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2021-07-05
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Berkshire Hathaway: At Least 20% Underpriced, And The Kraft Heinz Position
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{"i18n":{"language":"zh_CN"},"detailType":1,"isChannel":false,"data":{"magic":2,"id":155764943,"tweetId":"155764943","gmtCreate":1625454855882,"gmtModify":1633940525284,"author":{"id":3585145250045622,"idStr":"3585145250045622","authorId":3585145250045622,"authorIdStr":"3585145250045622","name":"Bhaga","avatar":"https://static.tigerbbs.com/8df89f7cbf6306c898f1bc0eef701a29","vip":1,"userType":1,"introduction":"","boolIsFan":false,"boolIsHead":false,"crmLevel":2,"crmLevelSwitch":0,"individualDisplayBadges":[],"fanSize":10,"starInvestorFlag":false},"themes":[],"images":[],"coverImages":[],"extraTitle":"","html":"<html><head></head><body><p>Like</p></body></html>","htmlText":"<html><head></head><body><p>Like</p></body></html>","text":"Like","highlighted":1,"essential":1,"paper":1,"likeSize":6,"commentSize":1,"repostSize":0,"favoriteSize":0,"link":"https://laohu8.com/post/155764943","repostId":1166658180,"repostType":4,"repost":{"id":"1166658180","kind":"news","pubTimestamp":1625454170,"share":"https://ttm.financial/m/news/1166658180?lang=&edition=full","pubTime":"2021-07-05 11:02","market":"us","language":"en","title":"Berkshire Hathaway: At Least 20% Underpriced, And The Kraft Heinz Position","url":"https://stock-news.laohu8.com/highlight/detail?id=1166658180","media":"seeking alpha","summary":"Summary\n\nInvestment commentators seem to derive a misplaced sense of schadenfreude from Buffett's in","content":"<p>Summary</p>\n<ul>\n <li>Investment commentators seem to derive a misplaced sense of schadenfreude from Buffett's investment in Kraft Heinz.</li>\n <li>The Warren Buffett fan club blindly follow the Sage of Omaha and have not been well rewarded in relation to their personal investments in Kraft Heinz.</li>\n <li>The truth is that neither group understands the Kraft Heinz investment made by Buffett. It makes sense for him in a way that would not work for you and me.</li>\n <li>I shall explain all and hopefully allow you to understand the Kraft Heinz investment.</li>\n <li>I also provide an appraisal of <a href=\"https://laohu8.com/S/BRK.A\">Berkshire Hathaway</a> today being at least 20% underpriced and a great value investment.</li>\n</ul>\n<p>Introduction</p>\n<p>Warren Buffett is an undeniable investing genius. His results speak for themselves. However, blindly following Buffett - as many investors do - is foolish as I shall explain.</p>\n<p>There exists an army of investors who closely watch the legendary investor's every move. If he buys something then the \"<i>Warren Buffett fan club\"</i>follows suit and they buy into the same company. I guess this is simply human nature. If someone appears to have the Midas touch then everyone wants a piece of the gold that he is creating.</p>\n<p>Certain investing websites allow investors to track Buffett and to blindly follow suit. Kraft Heinz (KHC) is a perfect example of why this kind of behaviour is ill advised.</p>\n<p>Many investment commentators question Buffett's investment in Kraft Heinz. The company certainly hasn't performed as well as other Buffett investments such as <a href=\"https://laohu8.com/S/AAPL\">Apple</a> (AAPL), <a href=\"https://laohu8.com/S/KO\">Coca-Cola</a>(NYSE:KO)or <a href=\"https://laohu8.com/S/WFC\">Wells Fargo</a> (WFC). But this does not make it a bad investment.</p>\n<p>These commentators, together with the Warren Buffett fan club who blindly follow their icon, fail to understand why Buffett invested in Kraft Heinz. So I shall attempt to break it down in this short article.</p>\n<p>What Works For Buffett Will Not Work For You</p>\n<p>Most of Berkshire’s (BRK.A) investments in stocks are held by its insurance companies. Buffett has always utilized the float from his insurance businesses to invest wisely and to enhance his returns. Very smart, but I guess that you cannot follow suit because you may not own any insurance companies.</p>\n<p>The remainder of its stock portfolio is held within the finance, rail and utilities, and at the holding company level of the <a href=\"https://laohu8.com/S/BRK.B\">Berkshire Hathaway</a> group.