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Stocks & Bonds

Bigger Berkshire, Trimmer Price

The purchase of Burlington Northern plus a stock split are big deals.

Editor's note: This article originally was published in Kiplinger's Personal Finance magazine. Read our updated online coverage for the latest developments involving Berkshire stock.

Berkshire Hathaway is about to expand just as its share price is about to slim down (although slimmer does not necessarily mean cheaper). It is a convergence of events that investors may find hard to resist.

Berkshire, of course, is Warren Buffett’s holding company, a crazy quilt of operating units and a portfolio of stocks worth $57 billion. In a major bet on the long-term health of the U.S. economy, Berkshire says it will buy the 77% of Burlington Northern Santa Fe Railway that it doesn’t already own for $34 billion. If consummated, the deal would be Berkshire’s largest acquisition ever.

Burlington’s appeal. Berkshire appears to be paying a rich price for the railroad, which operates in the western two-thirds of the U.S. Its $100-a-share bid is 31% higher than the price at which Burlington closed on November 2 (the day before the deal was announced). But Burlington may be worth more under Berkshire’s umbrella than by itself. A railroad is a cash-intensive business, and Berkshire can use the float on premiums collected by its various insurance businesses to improve Burlington’s returns at low cost, says Larry Coats, manager of Oak Value Fund.

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The Omaha company’s other major announcement was that it intends to split its Class B shares (symbol BRK-B) 50 for one. Buffett has long resisted splitting Berkshire’s famously high-priced shares: The Class B shares closed on December 4 at $3,320; the Class A shares (BRK-A) closed at $99,689. A single Class A share is now worth 30 Class B shares; it will be worth 1,500 B shares after the split. Berkshire wants to split the B shares to make it easier for Burlington investors to take stock for the deal instead of cash.

The split, expected to take effect early in 2010, won’t change the value of anyone’s Berkshire holdings. Nor will a split affect any of the stock’s fundamental measures of value, such as its ratio of price to book value (assets minus liabilities), a key yardstick for valuing insurance companies, a major component of Buffett’s empire.

But the split will make the shares more accessible to investors who want a piece of Buffett, and it will raise Berkshire’s trading volume. That increases the likelihood that Standard & Poor’s -- which considers a stock’s liquidity, among other things, when deciding which companies to include in its indexes -- will add Berkshire to the S&P 500 index. And that will almost certainly result in a short-term pop in the share price because index funds that track the S&P 500 will immediately add Berkshire to their portfolios.

Insurance, including high-profile Geico, accounts for about one-fourth of Berkshire’s business. Berkshire’s other units range from Dairy Queen to Clayton Homes to See’s Candies. It also controls MidAmerican Energy, a collection of electrical utilities, and Marmon Group, a manufacturing conglomerate. Berkshire’s investment portfolio includes sizable stakes in Coca-Cola, Wells Fargo and Procter & Gamble.

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Although valuing Berkshire is tricky because of all its moving parts, the stock does appear to be cheap. The Class A shares have traded at an average of 1.5 times book value over the past five years. Berkshire’s book value as of September 30, 2009, was roughly $81,200 per share, suggesting a fair value of about $122,000 per share, or 18% above the December 4 closing price. Morningstar pegs the fair value of the Class A shares at $131,000, suggesting even greater upside potential. If you can’t afford Berkshire today, buy the B shares after the split.