Monday, February 01, 2010

Berkshire Hathaway's Stock Split

Last week, I and a lot of other investors bought shares in Berkshire Hathaway for the first time in our lives, and were rewarded with some lucky timing. Berkshire Hathaway's A shares climbed to an inaccessible price years ago (they closed at $114,600 on Friday), and the B shares closed at $3,376.00 before the split, so most investors have never had the chance to buy into Warren Buffett's famous money making machine.
First, the company's B shares (BRK.B) split 50 to 1 on January 21, bringing the price down to an affordable $71.00. As word spread that investors could buy a few shares in the famous investor's company, the price started to go up. The new split price opened 5.1 percent higher on Monday than it had closed the previous Friday.
But the fun didn't stop there.
On January 26, Standard & Poor's 500 announced that Berkshire Hathaway would be added to the S&P 500 index, replacing Burlington Northern, which it had acquired. I learned in business school that being added to a big index adds a bit to a stock's value, as mutual funds add the stock to their portfolios. You can see the spike in price and trading volume last Wednesday morning. But the BRK.B share price continued to climb, as more investors bought the shares; volume remained high the rest of the week.
Last week's trading activity illustrates several important points about finance. Except for a quick bump from being added to the S&P 500 (which institutional investors probably knew was going to happen), finance theory teaches that BRK.B should not have climbed 7.0 percent in one week when the index fell 1.7 percent. There wasn't that much news about the underlying business. The efficient market hypothesis claims that, given perfect information, no security would behave in such an anomalous fashion. (Of course, stocks do that all the time, which even the most famous finance professors struggle to explain.)
Buffet's success over the years may be the most decisive exception to the efficient market hypothesis of our lifetime. He just shouldn't be that good.
How then can one explain Berkshire Hathaway's performance last week? Small investors drove the price up as they took the opportunity to buy into Buffett's legendary portfolio of companies. Warren Buffett didn't become a smarter investor in the course of the week (except that the stock split seems like a winning move).
What sets Buffett apart is that he buys businesses, not stocks. He doesn't acquire a company until he has taken a very close look, and decided he likes the management, which he rarely changes. He knows more about the companies he buys than the rest of the market, and he has learned to use his considerable market information and buying power to cut good deals. So the efficient market hypothesis holds; it's just that Buffett has better information and the means to exploit it.

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