The Buffett-doubter discount
An unusual price gap between the two classes of Berkshire stock suggests some investors may be losing faith in the Oracle of Omaha.
NEW YORK (Fortune) -- Warren Buffett on Saturday deemed Berkshire Hathaway's 2008 earnings and investment performances "unsatisfactory." Judging by some unusual recent action in Berkshire shares, he isn't alone in that assessment.
Berkshire's Class A (BRKA, Fortune 500) shares have dropped 48% from their 2007 peak. That selloff -- which is roughly in line with the 51% decline over the same period in the S&P 500 index of big companies -- has wiped more than $100 billion off the company's market value.
But an even better measure of unrest among some investors is the widening gap between the price of the Class A shares, which recently fetched $78,600 each, and the cheaper Class B (BRKB) shares Berkshire first issued in 1996.
Because a Class A share is convertible at the holder's request to 30 Class B shares, the Class B shares should trade for 1/30th the price of a Class A share -- around $2,620, going by recent prices. But the cheaper shares closed Friday at just $2,564, a 2% discount to the price implied by the trading in the Class A shares. And over the past month, the Class B shares have traded at a discount of as much as 7% - the biggest gap on record, going by stock data provided by Yahoo Finance.
The depressed relative value of the Class B shares suggests some investors may have lost faith in Buffett following Berkshire's rough 2008, which saw the firm's net worth decline for only the second time in 44 years.
Short-sellers, who seek to profit by selling shares they don't own and then buying at a lower price later, may have been pushing the cheaper Berkshire shares down in a wager that the company will be weakened by investment losses and underwater derivatives positions. Investors betting against Berkshire are drawn to the Class B shares in part by their greater availability: there are 14.6 million of them outstanding, against just over a million of the Class A shares.
Some skeptics contend Buffett has lost his touch and has started showing the signs of so-called style drift -- a failure to stick to the value investing principles that made him famous, such as owning shares only in companies that have a formidable competitive advantage over their rivals.
"Buffett has always said he buys companies with moats," said Doug Kass, a hedge fund manager who made money last year betting against Berkshire but has no position in it now. "But many of his large positions now, in companies like American Express (AXP, Fortune 500), U.S. Bancorp (USB, Fortune 500) and Wells Fargo (WFC, Fortune 500) -- you could argue the moats there are flooded by the commoditization of the financial products business."
Kass, who runs the Seabreeze Partners hedge funds in Palm Beach, Fla., said those questions are made more pointed by Buffett's decision to reduce his holdings in solidly performing Procter & Gamble (PG, Fortune 500) and Johnson & Johnson (JNJ, Fortune 500) in order to pay for other investments in 2008, even as he held onto his depreciating stakes in the three financial companies.
But Glenn Tongue, managing partner at Berkshire shareholder T2 Partners, said the excess decline in the cheaper Berkshire shares simply shows what happens when the markets go to extremes.
Tongue notes that before this month, the biggest gap in the values of the two Berkshire share classes came at the height of the tech stock craze. The B shares traded as much as 6.4% below their implied value compared with Class A shares in September 1999.
At the time, skeptics were saying Buffett had lost his touch as he sat out the eye-popping gains in hot tech names such as Qualcomm (QCOM, Fortune 500), the San Diego telecommunications chip company whose stock price doubled that summer and returned a staggering 2,600% that year. Since then, of course, the tech bubble has come and gone, only to be replaced by an even bigger bubble in the credit markets, whose popping has taken stocks back to 1997 levels.
"People who hold the Class A shares have lived through the ups and downs before," said Tongue, who said his fund spent last week selling some of its Class A stock to buy the discounted Class B shares. "The people who hold the Class B are the weaker hands, and some of them sell when they hear all the silly rumors out there."
So while Berkshire lagged far behind the market in the tech craze of 1999 -- the firm's net worth rose just fractionally that year, compared with a 21% gain in the S&P 500 -- the company outperformed the market in each of the next three years and has done so in seven of the last nine. Tongue said he expects to see more strong performances ahead.
"This is about as undervalued as we've ever seen the stock," said Tongue, who says T2 has owned Berkshire since the fund's 1999 inception and has recently has been adding to its position in large scale. "We're willing to bet Buffett hasn't gone silly."