The Insider Trade You Can't Afford to Miss
In 5 Top Financials Insiders Are Buying Now, I pointed to Don Keough's sizeable purchase of Berkshire Hathaway (NYS: BRK.B) shares during the current spate of market volatility board member. I suggested that this is a positive indicator since Keough, a former president of Coca-Cola (NYS: KO) and current Berkshire board member, has an outstanding track record as a businessman. But does a great businessman always make a good investor? How meaningful an indicator is this trade for prospective shareholders?
The track record speaks for itself
In order to answer those questions, I took a look at Keough's prior reported purchases of Berkshire Hathaway in order to determine whether they were made during opportune periods (i.e. when the shares were cheap!):
BRK-A Annualized Return*
S&P 500 Annualized Return (incl. dividends)*
Dec. 17, 2003
May 12, 2004
Jan. 5, 2005
June 6, 2011
Aug. 8, 2011
Source: SEC Filings, Standard & Poor's.
*Through Aug. 19, 2011.
On a relative basis, Keough's trades aren't awful -- they beat the S&P 500 by somewhere between two and three percentage points on an annualized basis. However, that outperformance is due to Berkshire's ability to grow at an above-average rate, not Keough's ability to spot when the shares were undervalued.
On an absolute basis, sub-3% returns are unacceptable for an equity investment. You could argue that if the shares are currently undervalued, they understate Keough's returns. But even if Berkshire's stock were trading today at its 10-year average price-to-book multiple (1.55), Keough's best purchase would only have generated an annualized return of 9% -- which is barely sufficient to justify investing in shares.
The director disappoints
In sum, Keough doesn't appear to be a great investor based on his Berkshire purchases, but he does have an important redeeming quality: It looks like he is improving over time; every successive purchase is made at a cheaper valuation than the one that precedes it (on the basis of the price-to-book multiple). The difference between paying a 7% premium to book value (this month's buy) and paying a 76% premium (Keough's first buy) is enormous: Over a 10-year period, it corresponds to an annualized return that is roughly five percentage points higher!
Keough wasn't much help -- we need to look elsewhere to assess whether Berkshire shares are cheap. To begin with, at a price-to-book value multiple of just 1.07 (at Friday's closing price), the valuation contains virtually no premium for management's ability to compound Berkshire's book value. As a reminder, over the past 46 years, Warren Buffett compounded per-share book value at an annualized rate of 20.2%. Buffett won't be at the helm over the next 46 years, but even if he were hit by a bus tomorrow morning on the way to his offices at Kiewitt Plaza, one can still make a strong argument that the shares are undervalued.
A hint from within the Fool community
Motley Fool community member mungofitch does just that in a great post on the Fool's Berkshire Hathaway discussion board in which he values the company as a multiple of the assets available for investment. He estimates those assets as a weighted sum of the company's book value, its insurance float, and its deferred taxes (the share price have tracked this metric quite closely going back to 1996). Even if you assume industry-average investment returns from Berkshire's management going forward, and you value the shares at one times the estimate of investable assets, that would still peg them at nearly a 60% premium to Berkshire's book value.
"...the firm is unusually cheap right now"
It turns out that the share price tracks this metric quite closely going back to 1996. Based on the historical relationship between the two, mungofitch concluded it's "pretty obvious that on this particular metric of value ... the firm is unusually cheap right now ... On this metric, BRK is around 6% cheaper now than it was in March 2000 at $45,000." I agree. [For our very young readers: March 2000 was the top of the Internet bubble, during which period investors abandoned Berkshire Hathaway on the notion that it had become hopelessly outdated in the "new economy."]
This is the fourth article in which I've highlighted Berkshire Hathaway since August 9 (the others are here, here, and here), but this is a prize stallion worth flogging. When you see a hundred-dollar bill lying on the ground, do you pick it up and thank your good fortune, or do you walk idly by, thinking, "That can't be a hundred-dollar bill; if it were, someone would already have picked it up." Great investor or not, Keough's buy is one insider trade you can't afford to miss.
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At the time this article was published Fool contributorAlex Dumortierholds no position in any company mentioned.Click hereto see his holdings and a short bio. You can follow himon Twitter. The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Berkshire Hathaway. The Fool owns shares of and has created a ratio put spread position on Wells Fargo.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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