warren buffet executive summary

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Finance 3717 for Shan HE, LSU, Warren Buffet Case Study Executive Summary

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Bradford Kilshaw
FIN 3717
Shan He

Warren E. Buffett, 2005On May 24, 2005, CEO of Berkshire Hathaway Inc., Warren Buffet, stated that one of the company's subsidiaries, MidAmerican Energy Holdings Company, acquired the electric utility PacifiCorp. MidAmerican bought PacifiCorp from its parent company, Scottish Power plc, for $5.1 billion cash and $4.3 billion in preferred stock and liabilities. This acquisition was the second largest of Buffet's career and his largest since 1998. Warren Buffet has long been viewed as one of the most savvy investors in the world. With an estimated net worth of $44 billion, he is one of the richest men walking the planet. Public interest in Buffet rose highly again with the large scale purchase of PacifiCorp.While at Columbia University, Warren Buffet studied under Benjamin Graham, noted for developing a method for identifying undervalued stocks. His method focussed on the value of assets like cash, net working capital and physical assets, and ultimately, Buffet modified it to focus on valuable franchises going unrecognized in the market as well. Buffet's investing strategy includes several different philosophies. Some approaches he uses include: economic reality, the cost of lost opportunity, value creation, risk and discount rates, diversification, investing behavior driven by information, analysis, and self-discipline, setting emotion aside, alignment of agents and owners, and measuring performance based on intrinsic value instead of profits.The first of Buffetts philosophies, Economic Reality, has been crucial in his successes. A key to this approach is that he defined economic reality as the level of the business itself, not the market, the economy, or the security. Buffet is a fundamental analyst of the businesses he is considering investing in. He sought to judge the simplicity of the business, operating history consistency and the attractiveness of its long-term prospects. Quality of management and the firms capacity to create value are also greatly taken into account. His philosophy, Value Creation: Time is Money, keys in on intrinsic value. Buffett defines intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. He mentions that, intrinsic value is all important and is the only logical way to evaluate the relative attractiveness of investments and businesses. Buffetts fifth philosophy focusses on risk and discount rates. In a conventional approach, the more risk one takes, the more return there should be on the investment. However, Buffett constantly avoids risk, and therefore uses a risk-free discount rate. He focused solely on firms with predictable and stable earnings. Buffett says, Risk comes from not knowing what youre doing. To a normal person/investor, this might sound arrogant. It is known that Buffett is an expert who clearly knows what hes doing. Warren Buffet and his partners are looking for very particular criteria in acquiring businesses, as they have been doing this for many years. Buffet speaks of searching for simple businesses, but at the same time they are constnatly searching for the proverbial elephants, which could be smart invetment opportunities. PacifiCorp would fall under a "large purchase", being that it earned $420.2M before taxes in 2005 and $393.5M in 2004. After taxes, PacifiCorp had net incomes of $248.1M and $251.7M in 2004 and 2005, respectively. The increase in income from 2004 to 2005 is positive news. Operating expenses decreased $192.3M from 2004 to 2005, which may show greater efficiency in terms of equipment and supplies. It appears, barring some sort of internal management conflict, that this is a good investment for Berkshire.