Question: Warren E Buffett 2005: Assess Berkshire’s investment in Buffett’s Big Four: American Express, Coca-Cola, Gillette, and Wells Fargo. Why did Buffett choose each of these companies?
27 Oct 2022,8:38 AM
CASE QUESTIONS: Warren E Buffett 2005
- Past performance: Discuss Berkshire Hathaway’s business strategy during 1965-2004. How well did Berkshire Hathaway perform during that period? Using financial databases (such as Bloomberg, Datastream, Yahoo Finance, etc.), assess Berkshire Hathaway’s performance in the past 10 years. Comment on your findings.
- Investment assessment: Assess Berkshire’s investment in Buffett’s Big Four: American Express, Coca-Cola, Gillette, and Wells Fargo. Why did Buffett choose each of these companies? How much is the annual return on investment on each company and all four as a whole?
- Investment valuation: Evaluate Berkshire Hathaway’s investment in MidAmerican Energy Holdings in 2000. Using the information from Exhibit 6, calculate the net gain to Berkshire Hathaway in 2000 dollars. First, calculate the free cash flow accruing to Berkshire from MidAmerican each year from 2001 to 2004. Second, discount the cash flows to year 2000 and compare with Berkshire’s investment in MidAmerican. Assume tax = 40% on EBIT, discount rate r = 9%, growth rate for the steady period starting 2004 g = 2%. Correction: Exhibit 6, Balance sheets, Assets: “Properties, plants, and equipment” and “Goodwill” figures are “gross” amount, not “net”. Clearly state your assumptions if any.
- Market reaction: What does the stock market seem to say about the acquisition of PacifiCorp by Berkshire Hathaway? Specifically, does the deal create value? If so, for which party? What does the $2.55 billion increase in Berkshire Hathaway’s market value represent? How does that fit in the literature of acquirer’s announcement returns?
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Choice of valuation methods: What do you think PacifiCorp is worth on its own before its acquisition by Berkshire? Which valuation method should you use to value PacifiCorp and why? Show clearly the steps to arrive at the following estimates in Exhibit 10 and assess whether the valuation process done in the case is reasonable. Create a football field graph summarizing all the valuation measures.
Enterprise Value as Multiple of: MV Equity as Multiple of:
|
|
Revenue |
EBIT |
EBITDA |
Net Income |
EPS |
Book Value |
|
Median |
6,252 |
8,775 |
9,023 |
7,596 |
4,277 |
5,904 |
|
Mean |
6,584 |
9,289 |
9,076 |
7,553 |
4,308 |
5,678 |
If you need to use a discount rate to discount cash flows then an appropriate discount rate estimate for PacifiCorp is approximately 9%.
- Bid assessment: How do you assess the bid for PacifiCorp by Berkshire Hathaway? How much does Buffett pay for PacifiCorp for its equity and as a whole? How do these values compare with the firm’s intrinsic values estimated in Exhibit 10? Does Buffett overpay for the deal?
- Investment philosophy: Critically assess Buffett’s investment philosophy. Identify the points where you agree and disagree with him.
Expert answer
Buffett has always been a very savvy investor, and his choices of investments reflect this. He chooses companies that he believes will perform well over the long term, and that have sound management teams in place. His investment in Coca-Cola is a perfect example of this; the company has consistently performed well over many years, and has a strong management team in place.
The annual return on investment for Berkshire's investment in Buffett's Big Four companies is as follows:
Disclaimer: The information on Pehdih is supplemental and for academic revision purposes only and is not a substitute for professional educational teachings from your tutors.
