For Buffett Fans, the Price Is Right

WARREN BUFFETT HAS TAKEN ADVANTAGE of the past year's financial turmoil to make more than $20 billion of promising investments for Berkshire Hathaway, including preferred stock and warrants issued by Goldman Sachs and General Electric , and a convertible issue from Swiss Re, the European reinsurer.

Buffett's investment coups haven't registered on Wall Street, where Berkshire's class A shares (BRK.A) are languishing at around $85,000. Down 12% this year, and way below their late 2007 peak of $149,000, the shares haven't participated much in the stock market's rally since the end of March.

Yet Berkshire itself looks appealing, at just 1.2 times our estimate of its current book value of $72,000 a share. In the past decade, the stock has traded for an average of 1.6 to 1.7 times book value, a measure of shareholder equity per share. The current price-to-book ratio is near the low reached in early 2000, when Berkshire's stock bottomed at about $40,000.

One fan tells Barron's that the stock could top $110,000 in the next year. If so, it would trade for roughly 1.4 times our estimate of book value in 12 months: $80,000 a share. That price target doesn't seem outlandish in view of the projected price-to-book-value ratio. In a better economic and financial environment, Berkshire might even trade up to $125,000 a share, implying a multiple of book value closer to the 10-year average.

Berkshire's class B shares (BRK.B), worth 1/30th of the A shares, fetch about $2,750 each. The B shares look like a better buy than the A shares, because they sell at a 3% discount to their theoretical value. But the discount has persisted for some time, and could continue, as the B shares can't be converted into A shares.

Berkshire's book value, which stood at $66,250 per share as of March 31, likely has risen since then because of the market's powerful rally. That has lifted the value of the company's famed equity portfolio, which now totals more than $50 billion. The market value of Berkshire's equity and bond derivatives also has increased, and we assume the company earned more than $1,000 a share from operations in the second quarter, in line with reported first-quarter figures. That's how we arrive at an estimated book value of $72,000 a share.

Following Buffett's advice, most Berkshire watchers focus on book value as a measure of the company's valuation, as reported earnings can be distorted by realized investment gains and losses. Historically, Berkshire's shares have tracked changes in book value.

The sluggish performance of Berkshire's shares may owe to several factors. Investors recently have favored economically sensitive and other "offensive" stocks; Berkshire is perceived to be defensive due to its financial strength, including a cash position of $23 billion on March 31.

Also, investors remain concerned about Buffett's miscalculated sale of long-term put options on $35 billion of equity indexes, including the Standard & Poor's 500, when stock prices were much higher. The puts showed a loss of about $5 billion on March 31, and it is difficult to value them based on Berkshire's limited disclosure. Berkshire has taken a big hit, as well, on some of its own equity holdings, including large stakes in ConocoPhillips (COP) and American Express (AXP). Both stocks have fallen more than 50% from their highs.

IT ALSO DOESN'T HELP THAT SHARES of property-and-casualty insurers are out of favor amid concerns about weak insurance pricing. Berkshire owns Geico, the No. 3 domestic auto insurer, as well as reinsurer General Re and a specialized reinsurance business focused on hurricanes, earthquakes and other high-risk events shunned by many insurers. Some investors worry, too, that Berkshire's large size -- the company now has a market value of $132 billion -- makes it tough for Buffett to generate high returns. Then there is his age: The Great One turns 79 next month.

None of these issues, save Buffett's age, is significant. Buffett sounded upbeat at Berkshire's annual meeting in May, saying he thought Berkshire stock could best the S&P 500 in the coming years. He noted that the stock hadn't kept pace with the growth in retained earnings in recent years. Asked whether Berkshire's competitive advantage would die with him, Buffett replied that Berkshire's strengths, including a unique business mix and culture, long-term orientation and patient shareholder base, will outlive him.