Berkshire Hathaway Portfolio

As mentioned in a previous post, I am planning on switching funds from a Vanguard index fund to Berkshire Hathaway (BRKB) in order to take advantage of the tax loss writeoff. I thought it would be interesting to see just how much of the share price is made up of Berkshire's common stock holdings and other investments.

I've been playing around with EditGrid, an online spreadsheet tool that allows for access of live data from Yahoo! Finance and other data sources. It looks like a pretty neat tool, and I'm thinking of eventually converting my portfolio tracking to this spreadsheet.

Using SEC filings and the latest 10-Q, I attempted to piece together the current value of Berkshire's investment holdings. This should update automatically so I can always look at how Berkshire is trading relative to its investment portfolio.




I estimated that about $86B of Berkshire's $145B total market cap comes from its investments, roughly 60%. Converted to A share pricing, that yields investments per share of $56,044. This compares to 2007 year-end $90,343 investment per share as stated in the 2007 annual report (A shares closed at $141,600 in 2007). Tilson Funds put out a report estimating $86,000 investments per share in Q3 '08 and $76,000 investments per-share as of 11/19/08. For reference, A shares closed at $130,600 on 9/30/08 and $84,000 on 11/19/08.

NOTE: I'm not sure if my way of calculation is the same as the method used by Berkshire and Tilson Funds. I'll need to investigate further to make sure that I'm doing it correctly.

The point of all this is that Berkshire's investment holdings make up a large portion of its current market value. That means that the implied value of Berkshire's many businesses is quite small. On November 19, you could have actually bought Berkshire at a cost nearly equal to the value of its investments, meaning businesses like Geico and See's Candies were being included for free. That makes for a pretty compelling investment argument to me. In this environment, I would much rather own a collection of (undervalued) businesses and investments hand-selected by Buffett rather than any index fund that likely includes a substantial amount of garbage.

Disclosure: The author is long BRKB. Current TogaPF portfolio holdings here.

Oil Speculation

The price of crude oil has been in freefall recently on fears of less demand due to the recession. Prices on the January 2009 futures contract dropped to $36 a barrel today, down from a high of $147 per barrel earlier in the year. At $36, this is less than half of Saudi oil minister Ali al-Naimi's $75 target fair price for crude, a price needed to support investment in new fields.

This is just bizarre. It's almost enough to make one believe that oil is plentiful and cheap. OPEC on Wednesday announced production cuts of 2.2 million barrels per day, and non-OPEC producers like Russia and Azerbaijan have announced plans to cut production as well.

While the world's economic woes cannot be ignored, I don't believe that the demand issues are likely to go away. There have been no fundamental changes to warrant the decline: economies are still dependent on oil for growth, no major new oil supplies have been discovered, and no alternative energy source is anywhere near in a position to substitute for oil. While growth may be delayed for a time, developing economies like China and India will continue to have huge demands for oil. A prolonged spell of cheap oil also delays the development of alternative energies as well as the search for new oil fields, as it no longer becomes economically feasible to pursue those options. Ultimately, it's all a matter of supply and demand. Coupled with the fact that crude prices remain denominated in the ever-weakening dollar, it seems to me nearly a sure bet that prices must rise.

How to Exploit the Mispricing

The most straightforward method is to buy securities that are correlated with the price of oil, such as oil companies or an ETF that tracks crude oil like USO. A quick check shows that USO does a reasonably decent job of tracking crude prices. If crude rebounds to OPEC's $75 target, that makes for an easy double.

Buying Call Spreads

One play whose risk/return proposition appears very attractive to me is to buy a call spread on USO. USO tends to trade at about 75%-80% of the price of crude and closed at $32.73 today, versus the January 2009 futures contract which closed at $36.20.

Here is a list of USO options expiring in January 2011, over two years from today.

You can buy an in-the-money call option (OLLAX)for about $13.60 with a $30 strike price. Thus, if USO trades above $43.60, or roughly $50-$55 per barrel for crude, by January 2011, you will break even. Anything above $43.60 is pure profit.

You can offset the price of the call option by selling another call option with a higher strike - the classic bull call spread. I did this for a January 2011 call option (ZVKAH) with a $60 strike, at a premium of about $6. By doing this, I basically sell off any upside in USO above $60, which is about $75 in terms of the cost of a barrel of crude. This reduces the cost of my spread to $13.60 less $6, or about $7.60.

You can choose to construct wider/narrower call spreads at different strike price points, which will impact the net cost of the spread. I chose to buy a spread at the $30 range so that my $30 call was already in-the-money.

In this case, I will profit if USO trades above $37.60 by January 2011. I can potentially make up to ($60 - $37.60) or $22.40, assuming USO trades above $60 at expiration. I am basically betting $7.60 for a potential return of up to $22.40, which is almost a 3:1 or 300% gain.

Additionally, I can unwind the position at any point over the next two years, as the prices of the options will change depending on how USO and crude prices change. The only drawback is that the bid/ask spread to unwind the position can be costly.

I believe there is a better than 50/50 chance that crude oil will rise above $75 per barrel over the next 2 years, and I can get a return of up to 300% if that actually happens. That's a bet I'm quite willing to make. Even today, a crude oil futures contract for delivery in January 2011 is trading at $62.09. The U.S. government outlook is for $51 crude oil for 2009.

There is probably an even more lucrative opportunity to be had trading futures here, but I don't have an account set up for that currently. In any event, buying the call spread seems like a solid speculative play to me. I normally refrain from speculation, but the risk/reward was too enticing to ignore.