</p>\n<p>Dividends of stocks at the insurers are 8.4% (40% of the 21% federal rate).Dividends on stocks held by the other subsidiaries and the holding company are taxed at 6.2% (30% of the 21% federal rate).</p>\n<p>So, let us focus on Kraft Heinz -Berkshire owns approximately 26.7% of that company.</p>\n<p>Buffett's Kraft Heinz shares are held by the parent company and because Berkshire owns more than 20% of the business, but less than 50%, it is deemed to be in 'a position of control' and so must account for its investmentusing the “equity method” of accounting.</p>\n<p>From a tax standpoint, dividends are taxed by the holding company at 4.2%, which is an 80% discount from the 21% corporate tax rate.</p>\n<p>Now consider that Kraft Heinz is a mature business which is stable but beyond the rapid growth phase of yesteryear. It does, however, generate nice levels of cash with its collection of well known consumer brands. So, without any significant opportunity to grow, decisions on allocation of the capital being generated by the business are relatively straight forward - return capital to shareholders by way of dividend!</p>\n<p>It is for this reason that it has a payout ratio of circa 75% and it pays almost a 4% yield. And so it suits Berkshire Hathaway that this cash cow is paying out 75% of its profits as dividends.</p>\n<p>Berkshire benefits greatly by earning profits as dividends because of the low taxes that it pays on dividends - something that does not apply to you or the<i>Warren Buffett fan club</i>who blindly follow the guru.</p>\n<p>For this <a href=\"https://laohu8.com/S/AONE\">one</a> holding in Berkshire's vast portfolio the dividend from a stable cash cow is what Buffett is looking for. And since Berkshire is in a “position of control,” I expect Buffett is driving the payout ratio as high as possible.</p>\n<p>I expect that <a href=\"https://laohu8.com/S/AONE.U\">one</a> day Buffett will exit the Kraft Heinz position. Perhaps Berkshire will take a brand and some cash and avoid a realized taxable cash gain. Buffett is the master of mitigating tax liabilities. However, the kind of tax avoidance mechanism available to Buffett are not available to you and me which is why blindly following buffet is foolish.</p>\n<p>By way of example, just look at how Buffett acquired <a href=\"https://laohu8.com/S/BGC\">General</a> Re-Insurance.</p>\n<p>For those not familiar with what happened, allow me to explain. In 1998 the entire stock market was overpriced and Berkshire was trading at more than 3x book. Buffett believed that Berkshire and its shares were worth approximately half of that price. So, how does Buffett play this situation?</p>\n<p>He used $22 billion worth of his overpriced stock as currency to acquire General Re. Buffett effectively acquired the investment portfolio of General Re, which he valued at $25 billion. And because he thought his stock was being priced by the market at twice its intrinsic value, he effectively paid the equivalent of $11 billion of value for $25 billion of assets! Genius!</p>\n<p>The Gen Re portfolio was 90% fixed income products which allowed Buffett to switch from a heavy concentration of over-priced equity investments into much better valued bonds. Best of all, because he used Berkshire shares as currency for the deal rather than cash he managed to reduce his portfolio exposure to an overpriced equity market by approximately half without paying a cent of capital gains tax, then at 35%. Even more of a genius!</p>\n<p>I cover this kind of thing in my book \"Success in the Stock Market\" if any of you is interested in learning more.</p>\n<p>So, returning to the topic of this article, what works for Buffett will not work for you.</p>\n<p>Accounting for positions using the equity method requires that Berkshire’s pro-rata portion of Kraft Heinz’s reported income be included in Berkshire’s income and serves to increase Berkshire’s cost basis by the amount of the pro-rata profit. Dividends received are an offset, effectively a return of capital, and reduce Berkshire’s cost basis by the amount of the dividend. The combination increases the cost basis by the amount of undistributed earnings. Cash taxes are paid by Berkshire only on the amount received as dividends. The undistributed earnings (retained by Kraft Heinz) are included in a deferred tax liability and are payable when Berkshire receives a cash distribution or when it sells the position. The deferred tax liability is created using Berkshire’s corporate tax rate of 21%. Berkshire applies a Dividend Received Deduction “DRD” on the dividends it receives as it expects undistributed earnings to ultimately be distributed. It’s this assumption by Berkshire that allows it to offset its 21% tax rate with an 80% deduction. Thus dividends from Kraft Heinz are now taxed at 4.2% and the deferred tax liability building for retained earnings by Kraft Heinz is established using a 21% tax rate.