Thursday, December 28, 2006

What's Berkshire Hathaway Worth, Anyway -- II ?

In October I shared a valuation analysis of Berkshire Hathaway Cl A common stock based on a multiple regression of BRK/A's book value and interest rates compared to its price. While the calculation is very simple it has had a surprisingly good fit with BRK/A selling price over the last 15 years.

At the time, based on the book value through mid-year, I estimated that the year-end 2006 fair value of BRK/A was about $105,000 per share. The chart above shows that Mr. Buffett's stock will likely finish the year near $110,000 and, according to our model is slightly over priced. Having said this, I have estimated BRK/A's year-end 2007 book value at $77,000. Using that figure and my estimate of interest rates, I arrive at a 2007 year-end "fair value" for BRK/A of just over $124,000. That is approximately a 13% expected return.

That seems like a good bet to me. Berkshire Hathaway is in a sweet spot in almost all of their businesses. I am still in the camp that believes that housing problems will slow economic growth more than expected. If this is the case, there is no stock I can think of that has more quality and profit potential than BRK/A.
PS. If anyone has a book value guess that you would like for me to plug into my model, please comment below, or email me. There are no Wall Street estimates that I see that I believe are reliable.

We own the stock in our Capital Builder style of management. It is the only stock we own that does not pay a dividend. DCM employees and my family own the stock.

This blog is for information purposes only. Do not make buy and sell decisions based on anything you read here. Please consult your own financial advisor.

Monday, December 25, 2006

Altria is Most Overvalued Dow Stock

Last week we explained that our Dividend Valuation Model was signalling that the Dow Jones Industrial Average was about 10% undervalued. We showed that with GE's recent dividend hike it was nearly 25% undervalued and one the cheapest stock in the Dow.

The obvious question that report raised was -- are there any stocks that are significantly overvalued? There are two stocks that our models rate as overvalued by at least 20%, Hewlett Packard, and Altria, the former Philip Morris. Of the two, Altria's Dividend Valuation Model is most convincing.

The chart below shows that Altria's current price is approximately 20% above its valuation "steps." The model also shows that the two previous times in the last 20 years when MO became overvalued for an extended period of time it experienced a sharp pullback.

We are not calling for a sharp pullback in MO, but we have a lot of confidence in our models and we believe MO is at least entering a period when valuation headwinds are likely to be swirling.

......................Altria Dividend Valuation................

Monday, December 18, 2006

Pfizer Hikes Dividend 21%: Good News or Bad News

A wise old doctor once told me that pharmaceuticals can harm and they can heal; they always have and they always will. He said that sometimes investors will focus on the healing side, and the drugs stocks will skyrocket; other times investors will focus on the harming side and they will go lower than you can imagine. Furthermore, there does not seem to be much in-between time, and the bad times can go on for a long time, just as can the good times. I have no idea when the current obsession with the harming side of the drug companies will end. I recently heard that 25 years ago the average person died of heart ailments in his or her late 60s. Today, at least in part because of incredible advances in medications related to the heart, the average person dies much later in life of cancer. Yet, new drugs to fight cancer are giving hope and longer years to millions of people. Today, Pfizer announced it was increasing its dividend 21%. Is this good news, or bad news? Is this a company with so many troubles that it is starting to pay people to stick with it? Or is this a company that is proud of its accomplishments in preserving and advancing health and is showing its belief in it own future and that of the pharmaceutical industry? Time will tell. For my money, I am a great fan of life, and most of the people I love have been granted longer life by medications from the drug companies. I know the harming side of the industry will always be with us, but as another wise person I know once said, "A person starts dying the day he is born." With today's announcement, Pfizer is now yielding over 4.5%. It's starting to look like a bond. Hmmm, I can receive bond-like income that is 85% free of federal income tax. In addition, our Dividend Valuation Model is signaling that PFE is nearly 20% undervalued. Not bad, especially when you consider, that one day I may wake up and the drug stocks will be "miracle healers" again. A wise man, or woman would not bet against that happening. This blog is for information purposes only. Do not make buy and sell decisions based on any information contained here. Please consult your own financial advisor.

Wednesday, December 13, 2006

GE: Price-Valuation Divergence is Growing

By Greg Donaldson and Mike Hull,

Donaldson Capital Management

We just completed a look at each stock in the Dow Jones Industrial Average through the lens of our Dividend Valuation Model.

Here's the good news. Among the 30 Dow stocks, the model shows that the average stock is about 10% undervalued. That is an important level because it is the same level of undervaluation that our top-down dividend valuation model is showing.

One of the most undervalued stocks in the Dow is General Electric. The interesting thing about GE is that it has had some good news lately that the market has completely ignored. CEO Jeffrey Immelt recently announced a 12% dividend hike, the third such double digit hike in as many years. He also confirmed earnings guidance for 2007 in the range of 10-13%.

GE has been a disappointing stock for the last few years. But a look at our dividend valuation chart for the company shows a wide gap has formed between the current selling price and the "fair value," as measured by historical relationships between dividends, interest rates and price.

