Case 1 Warren, E Buffet, 2005

Abstract

Case 1: Warren E. Buffet, 2005 discusses Buffet’s main investment philosophies and the acquisition of two companies he purchased in the early 2000’s. The two companies (MidAmerican Energy Holdings Company and PacifiCorp) he purchased were both in the energy industry. Some important facts are the 10 different exhibits that are included after the reading. They include the different business segments Berkshire owns, major investees of Berkshire, examples of value creation/destruction, condensed consolidated financial statements for the two companies discussed in the reading, Berkshire’s acquisition criteria and an exhibit of comparable energy firms. The problems related to items such as whether Buffet overpaid for certain companies, the impact of the acquisitions to the market, what Buffet’s investment philosophies are and if the discount dividend model can be applied. The reading and exhibits alone provide more than enough information to thoroughly answer each of the questions. My one recommendation would be to read the given material a few times to make sure you comprehend it before starting the problems.

Introduction

        The majority of the facts involved in this case are included in the Exhibits which are provided below. Outside of that the other important facts are the investment philosophies of Buffet and the information that discussed how Berkshire Hathaway, Scottish Power plc, and the S&P 500 reacted to the purchase of MidAmerican Energy Holdings Company that is on the first page of the case.

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Problem

The problems included in this case study were the following:

1. Buffet’s investment philosophy has six points. Please prepare a well-written, in-depth description of each point. In addition, identify whether or not you agree or disagree with each point. Justify your position.

2. What does the stock market seem to be saying about the acquisition of PacifiCorp by Berkshire Hathaway?

3. Well, maybe Buffett is overpaying – does he have a record of overpaying in the past?

4. Can we use the dividend discount model to value PacifiCorp? Why or why not?

5. Based on the multiples for comparable regulated utilities, what is the range of possible values for PacifiCorp (Use Exhibit 10.)

Analysis

        This case did not involve a lot of number crunching analysis, it was more just read the provided information and exhibits then interpret the data. The only formulas I used were in the chart I created in excel to find the gain in the share price which I computed by taking the current market price minus the initial cost divided by the total shares. The other equation that was needed is the dividend discount model which equals the next expected annual dividend divided by the discount rate minus the dividend growth rate.

Summary and Recommendation

In this section the answers are provided to each of the five questions that needed to be answered above in the problem section.

Question 1:

Warren Buffet has six main investment philosophies and they are:

(1)The first is economic reality not accounting reality. Which means that accounting reality pretty much conforms to the rules laid out by GAAP (Generally Accepted Accounting Principles) which are conservative and do not include important items like intangible assets (patents, trademarks, special managerial expertise, and reputation). I completely agree with the philosophy GAAP does not emphasize intangible assets as well as they should be. All of the intangible assets I stated above are very important and if you do not include them when determining the value of a business, the value of the business will be diminished to the extent of how invested they are on their intangible assets (which could quite a bit or very little depending on the nature of the business).

(2) The second philosophy is the cost of lost opportunity which is essentially the opportunity cost. If a person invests in a certain business what is the benefit or disadvantage of the next best investment in a different company. I also agree with this philosophy ever since I took my first economic class and learned about opportunity cost, I consider this in everything I do especially with investing my own capital.

(3) Measure performance by gain in intrinsic value not accounting profit is the third philosophy. This means an investor should focus on receiving the highest average annual rate of gain in intrinsic value on a per share basis. The investor should avoid focusing on how well the company is doing profit wise or the size of the company. I agree with the first part of this and disagree with the second part. As an investor, you should greatly care about the intrinsic value per share, but the investor should not completely ignore how well the company is profit wise. If the investor completely ignores the accounting profit, the company may go under and the investor would lose majority of his or her investment so they should pay attention to that to some extent.

(4) The fourth philosophy is investing behavior should be driven by information, analysis and self-discipline, not by emotion or “hunch”. This philosophy is straightforward and I agree with it. An investor should solely be focused on the facts and eliminate any emotional ties they may have with a specific company.

(5) His fifth philosophy is that investors typically purchase far too many stocks rather than waiting for one exceptional company. Buffet believes that people diversify too much and should figure businesses out that they understand and concentrate on them. I also agree with this as an investor I know a lot about the precious metals industry and pharmaceuticals so I focus entirely on those two industries because I know I will not make a mistake because of my knowledge in them.