</p>\n<p>Now consider the situation for you and me if Kraft Heinz was in our own private portfolio. With little or no capital growth prospects all we have is the dividend income. That is paid out of Kraft Heinz's net earnings (so after it has paid corporate tax) and when we receive the dividend we are subject to income tax (double taxation!)</p>\n<p>While Buffett enjoys greater tax efficiency, we suffer great tax inefficiency. This is why following everything the Sage of Omaha does is foolish. This, in my humble opinion, includes investing personally in Kraft Heinz.</p>\n<p>Kraft Heinz is a mediocre business with little prospect for growth and some of its brands are in fact in decline.I wouldn't buy it. I wouldn't recommend you to buy it either. But for Buffett it does make a great deal of sense (commentators/journalists in the investing community take note!).</p>\n<p>If you want to derive the financial benefits that Buffett is able to extract from his investment in Kraft Heinz and other holdings in his portfolio then my advice to you is to invest in Berkshire Hathaway rather than investing in the companies that Berkshire Hathaway invests in.</p>\n<p>Berkshire Hathaway - Underpriced By At Least 20%</p>\n<p>I believe Berkshire Hathaway to be vastly underpriced today as I shall go on to explain.</p>\n<p><img src=\"https://static.tigerbbs.com/bd35aaa75c637e9b1f67c110081a4d0e\" tg-width=\"635\" tg-height=\"417\" referrerpolicy=\"no-referrer\">Data byYCharts</p>\n<p>Valuing Berkshire Hathaway is a complex affair due to the fact that it requires analysis on a sum of parts basis. I could write a small book on a single valuation and so it is well outside the scope of this article.</p>\n<p>However, there are some quick and dirty valuation techniques that one may deploy to provide a good indication of value. They invariably require a little Sherlock Holmes sleuth work of reading between the lines to find valuable valuation clues. Allow me to explain one of them.</p>\n<p>Buffett is still buying back Berkshire Stock at an unprecedented rate. This is a first major clue.</p>\n<ul>\n <li>Buffett bought back about $9bn of stock in H2 2020 and buybacks continue at pace.</li>\n <li>There were approximately $6.6 billion worth of buybacks during Q1 2021.</li>\n <li>Buybacks in the second quarter of 2021 may be calculated as follows. The April 22ndForm 10-Q filing reveals the amount spent on buybacks between March 31st(end of Q1) and April 22nd.So this is known to be $1.4 billion. On June 21stBerkshire’s13D filing(associated with its regular contribution of Berkshire shares to the Gates Foundation - $4.1bn USD on this occasion) allows us to calculate buybacks that occurred between April 22ndand June 21st. We do this by taking the statement of Buffett’s economic interest of 15.8% to calculate the number of shares outstanding at June 21st. This indicates that Berkshire had 2.265 billion class B share equivalent outstanding on June 21 (with class A stock converted to class B). This is down about 23 million since March 31 and 18 million lower that the April 22 figure. The implication being that over $5bn of stock was repurchased in <a href=\"https://laohu8.com/S/QTWO\">Q2</a> 2021. But June 21stis not the end of Q2, so if we extrapolate the data to the end of the quarter we arrive at approximately $7bn of repurchases in Q2.</li>\n</ul>\n<p>So in the last 12 months Buffett has spent a not insignificant $22.6bn buying back Berkshire stock.</p>\n<p>What does this tell us?</p>\n<p><a href=\"https://laohu8.com/S/FBNC\">First</a>, let’s take a step back and consider what we know about Buffett's threshold for buying back stock.