Dividend Valuation Chart

The green candy cane at the far right of the chart below shows our dividend valuation model estimate of GE's price for the coming year. This is not an exact science, but it does give clues about how GE has acted in the past with the dividend growth and interest rates we are predicting for the coming year.

Probably the most important signal we see in the chart is that GE's valuation "steps" have been rising consistently for the last three years while the stock price has been flat to down. While the fit between GE and it dividend valuation is not particularly tight, it is clear that, except for the bubble in the late 1990s, GE's price has trended at the same angle as the model.

The divergence between price and valuation over the past three years is not likely to hold. Either valuation will come tumbling down, and soon, or price has a lot of catching up to do.

Our best guess is that GE might be as much as 25% undervalued.

..............GE Dividend Valuation........

This blog is for information purposes only. Do not buy and sell decisions based on the information contained here. Consult your own financial advisor.

Monday, December 11, 2006

Housing: It Ain't Over 'Til Its Over

There is a lot of wishful thinking about housing in the headlines. Today the National Association of Realtors projected that housing would turn NEXT quarter. So let me get this straight. That condo next to mine in the West, which sold for $X three years ago and is now is on the market for nearly $2X is likely to sell next quarter. At the risk of being persona non grata West of the Rockies, my answer to the National Association of Realtors and real estate speculators is, "Ain't no way." The skyrocketing prices of housing and the concurrent new construction in many parts of the country over the past 4 years have caused a glut that will take another year, maybe more, to work through. The reason is simple. Right across the street from my neighbor and me is a whole new development of handsome, nicely appointed units priced at $1.9X. I took a self guided tour through the development a few weeks ago, and I stumbled on one of the sub-contractors. I voiced my admiration of the workmanship and then asked him how they were selling. He said, "Funny thing; we had lots of interest in the project eight months ago, even some earnest money, but to my knowlege we have not sold any. That's not funny. That's called lack of demand, that's called too much supply. That's bad news for real estate and real estate investors. My story is purely anecdotal, but it is a symptom of why real estate in some parts of the country has a long way to go before its supply and demand reach equilibrium. Much of the Midwest is in good shape, but as I have said before, housing at the "right" address, or with a view of the mountains, lakes, oceans, or the 18th hole of a course that Jack built, is in for a long period of stagnation. Too much of it has been built, and in my judgment, some prices are likely to fall by more than most people believe, including my neighbors, mine, and the new development across the street. The reason is the banks. The developer of the project across the road from me probably hasn't thought about it, but his banker has been watching his progress. Bankers are nosey that way when it's their money. Bankers have sophisticated models that tell them how things are going, and they know in certain areas things are not going well. In another generation, in another real estate contraction, the banks played the bag holder. They hung in there with all the builders and speculators, and in the end, their bags held all the real estate, which they then sold for pennies on the dollar. A long history of bag holding has been a slow but sure teacher to the banks. They have decided they are not going to be the bag holder this time. They will call loans early and often. The reason is because they have a ready buyer -- private equity funds. Private equity funds will buy anything for the right price, and the banks have decided if they are always to be the bag holder when the dust clears they might as well sell their loans to the private equity funds sooner rather than later. This scenario sounds like tough medicine for the economy, and while it will be difficult if you are a big borrower with slow moving properties. The news is not all bad, however. This scenario implies a sharp, narrow correction in real estate that will resolve itself without major damage to the banks or to the economies of whole regions of the country. But having said this, this process will not be complete by next quarter. Furthermore, there will be very worrisome headlines in the weeks and months ahead about mortgage defaults and foreclosures that could make it Feel like the housing problem will go on indefinitely. The operative words in my judgment are sharp and narrow, but I'll keep you posted. The stock market is painting the best face on the financial facts at this time. But the facts will soon turn darker as a result of the lingering housing slowdown, and the current bull market will narrow dramatically. High-quality, blue chip stocks will be the only bull standing by the middle of 2007. Blue Chips will continue to get a lift from their international business, which will continue to be strong in 2007. Stocks have already priced in a Fed rate cut in March. Recent employment data is much too strong for a March rate cut. I think the cut will come much later and for cause. History shows us Fed rate cuts are not presaged by such a celebratory atmosphere as the one we are currently witnessing in the US stock market. Blue Chips are, indeed, underpriced by 10%, but the average stocks in no bargain. Next time: A look at some undervalued stocks. This blog is for information purposes only. Do not make buy and sell investment decisions as a result of anything you read here. Please consult your own financial advisor.

Wednesday, December 06, 2006

Donaldson Capital's New Website

At long last, Donaldson Capital has completed its new website. The link below will take you to the site directly. We began research on what kind of a website we really needed over a year ago. We wanted something that would share the "head and heart" of our firm. Mike Hull, Tom Piper, and Nick Donaldson did a great job of pulling together the content. A local advertising agency completed the creative work. This is our beta version, so if you see changes that need to be made, please email Nick Donaldson at Here is the link to the site: Merry Christmas and Happy New Year