the early 1980s, when Schwartz did, would be a millionaire now, barely a quarter-century later. There’s your retirement all squared away.

But as it says in the fine print of any investment, past performance is no guarantee of future results. Investment advisers caution that Berkshire’s returns are likely to dissipate, mainly because the company and Buffett have become victims of their own success. Berkshire’s market value of more than $150 billion and annual sales exceeding $100 billion suggest that it has run afoul of the law of large numbers. At that size, it takes ever bigger acquisitions to have a significant impact on earnings, so earnings growth is bound to slow.

“It’s not as easy for them to move the needle as when [Berkshire Hathaway] was a $15 billion or $20 billion company,” said Brian Washkowiak, director of research for Talon Asset Management, a Chicago financial planning firm. “We consider ourselves Warren Buffett disciples,” he added, “but I would advise against putting all your eggs into Berkshire Hathaway.”

Tom Forester, manager of the Forester Value Fund, noted that Buffett’s following with the public has sent Berkshire’s stock to a sizeable valuation premium over the broad market. It traded recently at 31 times its profits for the latest four quarters, compared with just over 20 for the S&P 500.

“I’m more a fan of [Buffett’s] investment acumen than I am of Berkshire,” Forester said. “I’m a value guy, too, so I don’t like paying premiums for things.” By other measures, however, Berkshire shares look cheaper: Barron’s estimates that shares are trading at 1.2 times book value.

The Age Factor

The other caveat issued to prospective Berkshire shareholders is actuarial, not financial. Buffett is 79, and his inevitable departure one day gives the laudatory remarks about him a more ominous ring. When Schwartz calls Berkshire “a unique company run by a unique individual,” it raises questions about how it will fare when someone who is not one of a kind takes over.

Whatever misgivings they may have about Berkshire, these investors consider it an excellent holding, as long as there are plenty of other assets to go with it. “What I would tell most clients is that they need other pieces of broad exposure,” Graziadei, of TIAA-CREF, advised. With Berkshire’s heavy concentration in large American companies, he would focus on complementary asset classes, such as bonds of different types; international stocks, including emerging markets for risk-tolerant investors; and possibly real estate. Washkowiak made similar suggestions, and he would also allocate capital to small and medium-sized companies.

When assessing Berkshire’s place in a portfolio and the right price to pay for the stock, investors would do well to give it the same scrutiny as Buffett does with his prospective investments, Graziadei said.

“You must be committed to truly understanding this company inside and out,” he said, “and developing the expertise to make a judgment call and buy when you think it’s undervalued.”

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