</p>\n<p>Share buy-backs are among the most misunderstood and also the most abused aspects of modern capitalism. This is a huge topic and I devote an entire chapter of my book to it for anyone interested. However, for the purpose of this article know this. When executed above true book value (most of the time) buybacks will erode shareholder equity.</p>\n<p>This is not particularly well understood by shareholders or C-Suite executives. Accordingly I shall use this opportunity to explain how this works in practice with a simple analogy.</p>\n<p>Imagine owning a $1m house equally with your partner. Personally you also have $750,000 cash in the bank, so the total value of your personal assets is half of the house ($500,000) plus $750,000 cash. A total of $1.25m.</p>\n<p>You offer to buy your partner’s share in the house which has a book value of $500,000 (half of $1m).</p>\n<p>You ought to be happy paying anything up to $500,000 (a multiple to book that is less than or equal to 1) but you should not be prepared to pay more than that number. Buying at a premium (where the PB multiple is greater than 1) erodes the total value of your assets by the amount of the premium paid. If you don’t believe me, allow me to demonstrate the fact.</p>\n<p>If you pay $600,000 for your partner's share of the house (a multiple of 1.2x book) what do your assets look like after the deal? You now have a $1m house and a balance of $150,000 cash in the bank. Now your total asset value has shrunk from $1.25m to $1.15m. You have eroded your personal wealth by $100,000 which is the amount by which you overpaid for the share of the house.</p>\n<p>The same is true when repurchasing company stock above book – it destroys shareholder value in exactly the same way.</p>\n<p>The opposite is also true - so repurchasing below book is accretive to shareholder value.</p>\n<p>While a repurchase operation will always be presented as a means of returning value to the shareholders, the ugly truth is that buy-backs more often than not destroy shareholder value.</p>\n<p>Buffett understands this very well. Judging by the number of companies that repurchase their own stock at huge premiums to book I can confidently say that Buffett is one of the few CEOs who does understand it.</p>\n<p>The quick witted readers will now be asking, “Why then has Buffett been paying 1.1x book and then 1.2x book for stock repurchases?”</p>\n<p>Great question!</p>\n<p>The answer is simple and it brings us back to our Sherlock Holmes conclusions on the valuation of Berkshire Hathaway.</p>\n<p>Many of the assets bought by Buffett over the years are recorded on the Berkshire Hathaway balance sheet at cost rather than at their true market value. Said differently, the value of Berkshire's assets is vastly understated in its annual and quarterly reports. This means that when Buffett says that he will repurchase at 1.2x book, what he is actually saying is that the book value understates the true value of the business and that every 83 cents on the balance sheet is really worth $1 in the real world. This means that 1.2x of reported book value is equivalent to no more than 1.0x real book value.</p>\n<p>Now I hope that you can see where I am going with my detective work.</p>\n<p>Buffett is way too sharp to destroy shareholder equity by overpaying for Berkshire Stock, not least because he is Berkshire's largest shareholder! Buffett will only be interested in allocating capital in such a way that is accretive to shareholder value, namely at a multiple of book less than 1.0x.</p>\n<p>Now consider that no-one, other than perhaps Charlie Munger, knows the true value of Berkshire Hathaway better than Buffett. So, reading between the lines, Buffett is telling us that the true value of the business is at least 20% higher than the share price implies, we ought to capitalize on that information!</p>\n<p>It is also worthy of note that as the number of shares decreases due to buybacks, the price per share representing a true 1.0x book value also increases. Appreciation in the underlying value of balance sheet assets also pushes the threshold price higher. This explains why Buffett is constantly re-assessing the price at which he is prepared to buy back his own stock.</p>\n<p>I hope that this was helpful.</p>\n<p>I devote an entire chapter of my book \"Success in the Stock Market\" to the topic of buybacks and so I have only scratched the surface in this comment. If you are interested in learning more please take a look at the book.