In a previous piece, I covered two of Whitney Tilson’s recent picks from last week’s Value Investing Congress (Netflix, Inc. (NASDAQ:NFLX) and Spark Networks Inc (NYSEAMEX:LOV)). Now, I’ll look at Tilson’s other two picks from that Congress — American International Group Inc (NYSE:AIG) and Berkshire Hathaway Inc. (NYSE:BRK.B).
Not your father’s American International Group Inc (NYSE:AIG)
Tilson believes that American International Group Inc (NYSE:AIG) is now a leading, “financially sound,” multi-line insurance company focused on its core businesses; specifically, property and casualty insurance.
Recently, American International Group Inc (NYSE:AIG) has been a tremendous performer — shares are up nearly 40% in the last six months — but Tilson thinks there’s more to come. He expects the company to increase its buyback program and initiate a dividend.
Most interestingly, Tilson sees the Treasury’s exit from AIG as a big boon to the stock. He admits that he “can’t prove it,” but suspects that AIG’s management has been intentionally holding back on the firm’s true earnings potential.
This is because, while the firm was under partial government ownership, management’s individual earnings were limited. But now, since the Treasury has sold out of its remaining AIG stock, the company has adopted a more traditional pay structure.
In short, management will deliver and push shares higher because they are incentivized to do so — under the government, they weren’t.
Ultimately, Tilson believes AIG shares will rally to at least $54, and as much as $79.
But is this realistic? Tilson’s case appears fairly sound, but there are a few facts that should be considered.
The problems with investing in AIG
The first is that AIG is one of the most beloved stocks in the hedge fund community. That is to say, it’s one of the most owned stocks among funds, which might be interpreted as a good thing — the smart money likes AIG. But it can also have a downside — if funds start to exit en masse, shares can rapidly tumble.
Like AIG now, Apple was a hot stock among funds last summer. When several of those funds exited last fall, shares of the Cupertino tech giant dropped.
The second is, as I already mentioned, the fact that AIG has rallied so significantly in recent months — is the rally overextended at this point? If AIG is an attractive investment, then the performance of the last six months shouldn’t matter. But if all the hedge funds have already bought in, and shares have already rallied so significantly, perhaps it’s too late to get in.
The last is that, despite the fact that AIG seems reformed, investors still associate the company with the larger global financial system (the Federal Reserve remains its regulator as a systemically important financial institution). In the event of a market sell-off, AIG could be hit particularly hard.
Buying Buffett is still a good bet
In addition to AIG, Tilson also likes Warren Buffett’s company, Berkshire Hathaway Inc. (NYSE:BRK.B). Like AIG, Berkshire’s stock has been rallying, but Tilson still believes it’s 15% below its “intrinsic value.”
Tilson cites Nomura’s work, noting that an analyst doing a sum of the parts valuation estimated Berkshire Class A shares to be worth roughly $184,000 per share (they currently trade near $167,000).
Of course, Tilson has been a fan of Buffett for years. In February 2012, Tilson told CNBC viewers he was buying Berkshire stock aggressively and believed that it had 50% upside. At the time, Class A shares were trading just below $120,000.
Tilson also took that opportunity to respond to a common criticism Berkshire investors face — why buy Buffett’s company when you can just buy the stocks he invests in?
Buffett’s biggest holding is Wells Fargo & Co (NYSE:WFC)
For example, Berkshire holds a significant stake in Wells Fargo & Co (NYSE:WFC) — roughly 7.5% of the bank.
As Berkshire’s largest holding, Buffett wouldn’t shoot down anyone’s idea to invest in Wells Fargo. The bank sports a solid 3.2% dividend and trades with a below-market PE ratio of 10.8.
Despite new banking regulations, Buffett told attendees at Berkshire’s recent shareholder meeting that he continues to like Wells Fargo and doesn’t expect another bubble to originate from the banking system anytime soon.
No more middleman
So why not just cut out the middleman and buy Wells Fargo’s stock directly? Because, as Tilson said, Berkshire is much more than that. About half of Berkshire’s holdings are private companies.
Berkshire holds dozens of companies outright, including GEICO, Fruit of the Loom, Dairy Queen, and Lubrizol. The only way to get access to these companies is by buying Berkshire stock.
The Berkshire bear case
But buying Berkshire might not be such a simple slam dunk after all. CNBC contributor Doug Kass was featured at the Berkshire shareholder meeting this year as the token bear. Kass is short shares of Berkshire.
Kass’ bear thesis is largely composed of two parts: issues of succession and issues of size.
No doubt, Berkshire’s impressive performance in recent decades has been driven by the business prowess of Buffett and Charlie Munger. The former is 82, the latter is 89, and neither is immortal.
When Buffett and Munger are gone, can Berkshire continue to deliver such impressive results? Kass doubts it.
Kass’ second issue is one of size. Over the last several years, Berkshire has grown to be a tremendously large company. Kass notes that in years past, the firm hunted for acquisition targets that might be referred to as “gazelles” — today, the firm must buy “elephants.”
As Berkshire is so large, it might be expected to perform like a stock index, and is therefore incapable of outperforming the broader market.
Tilson’s picks
As opposed to Tilson’s Spark Networks and Netflix picks, AIG and Berkshire appear to be more solid investments. Yet, they aren’t without issue. Investors should do their own homework before following anyone into a trade.
The article Why Whitney Tilson Thinks You Should Buy AIG, Berkshire Hathaway originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
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