Thursday, June 14, 2012

BRK: Buffett's stagnant pond

Everyone keeps an eye on what the Sage of Omaha is buying and selling. Warren Buffett is a rock star among traders. When I think of the famed value investor, I see him moving around Nebraska's "Gateway to the West" surrounded, like Lady Gaga,  by his posse and pursued by paparazzi eager for a photo and perhaps a stock tip.

KO, WFC, PG, WMT -- Buffett's portfolio is legendary, and there are websites out there in the Cloud dedicated solely to keeping track of his holdings.

But Buffett, as president and CEO of Berkshire Hathaway, is a business owner in his own right, and today I will run Berkshire through my analytical engine and see what I think of Buffett's management.

Berkshire Hathaway Inc. (BRK) started as an insurance company, but under Buffett's leadership it has become a holding company, vacuuming up as subsidiaries a number of companies that Buffett likes and taking heavy stakes in others.

BRK has two flavors of stock. Class A, which has voting rights, presently trades for $121,936 a share and has no options contracts. Class B, which lacks voting rights, trades for about $81 and does have options contracts.

The charts for the classes are fairly similar, but I'll use the more widely traded (and affordable!) Class B for my discussion.

BRK has basically been in the doldrums since February, moving in a sideways pattern ranging from about $82 down to $78. It is presently trading above the mid-range, with 1.6% to go before it hits the high price of the current sidewinder, set May 7.

Big picture, the sideways pattern comes in what looks to me, on the weekly chart, to be a downtrend confirmation in the making.

Coming off a 2009 recession low, BRK made a higher low of $68.48 in May 2010 on its way up to a swing high of $87.65 in February 2011. From there, it declined to $67.55 in September 2011, and now has risen to the present sideways movement in the low $80s. That amounts to a lower high following a lower low. That is a downtrend.

The counter argument is that BRK could well break above the $82.59 high and continue upward. On the weekly chart, it would need to peak above $87.65 to negate the downtrend.

Berkshire Hathaway has return on equity of 7%, on the low side of the range that usually piques my interest, and long-term debt is just a bit higher than I like, at 35% of equity.

Earnings have risen sharply the last three quarters, with two surprises, one to the upside last quarter and another to the downside the quarter before that.

Institutions own a bare 18% of shares, and of the Class B shares is slightly above parity -- it takes $1.35 in shares to control a dollar in sales.

(The low institutional ownership is unsurprising. Owning Berkshire means that you're putting investment strategy in Buffett's hands. If I ran a gazillion dollar institutional portfolio, I would much prefer that my own team and advisers make the investment decisions.)

The analyst consensus is mildly negative.

BRK on average trades 4.5 million Class B shares daily. That support a good selection of option strike prices, with high open interest and narrow bid/ask spreads.

Implied volatility stands at 17%, in the lower half of the six-month range, and has been stair-stepping higher since June 7.

Option prices assume that 68.2% of trades over the next month will fall between $77.25 and $85.41, for a maximum gain or loss of 5%.

Berkshire Hathaway most like will next publish earnings in August (no date has been announced). It pays no dividends, no doubt a reflection of Buffett's preference that companies retain their earnings in order to grow capital value.

Decision for my account: Not to detract from Buffett's sagely reputation, but BRK is not a trade that I would want to make. The chart, the implied volatility, the low return -- all have the swampy smell of a stagnant pond inhabited by dragonflies and frogs, and perhaps an odd gekko or two.

Having said that, there is a way to play BRK that could be profitable: Selling iron condors, a four-leg options construction that profits when a stock stays within a range. The options pricing would allow construction of an iron condor wide enough to cover both the ceiling and the floor of the recent trading range. 

For example, if I sell the July $80 call and $77.5 put, and hedge that by buying the July $82.5 call and $75 put, I have a position that will make $110 per contract in the remaining five weeks of its life if the stock remains between about $76.40 and $83.60. The risk is only slightly higher than the reward, and the buying power effect of the trade is only $146 at my brokerage. Lay on 10 contracts, and that's an easy grand.

An iron condor profits if a stock goes nowhere, and at this point, that's pretty much where I see BRK going.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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