</p>\n<p>By the way, I am long Berkshire Hathaway. I believe it to be vastly undervalued currently and my more detailed analysis suggests that it is trading at between 69c and 77c on the $1. For this reason I think that Buffett will continue to repurchase for quite some time to come.</p>\n<p>I wish you every success in your investing endeavours.</p>","collect":0,"html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>Berkshire Hathaway: At Least 20% Underpriced, And The Kraft Heinz Position</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nBerkshire Hathaway: At Least 20% Underpriced, And The Kraft Heinz Position\n</h2>\n\n<h4 class=\"meta\">\n\n\n2021-07-05 11:02 GMT+8 <a href=https://seekingalpha.com/article/4437727-berkshire-hathaway-at-least-20-percent-underpriced-and-the-kraft-heinz-position><strong>seeking alpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Summary\n\nInvestment commentators seem to derive a misplaced sense of schadenfreude from Buffett's investment in Kraft Heinz.\nThe Warren Buffett fan club blindly follow the Sage of Omaha and have not ...</p>\n\n<a href=\"https://seekingalpha.com/article/4437727-berkshire-hathaway-at-least-20-percent-underpriced-and-the-kraft-heinz-position\">Web Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","type":0,"thumbnail":"","relate_stocks":{},"source_url":"https://seekingalpha.com/article/4437727-berkshire-hathaway-at-least-20-percent-underpriced-and-the-kraft-heinz-position","is_english":true,"share_image_url":"https://static.laohu8.com/e9f99090a1c2ed51c021029395664489","article_id":"1166658180","content_text":"Summary\n\nInvestment commentators seem to derive a misplaced sense of schadenfreude from Buffett's investment in Kraft Heinz.\nThe Warren Buffett fan club blindly follow the Sage of Omaha and have not been well rewarded in relation to their personal investments in Kraft Heinz.\nThe truth is that neither group understands the Kraft Heinz investment made by Buffett. It makes sense for him in a way that would not work for you and me.\nI shall explain all and hopefully allow you to understand the Kraft Heinz investment.\nI also provide an appraisal of Berkshire Hathaway today being at least 20% underpriced and a great value investment.\n\nIntroduction\nWarren Buffett is an undeniable investing genius. His results speak for themselves. However, blindly following Buffett - as many investors do - is foolish as I shall explain.\nThere exists an army of investors who closely watch the legendary investor's every move. If he buys something then the \"Warren Buffett fan club\"follows suit and they buy into the same company. I guess this is simply human nature. If someone appears to have the Midas touch then everyone wants a piece of the gold that he is creating.\nCertain investing websites allow investors to track Buffett and to blindly follow suit. Kraft Heinz (KHC) is a perfect example of why this kind of behaviour is ill advised.\nMany investment commentators question Buffett's investment in Kraft Heinz. The company certainly hasn't performed as well as other Buffett investments such as Apple (AAPL), Coca-Cola(NYSE:KO)or Wells Fargo (WFC). But this does not make it a bad investment.\nThese commentators, together with the Warren Buffett fan club who blindly follow their icon, fail to understand why Buffett invested in Kraft Heinz. So I shall attempt to break it down in this short article.\nWhat Works For Buffett Will Not Work For You\nMost of Berkshire’s (BRK.A) investments in stocks are held by its insurance companies. Buffett has always utilized the float from his insurance businesses to invest wisely and to enhance his returns. Very smart, but I guess that you cannot follow suit because you may not own any insurance companies.\nThe remainder of its stock portfolio is held within the finance, rail and utilities, and at the holding company level of the Berkshire Hathaway group.\nDividends of stocks at the insurers are 8.4% (40% of the 21% federal rate).Dividends on stocks held by the other subsidiaries and the holding company are taxed at 6.2% (30% of the 21% federal rate).\nSo, let us focus on Kraft Heinz -Berkshire owns approximately 26.7% of that company.