Email – #508

There are good investors and there are great investors.

Berkshire Hathaway’s Warren Buffet falls under the latter category.

You’ve all heard the stories about his investing style and his returns. He has returned his investors hundreds of millions of dollars of returns on their investments and he has made billions along the way.

His investment style, while simple to understand, is not the only reason that he and Berkshire have succeeded. The way Buffett really makes money is by being extremely opportunistic and to buy when others are selling.

Take the recent crash for example. He stepped up and bought into GE and Goldman Sachs at or near their lows, parlaying his capital into hundreds of millions in profits.

You and I could have done the same, but the question becomes one of access. Berkshire has ultimate access to every deal on the street. To think that Buffett and Berkshire are not privy to non-public information would be a very naive position to take. But the world’s greatest investors have always had an edge; a way to get into the right deals at the right time.

That right time is almost always when others are heading in the opposite direction. They know the value of time.

Getting In Good On The Cheap

Up until now, there was no way to play Berkshire shares unless you wanted to pony up more than $4,000 per share or more than $120,000 per share if you wanted the same class of shares that Buffett owns.

That all changed about a month ago when Berkshire Class B shares split 50 for 1. That split did not affect the market value of the conglomerate, the business prospects or the management style. What it did was create a class of the shares that investors could buy at a perceived lower price.

Basically nothing much changed except for one really important and overlooked factor. The new Berkshire is now sporting options. And better still, it has LEAP options as well.

The current market looks very strong. We are involved in the long side and also the short side. I hate to be totally one-sided on any trade or market, and sometimes it pays to have insurance.

In our case we are short China for the next couple of years. But, there is also no denying that the market is trying to head higher regardless of all the signs that say it should be lower. That’s just how the markets work sometimes.

What we are going to do is get on board with the greatest investor and investment vehicle of our time, but with a pittance at risk compared to what we would have had to pay just two months ago.

The Play

If the market continues higher, so will Berkshire. If the market falters, Berkshire may still head higher as it contains a slew of recession proof investments. Of course, as a stock that trades in the market, the actual share price can move with the market, so there are no guarantees.

At current levels, BRK is not overvalued. It’s a company that has more than 70 operating companies and a ton of cash on its books.

Berkshire has historically been valued based on its book value. That number has averaged around 1.65 book. Based on current prices and a book value of around $80,000 per share, BRK is trading at about 1.5 times book value.

BRK as a stock is not immune to market pricing though. While the upside for this giant is exceptional considering its profitable enterprises and the hugely profitable bets it made when the markets touched their lows last year, it’s share price is still subject to investor whims in the short-term.

To counter the possibility that we are at or near a high in the market, we will buy the Berkshire January 2012 $80 call LEAPS (BRB’B JAN12 80C) in two tranches.

It is currently trading at $11.20 on the offer. This represents about a 14% of the current price of $81.67. So here’s where we’ll buy our first tranche:

If the market pulls back hard in the next couple of months, we will place our second trade when the shares are in the $60 to 70 range.

Our goal for Berkshire shares is to break the $100 mark within the next twelve months. At that level Berkshire will be trading at its historical book value based on the 2011 valuation at current growth rates. Of course, we will take profits sooner if the opportunity presents itself.

Buy the BRK’B JAN12 80C LEAPS at current levels and do not pay more than $11.20 .

Karim