Warren E Buffet, 2005

What is the possible meaning of the changes in stock price for Berkshire Hathaway and Scottish Power plc on the day of the acquisition announcement? Specifically, what does the $2.55 billion gain in Berkshire’s market value of equity imply about the intrinsic value of PacifiCorp?

The possible changes in stock price for Berkshire Hathaway and Scottish Power plc on the day of acquisition announcement indicates the market approval for the acquisition and for both sellers value was created. Berkshire’s Class A shares price closed up 2.4% while Scottish Power’s shares jumped 6.28% and the S&P closed at 0.02% showing an overall approval. After the acquisition of Scottish Power plc class A shares reached $85,000.00, S&P 500 grew from 96 -1194. Buffet believed in his investment philosophy which created value to any business he obtained. Buffet created eight philosophies, these philosophies are;

1. Economic reality, not accounting reality.
2. The cost of the lost opportunity.
3. Value creation: time is money.
4. Measure performance by gain intrinsic value, not accounting profit.
5. Risk and discount rates.
6. Believed that investors should hold wide-range portfolio of stocks in order to shed company-specific risk.
7. Investing behavior should be driven by information. Information awareness is important for investing.
8. Alignment of agents and owners, treating his workers like family.

Buffet avoided risk and therefore used the risk-free discount rate. His firm also did not use debt financing and focus only on companies that had predictable stable earnings. Overall, Berkshire Hathaway was performing brilliantly and the Class A shares were amongst the highest shares on the New York Stock Exchange, partly because they had a split in stocks and dividends were never paid, retain corporate earnings.

The possible meaning of the changes in stock price is due to the fact that the deal created value for both buyers and sellers. Berkshire was more diversified after the acquisition and the $2.55 billion gain in Berkshire’s market value of equity implied that the intrinsic value of PacifiCorp was good because it fell within the range of competitors based on these calculations. 1.$2.55 / 312/18 million = $8.17 – Berkshire is willing to pay this premium for each share of PacifiCorp 2.5.1 / 312.18 million = $16.30 per share of PacifiCorp

The $2.55 billion gain in Berkshires market value imply that PacifiCorp’s intrinsic value could also indicate that the business can be modeled to add value that goes above and beyond the charge for use of capital in that business. The gain in their intrinsic value can be equivalent to the monetary profit and market-value-added measures used to earn returns in excess of the cost of capital. Berkshire’s alternative course of action to create value would be to come up with unique strategies that are different to its competitors to stay ahead. Also, continue investing in companies that only predict real stable growth over time.

Case 12: Value Line Publishing
1. What do the financial ratios in case Exhibit 7 tells you about the operating performance of Home Depot? What additional information do the different ratios provide? Complete and compare a similar analysis for Lowe’s.

Value Line Publishing shows the resilient competitive performance of Home Depot and the durable stock-market performance of Lowe’s. The two companies are head to head in fierce competitors with prompt expansion strategies that have doubled. Lowe’s and Home Depot have done well by going beyond the traditional home center and offering alternatives such as sales online and one stop design shopping. Both Home Depot and Lowe’s have entered the same markets where Home Depot has entered large metropolitan areas and Lowes on rural areas. Both companies have created competition that will have a competitive edge in prices. Both companies have dominated this industry and Home Depot has expanded to international markets, but Lowe’s has not.

Home Depot finances are based on sales forecasting decisions and inventory turnover, while Lowe’s looks at merchandising, pricing and market-share gains. Home Depot’s CEO goal is to make the stores efficient in operations and inventory turnover while at the same time cutting costs. He will focus on helping employees improve customer service and restocking shelves after hours.

The financial ratio of Home Depots shows that working capital has been growing yearly and over the past five years capital has doubled in the industry. Home Depot’s return on capital had a slight rise in the year 1999 of 17.3% which indicates how efficient Home Depot has been allocating its borrowed and owed funds to generate profitable returns. Over the course of 2000 and 2001 there was a slight decline by 2.2% and 2.1% respectively in their return on capital.

Home Depot’s cash operating expenses/sales in 2001 was 20.9%. This indicates that their operating expenses through sales have increased between 2000 and 2001 by 0.2% which is not a significant amount which could be explained by the changes made the CEO, Carrie Galeotafiore. Home Depot’s operating margin had the highest in 1999 of 9.9%. This indicates what proportion of the company’s revenue is left over after paying for wages and raw material. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.

Inventory turnover for Home Depot has been increasing every year. This ratio normally measures how many times a company’s inventory is sold on average to replace it inventory. In 2001 Home Depot’s inventory turnover is 5.4, indicating that inventory is turned over 4.5 times per year. Additional information of Home Depot shows that financial ratios help their business to constantly evaluate their performance, comparing it with their historical figures and the industry market competitors.

In recent years Lowe’s has caught a lot of attention in the investor community with its impressive performance. Lowes has grown significantly but it is still half the size of Home Depot. Lowe’s has to battle Home Depot on its home turf to keep growing at a steady pace, expanding into bigger markets such as Boston and New York. Although this can be a risky strategy there seems to be plenty of room to grow: Lowe’s now has only 50% of its stores in metro markets. Therefore there is still considerable market share to gain.