The Next Great Value Investor At Berkshire

by Adam Brownlee

In 47 years of performance from 1965 to 2011, Berkshire Hathaway‘s (BRK) book value has blitzed the S&P 500 in all but eight years, turning in a 19.8% annual gain versus the S&P’s 9.2%.

For many Berkshire shareholders, this performance is the result of one man’s savvy,Warren Buffett; and with succession plans lingering, many wonder, will the returns continue?

Succession at Berkshire has been a major shareholder topic of discussion for some time now. In the 2007 annual shareholder letter, Buffett said that were he to die “tonight,” the company would have three outstanding candidates for the CEO role, half of his job. The investment role however, had yet to be filled.

As the years passed, at each shareholder meeting a question would spring up asking for news regarding the search and, invariably, the same response would come back that “the search continued.” Finally, in 2011 with the hiring of Todd Combs, Buffett at least had a man waiting in the wings and in the 2012 Berkshire annual letter, he announced the board had in fact picked an unidentified individual to succeed him.

The burning question now is, just who is this potential candidate and can the future of Berkshire be found in that individual’s investing style and picks?

Todd Combs graduated from Columbia Business School in 2002 and served briefly as a bank regulator and insurance executive before launching Castle Point Capital, a long/short financial service hedge fund. Combs maintained a solid, annualized return of 6.24% as the CEO and director of the fund from its inception in 2005 until 2010.

Since joining Berkshire in January 2011, Combs has made a couple of very Buffett-like investments in the companies of Dollar General (DG) and MasterCard(MA). The Dollar General position is reminiscent of a hallmark, Buffett position. Wal-Mart (WMT) and MasterCard seem to echo American Express (AXP), which Berkshire began purchasing in 1994. A head-to-head comparison of the Dollar General and Wal-Mart positions may shed some light on the future of Berkshire.

The second candidate is Ted Weschler. Before joining Berkshire in 2012, Weschler ran Peninsula Capital Advisors, a hedge fund out of Charlottesville, Virginia. Like Buffett, Weschler focuses on a small set of companies and “is obsessed with reading corporate annual reports, running a concentrated portfolio and holding investments for long periods of time.”

He takes a “total immersion” approach to analyzing companies, “educating himself on every available bit of public information and then digging in much deeper with management and people throughout the industry.

Dollar General is the micro Wal-Mart of the retail industry, located in communities too small for Wal-Mart. In business since 1955, the company offers a “carefully edited assortment” of popular retail household products such as cleaning supplies and health and beauty aids, and sports brand names such as Procter & Gamble, Kellogg, General Mills and Nabisco.

In 2011, Berkshire purchased 1.5 million shares of Dollar General for approximately $46.5 million. As of early summer 2012, Dollar General is trading at $52.38 making the position worth approximately $78.5 million.

Wal-Mart is the world’s number one retailer with some 2.2 million employees and more than 4,000 stores, including 3,000-plus supercenters that sell groceries and general merchandise. Net sales increased by nearly 6% in 2012 while net income dropped by almost $700 million or 4.3% compared to last year.

Berkshire purchased Wal-Mart in 2005 and 2009 paying an average share price of $48. With a holding of 39 million shares (end of 2011) and a current share price of $67.70, the position is worth approximately $2.6 billion with a built-in profit of $610 million.

The Buffett Analysis
In general, Buffett-style investments exhibit the following characteristics:

  • An underlying business with a durable, competitive advantage
  • A long-term track record of steady increasing earnings
  • A higher than average return on equity
  • The ability to retain earnings
  • Low long-term debt
  • Healthy margins
  • A strong initial rate of return and a competitive future value and rate of return.

A financial statement analysis reveals that both Dollar General and Wal-Mart strike true on many of these metrics.

In terms of companies with a durable competitive advantage, think of the Coca-Cola’s of the world, the Hershey’s, Kellogg’s and Gerber’s. The recipe for chocolate has not changed much over the past 100 years and it is likely that in the next 20, folks will still be reaching for a Hershey’s chocolate bar or sipping on a refreshing Coke.

Both Todd Combs and Ted Weschler bring solid investing prowess to the Berkshire table. In the past, they both delivered strong hedge fund results during a tumultuous time. Combs, in particular, has recently made some very Buffett-like investments and although a thorough analysis will not predict the future or post-succession Berkshire returns, it does seem to reveal that Buffett-like investments have a future in the fold of Berkshire.

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