New Trade $BRK/B – The Oracle’s Muse

by Enis January 28, 2014 12:27 pm • Commentary

Berkshire and Mr. Buffett were in the headlines last week after Bloomberg did a profile of Tracy Britt Cool, Buffett’s 29 year-old jack-of-all-trades at the conglomerate.  The article concluded:

The groundwork and relationships that she’s building through her travel and events like those will serve the next Berkshire CEO well, said Buffett, who hasn’t publicly identified his replacement.

“Tracy can be of particular value, I think, to my successor,” he said. “She’ll have so much operational familiarity with the really dozens of companies, probably more than anybody else.”

Putting aside Buffett’s sidekick though, the article focused my attention on BRK/B stock.  BRK/B went on an incredible run from its October 2011 low of $65.35 to its all-time high set in July 2013, near $120, almost doubling in that period.  Quite a feat for a $275 billion market cap company.  

The monthly chart shows just how strong that rally was:

[caption id="attachment_35464" align="alignnone" width="600"]BRK/B monthly chart, Courtesy of Bloomberg BRK/B monthly chart, Courtesy of Bloomberg[/caption]

However, the stock has clearly stalled out in the past 6 months, even as the broader market has continued to march higher.  BRK/B broke cleanly below its 200 day moving average on Friday for the first time since December 2011.  That’s a long time:

[caption id="attachment_35466" align="alignnone" width="600"]BRK/B daily, 200 day moving average in yellow, Courtesy of Bloomberg BRK/B daily, 200 day moving average in yellow, Courtesy of Bloomberg[/caption]

Fundamentally, Berkshire is a very well run holding company.  Buffet and Munger are legends for a reason.  The company gets about 25% of revenues from insurance, 25% from McLane company (an American supply chain services company), 15% from Burlington Northern, the railroad, and 35% from other businesses.  It’s quite concentrated in the U.S., though its industry diversification offers some protection in cyclical downturns.

However, when I look at valuation in BRK/B, it doesn’t look very cheap.  Buffett and Co. consistently point to Price/Book as their benchmark for value, and at 1.3x, it’s not high by any means.  But at 19x P/E with earnings growth of only 5% expected, the market is not getting a high return for the risk in the name.  A holding company like BRK/B usually doesn’t trade much above book in any case.  Loews (L) is a good example, trading at only 0.9x book.

In other words, the technicals are looking quite concerning, without a great fundamental valuation to protect the stock from a 10-15% correction to that long-term support around $100.  With that in mind, here’s the trade:

Trade: BRK.B ($112.03) Bought March 110/100 put spread for $1.30

-Bought 1 Mar 110 put for 1.53

-Sold 1 Mar 100 put at 0.23

Break-Even on Mar expiration:

Profits: between 108.70 and 100 make up to 8.70, below 100 make full 8.70

Losses: between 108.70 and 110 lose up to 1.30, max loss of 1.30 above 110

Trade Rationale:

Normally, we’d just buy the Mar 110 put outright, but we view the Mar 100 put as a good sale to cheapen the trade a bit since 100 is big long-term support, and skew is steep enough that the put is somewhat bid.  We debated waiting on the entry for this trade, to see if BRK/B could muster a bounce back to the 200 day ma around 114, but with the tepid bounce the past 2 days, we decided to enter the position today with an eye on an eventual break of $110 support in the next 6 weeks.