And What if Oil Prices Stay Low?

Somehow, I wouldn't count on the price of crude to stay this low. But if it does, that's fine by me. If oil prices continue to stay low, that should bring good news at the gas pump and to the economy overall. We can return to our profligate habits of McMansions and Hummers. You can probably pick up both now for pennies on the dollar.

Disclosure: The author is long USO.

Year End Moves

I haven't had much time to post lately, so my apologies for that. I can't believe it's been over a month since my last post.

Now that the Fed has gone down swinging with rate cuts to essentially 0%, I don't expect the cash returns from savings accounts to be particularly attractive for the near future. Indeed, it was just last week that the Treasury sold 4-week bills at the mouth-watering discount rate of 0%. Clearly, if anything could be considered overvalued in this market, cash and its perceived safety would have to be a forerunner.

With the markets responding favorably to yesterday's cut, I took the opportunity to close out some positions. The problem now, as Obama noted, is that the Fed has run out of its traditional ammunition to fight recession. It's nice that they've come out saying they'll do all they can to help the economy, but it's not as though they were holding back before. Some sort of drastic fiscal response is now a near certainty. The threat of deflation is the key fear now, but these moves will likely have inflationary repercussions at some point.

Consequently, I've been adding more cash to my portfolio. As mentioned before, selling puts now seems like a much more lucrative way to put my cash to work, as well as a more disciplined way to enter stock investments.

Preferred Shares

I've also been researching preferred shares and convertible bonds as potentially safer investments that still capture most of the upside value of common stock. Companies are now readily cutting dividends on common shares to preserve capital, but are still making their payments on preferred shares and bonds.

I'm pretty new to these investments, so I'm still learning how to best dig up information about them. The data in Yahoo Finance isn't that great for looking up preferred shares, so I've found that the company website and SEC filings have been the best resource. I'm leaning toward the preferred shares of natural resources companies like Freeport McMoran and Chesapeake Energy, which have large holdings in necessary commodities. For example, I recently made an investment in Chesapeake Energy Series D preferred shares. Here is an excellent writeup on the investment case. I took a look at the features of Chesapeake's various stock classes, and also found the D shares to be the most attractive based on its offering size, its conversion characteristics, and its 10%+ yield.

Oil

Prices have come down so fast that it's almost a pleasure to go to the gas station. If you're a driver, it would be terrific to lock up <$2 prices for gas for the next few years. A number of other bloggers have written about how to construct a rough hedge on gas prices by buying ETFs that track oil, such as USO or OIL. If oil prices increase over the next few years, the pain at the pump will be offset by the increase in the value of the ETF. If oil prices decline, the ETF will fall in value but so will gas prices.

I chose to invest in USO as there is also the possibility of writing options on that ETF. As prices continue to fall, I think there may be an opportunity to write a call spread on USO.

Tax Losses

The majority of my passively managed portfolio is in Vanguard index funds. As the year wind downs, I think most index fund investors have suffered some epic losses. I've been looking to take advantage of selling some investments for the tax writeoff.

Normally, I would be hesitant to sell any index funds, as I would much prefer to buy and hold. In this environment, however, I think it does make sense to sell index funds as long as you switch to a similar investment. By doing this, you can exploit the tax savings while maintaining your original investment exposure.

For example, let's say you originally invested $10,000 in a Vanguard S&P 500 fund. For simplicity, assume that the Vanguard investment is now worth $7,000. You could liquidate the investment, claim $3,000 in losses, and invest the other $7,000 in a similar investment, such as the S&P 500 ETF SPY. When the $7,000 appreciates someday back to $10,000, you could sell it and claim $3,000 in (long-term) capital gains, which has a lower tax rate than ordinary income. There's a good explanation here.

Now you can't do this for the same investment, as that would violate the SEC's wash sale rule. The example given above is toeing the line in my opinion, but I don't think it's actually disallowed. However, since almost everything in this market has dropped 40%+ this year, it's not as difficult to find a replacement.

I plan to sell a chunk of my Vanguard Total Stock Market Index fund and switching to Berkshire Hathaway (BRKB). I unfortunately was out of the country and not following the markets when Berkshire was trading below $3,000 in late November. Here is a comparison of how the two have traded. I feel more comfortable with the Berkshire collection of assets rather than the overall market. Whitney Tilson had a solid article discussing this a month ago.

Recent Moves

Although I haven't been writing much, I've still been fairly active on the trading front (at least for me). Here's a list of my recent trades:

• US Oil Fund (USO) - 12/16/08 - BOUGHT 100 shares at $36.25
  
• Autodesk (ADSK) - 12/16/08 - BOUGHT 1 $20 December '08 put at $1.30 (closed position)
  
• BP (BP) - 12/05/08 - BOUGHT 100 shares at $41.72
  
• Chesapeake Energy (CHK-D) - 12/05/08 - BOUGHT 100 preferred shares at $43.50
  
• Freeport McMoran (FCX) - 12/03/08 - SOLD 4 $12.50 May '09 put at $2.89
  
• GE (GE) - 11/13/08 - SOLD 2 $10 March '09 put at $1.45
  
• Nokia (NOK) - 11/11/08 - BOUGHT 100 shares at $13.76
  

Disclosure: The author is long ADSK, BP, CHK, FCX, GE, NOK and USO. Current TogaPF portfolio holdings here.