\nBuffett's Kraft Heinz shares are held by the parent company and because Berkshire owns more than 20% of the business, but less than 50%, it is deemed to be in 'a position of control' and so must account for its investmentusing the “equity method” of accounting.\nFrom a tax standpoint, dividends are taxed by the holding company at 4.2%, which is an 80% discount from the 21% corporate tax rate.\nNow consider that Kraft Heinz is a mature business which is stable but beyond the rapid growth phase of yesteryear. It does, however, generate nice levels of cash with its collection of well known consumer brands. So, without any significant opportunity to grow, decisions on allocation of the capital being generated by the business are relatively straight forward - return capital to shareholders by way of dividend!\nIt is for this reason that it has a payout ratio of circa 75% and it pays almost a 4% yield. And so it suits Berkshire Hathaway that this cash cow is paying out 75% of its profits as dividends.\nBerkshire benefits greatly by earning profits as dividends because of the low taxes that it pays on dividends - something that does not apply to you or theWarren Buffett fan clubwho blindly follow the guru.\nFor this one holding in Berkshire's vast portfolio the dividend from a stable cash cow is what Buffett is looking for. And since Berkshire is in a “position of control,” I expect Buffett is driving the payout ratio as high as possible.\nI expect that one day Buffett will exit the Kraft Heinz position. Perhaps Berkshire will take a brand and some cash and avoid a realized taxable cash gain. Buffett is the master of mitigating tax liabilities. However, the kind of tax avoidance mechanism available to Buffett are not available to you and me which is why blindly following buffet is foolish.\nBy way of example, just look at how Buffett acquired General Re-Insurance.\nFor those not familiar with what happened, allow me to explain. In 1998 the entire stock market was overpriced and Berkshire was trading at more than 3x book. Buffett believed that Berkshire and its shares were worth approximately half of that price. So, how does Buffett play this situation?\nHe used $22 billion worth of his overpriced stock as currency to acquire General Re. Buffett effectively acquired the investment portfolio of General Re, which he valued at $25 billion. And because he thought his stock was being priced by the market at twice its intrinsic value, he effectively paid the equivalent of $11 billion of value for $25 billion of assets! Genius!\nThe Gen Re portfolio was 90% fixed income products which allowed Buffett to switch from a heavy concentration of over-priced equity investments into much better valued bonds. Best of all, because he used Berkshire shares as currency for the deal rather than cash he managed to reduce his portfolio exposure to an overpriced equity market by approximately half without paying a cent of capital gains tax, then at 35%. Even more of a genius!\nI cover this kind of thing in my book \"Success in the Stock Market\" if any of you is interested in learning more.\nSo, returning to the topic of this article, what works for Buffett will not work for you.\nAccounting for positions using the equity method requires that Berkshire’s pro-rata portion of Kraft Heinz’s reported income be included in Berkshire’s income and serves to increase Berkshire’s cost basis by the amount of the pro-rata profit. Dividends received are an offset, effectively a return of capital, and reduce Berkshire’s cost basis by the amount of the dividend. The combination increases the cost basis by the amount of undistributed earnings. Cash taxes are paid by Berkshire only on the amount received as dividends. The undistributed earnings (retained by Kraft Heinz) are included in a deferred tax liability and are payable when Berkshire receives a cash distribution or when it sells the position. The deferred tax liability is created using Berkshire’s corporate tax rate of 21%. Berkshire applies a Dividend Received Deduction “DRD” on the dividends it receives as it expects undistributed earnings to ultimately be distributed. It’s this assumption by Berkshire that allows it to offset its 21% tax rate with an 80% deduction. Thus dividends from Kraft Heinz are now taxed at 4.2% and the deferred tax liability building for retained earnings by Kraft Heinz is established using a 21% tax rate.