Buffett’s Sweetheart Deals Boost Berkshire’s Bottom Line

U.S. stock markets had a mixed week. The Dow Jones Industrial Average rose 0.29% even as the S&P 500 pulled back 0.44%. The tech-heavy Nasdaq tumbled 2.19%, while the MSCI Emerging Markets Index fell by 0.64%.

Your Smart Money Masters holdings continued to march to the beat of their own drummer. Navigator Holdings (NVGS) rose another 4.35%, continuing its recent strong recovery. Markel Corp (MKL) increased by 3.20%. Berkshire Hathaway (BRK-B) jumped 2.57% and Restaurant Brands International (QSR) eked out a slight gain.

This past week saw some big news surrounding Warren Buffett’s Berkshire Hathaway. Berkshire’s share price in 2017 has been nothing to write home about. The stock is up 5.41% so far this year, compared to the S&P 500’s 8.49%

This weak relative performance belies the impact of Buffett’s sweetheart deals, which keep generating extraordinary profits for Berkshire.

On Friday, Buffett exercised Berkshire’s warrants to buy 700 million Bank of America (BAC) common shares. This has been Buffett’s most profitable financial sector investment since the financial crisis of 2008.

In the summer of 2011, Berkshire Hathaway invested $5 billion in Bank of America through preferred stock, thereby helping the banking company raise capital to bolster its balance sheet. Buffett negotiated a 6% yield ($300 million annually in dividends) on his investment. The bailout also came with warrants to buy 700 million Bank of America shares for $5 billion at $7.14 a share.

Over the past six years, Bank of America’s share price has recovered strongly. At Friday morning’s trading price of $24.33, Berkshire’s warrants were in the money by about $12 billion. By Monday, Buffett was Bank of America’s second-largest shareholder.

Such deals give Buffett a huge edge over ordinary stock pickers.

Take the case of another Smart Money Masters recommendation, Kraft Heinz (KHC).

Recall that in 2013, Berkshire and Brazilian private equity firm 3G Capital acquired Heinz for about $23 billion, with each party paying 50% of the purchase price. Two years later, the pair struck a deal to merge Heinz’s iconic ketchup brands with Kraft Foods.

Since then, Kraft Heinz shares have performed strongly. In its 2016 shareholder letter, Buffett disclosed that Berkshire’s profit on the deal was near $20 billion, based on his initial investment of $9.8 billion.

The complexity and profitability of these deals suggest two things.

First, unlike what dozens of books tell you, you really can’t invest like Buffett. He doesn’t make his big returns betting on stocks. His outperformance comes from sweetheart deals that ordinary investors cannot replicate.

Second, you should feel comfortable in holding Berkshire despite its lagging share price in 2017. After all, the gains from Buffett’s complicated financial engineering eventually pass through to Berkshire Hathaway’s shareholders.

Portfolio Update

Several of your Smart Money Masters holdings are below their 50-day moving averages (MA) and are currently HOLDs. However, Navigator Holdings (NVGS) has gained ground and is now less than $0.50 below its 50-day MA.

Sincerely,

Nicholas A. Vardy