Shorting Berkshire Isn't Smart

 | May 08, 2013 | 10:30 AM EDT  | Comments
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Stock quotes in this article:

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Most regular readers of this column know that I'm a value investor. I use quotation marks because I feel "value" is an inherent part of any investment approach, but if you want to use labels, go for it. Readers also know that I'm a big Warren Buffett fan. That being said, my stance against shorting Berkshire Hathaway (BRK.A, BRK.B) has nothing to do with my respect and admiration for Buffett. It has everything to do with the fact that Berkshire is in as good shape as it has ever been.

I won't deny the oversized Buffett effect. There's no denying that Goldman Sachs (GS) agreed to pay Berkshire 10% on $5 billion in preferred stock and give it warrants to buy $5 billion worth of stock at $113 a share because of Buffett. Two-and-a-half years later, Goldman redeemed the preferreds for $5.5 billion in addition to the $1.25 billion or so Berkshire received in interest. Bank of America (BAC) on paper has been an even more lucrative investment for Buffett and Berkshire.

At the end of the day, Buffett gets deals because of who he is and the fact that Berkshire has capital it is willing to deploy quickly. That won't change in a post-Buffett Berkshire. Perhaps the new CEO gets 8% instead of 10%, but there is something to be said for precedent -- and Buffett has set the precedent for Berkshire's deals.

The nucleus of Berkshire's operations is not these attractive deals but the insurance, utilities and railroad holdings that spin off and then deploy capital. So far, Buffett's two new lieutenants, Todd Combs and Ted Weschler, have proven themselves very capable of deploying capital. Like Buffett, they will only get better with time.

For the past five years, Berkshire has averaged $5 billion in interest, dividend and other investment income. I don't see that going away as most of it comes from dividends from names like Coca-Cola (KO), Wells Fargo (WFC), American Express (AXP) and IBM (IBM). The railroad business is stable over the long run and so are insurance, candy and tools.

So why short such a stable, blue-chip business? The ultimate short -- a business that completely goes under -- promises a capped 100% return but unlimited downside. But Berkshire is considered one of the most admired and well-run companies. Sure, after Buffett departs you may get a pullback in shares, but when will that be, and how much will the stock drop: 10%, 20% or 30%? Berkshire is in the S&P 500 and institutional funds provide price support. When Buffett is no longer there and Berkshire decides to return excess capital via a dividend, Buffett's absence could actually lift the stock.

It seems to me that the risk-reward scenario of shorting Berkshire -- one of the most conservatively run and best-managed businesses -- is not even close to being an intelligent bet right now.

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