\nNow consider the situation for you and me if Kraft Heinz was in our own private portfolio. With little or no capital growth prospects all we have is the dividend income. That is paid out of Kraft Heinz's net earnings (so after it has paid corporate tax) and when we receive the dividend we are subject to income tax (double taxation!)\nWhile Buffett enjoys greater tax efficiency, we suffer great tax inefficiency. This is why following everything the Sage of Omaha does is foolish. This, in my humble opinion, includes investing personally in Kraft Heinz.\nKraft Heinz is a mediocre business with little prospect for growth and some of its brands are in fact in decline.I wouldn't buy it. I wouldn't recommend you to buy it either. But for Buffett it does make a great deal of sense (commentators/journalists in the investing community take note!).\nIf you want to derive the financial benefits that Buffett is able to extract from his investment in Kraft Heinz and other holdings in his portfolio then my advice to you is to invest in Berkshire Hathaway rather than investing in the companies that Berkshire Hathaway invests in.\nBerkshire Hathaway - Underpriced By At Least 20%\nI believe Berkshire Hathaway to be vastly underpriced today as I shall go on to explain.\nData byYCharts\nValuing Berkshire Hathaway is a complex affair due to the fact that it requires analysis on a sum of parts basis. I could write a small book on a single valuation and so it is well outside the scope of this article.\nHowever, there are some quick and dirty valuation techniques that one may deploy to provide a good indication of value. They invariably require a little Sherlock Holmes sleuth work of reading between the lines to find valuable valuation clues. Allow me to explain one of them.\nBuffett is still buying back Berkshire Stock at an unprecedented rate. This is a first major clue.\n\nBuffett bought back about $9bn of stock in H2 2020 and buybacks continue at pace.\nThere were approximately $6.6 billion worth of buybacks during Q1 2021.\nBuybacks in the second quarter of 2021 may be calculated as follows. The April 22ndForm 10-Q filing reveals the amount spent on buybacks between March 31st(end of Q1) and April 22nd.So this is known to be $1.4 billion. On June 21stBerkshire’s13D filing(associated with its regular contribution of Berkshire shares to the Gates Foundation - $4.1bn USD on this occasion) allows us to calculate buybacks that occurred between April 22ndand June 21st. We do this by taking the statement of Buffett’s economic interest of 15.8% to calculate the number of shares outstanding at June 21st. This indicates that Berkshire had 2.265 billion class B share equivalent outstanding on June 21 (with class A stock converted to class B). This is down about 23 million since March 31 and 18 million lower that the April 22 figure. The implication being that over $5bn of stock was repurchased in Q2 2021. But June 21stis not the end of Q2, so if we extrapolate the data to the end of the quarter we arrive at approximately $7bn of repurchases in Q2.\n\nSo in the last 12 months Buffett has spent a not insignificant $22.6bn buying back Berkshire stock.\nWhat does this tell us?\nFirst, let’s take a step back and consider what we know about Buffett's threshold for buying back stock.\nShare buy-backs are among the most misunderstood and also the most abused aspects of modern capitalism. This is a huge topic and I devote an entire chapter of my book to it for anyone interested. However, for the purpose of this article know this. When executed above true book value (most of the time) buybacks will erode shareholder equity.\nThis is not particularly well understood by shareholders or C-Suite executives. Accordingly I shall use this opportunity to explain how this works in practice with a simple analogy.\nImagine owning a $1m house equally with your partner. Personally you also have $750,000 cash in the bank, so the total value of your personal assets is half of the house ($500,000) plus $750,000 cash. A total of $1.25m.\nYou offer to buy your partner’s share in the house which has a book value of $500,000 (half of $1m).\nYou ought to be happy paying anything up to $500,000 (a multiple to book that is less than or equal to 1) but you should not be prepared to pay more than that number. Buying at a premium (where the PB multiple is greater than 1) erodes the total value of your assets by the amount of the premium paid. If you don’t believe me, allow me to demonstrate the fact.\nIf you pay $600,000 for your partner's share of the house (a multiple of 1.2x book) what do your assets look like after the deal? You now have a $1m house and a balance of $150,000 cash in the bank. Now your total asset value has shrunk from $1.25m to $1.15m. You have eroded your personal wealth by $100,000 which is the amount by which you overpaid for the share of the house.\nThe same is true when repurchasing company stock above book – it destroys shareholder value in exactly the same way.\nThe opposite is also true - so repurchasing below book is accretive to shareholder value.\nWhile a repurchase operation will always be presented as a means of returning value to the shareholders, the ugly truth is that buy-backs more often than not destroy shareholder value.\nBuffett understands this very well. Judging by the number of companies that repurchase their own stock at huge premiums to book I can confidently say that Buffett is one of the few CEOs who does understand it.\nThe quick witted readers will now be asking, “Why then has Buffett been paying 1.1x book and then 1.2x book for stock repurchases?”\nGreat question!\nThe answer is simple and it brings us back to our Sherlock Holmes conclusions on the valuation of Berkshire Hathaway.\nMany of the assets bought by Buffett over the years are recorded on the Berkshire Hathaway balance sheet at cost rather than at their true market value. Said differently, the value of Berkshire's assets is vastly understated in its annual and quarterly reports. This means that when Buffett says that he will repurchase at 1.2x book, what he is actually saying is that the book value understates the true value of the business and that every 83 cents on the balance sheet is really worth $1 in the real world. This means that 1.2x of reported book value is equivalent to no more than 1.0x real book value.\nNow I hope that you can see where I am going with my detective work.\nBuffett is way too sharp to destroy shareholder equity by overpaying for Berkshire Stock, not least because he is Berkshire's largest shareholder! Buffett will only be interested in allocating capital in such a way that is accretive to shareholder value, namely at a multiple of book less than 1.0x.\nNow consider that no-one, other than perhaps Charlie Munger, knows the true value of Berkshire Hathaway better than Buffett. So, reading between the lines, Buffett is telling us that the true value of the business is at least 20% higher than the share price implies, we ought to capitalize on that information!\nIt is also worthy of note that as the number of shares decreases due to buybacks, the price per share representing a true 1.0x book value also increases. Appreciation in the underlying value of balance sheet assets also pushes the threshold price higher. This explains why Buffett is constantly re-assessing the price at which he is prepared to buy back his own stock.\nI hope that this was helpful.\nI devote an entire chapter of my book \"Success in the Stock Market\" to the topic of buybacks and so I have only scratched the surface in this comment. If you are interested in learning more please take a look at the book.\nBy the way, I am long Berkshire Hathaway. I believe it to be vastly undervalued currently and my more detailed analysis suggests that it is trading at between 69c and 77c on the $1. For this reason I think that Buffett will continue to repurchase for quite some time to come.\nI wish you every success in your investing endeavours.","news_type":1,"symbols_score_info":{"BRK.A":0.9,"BRK.B":0.9,"KHC":0.9}},"isVote":1,"tweetType":1,"viewCount":455,"commentLimit":10,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"symbols":[],"verified":2,"subType":0,"readableState":1,"langContent":"EN","currentLanguage":"EN","warmUpFlag":false,"orderFlag":false,"shareable":true,"causeOfNotShareable":"","featuresForAnalytics":[],"commentAndTweetFlag":false,"andRepostAutoSelectedFlag":false,"upFlag":false,"length":4,"xxTargetLangEnum":"ORIG"},"commentList":[],"isCommentEnd":true,"isTiger":false,"isWeiXinMini":false,"url":"/m/post/155764943"}
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