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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 211739  
Subject: Re: Buffett premium Date: 2/25/2013 9:28 AM
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I have a feeling that the next CEO will be approached all the time.

Of course the next CEO will be approached all the time. I'm sure the supply of pitch books will only increase over time. That's obvious given Berkshire's size and capability to do deals.

But that is not the question. The issue is whether Warren Buffett has the capability to make deals that his successor will not be able to make. And the answer to that seems obvious to me. There are two major categories of deals that historically have been made by Buffett that will be much harder for his successor to emulate: (1) Deals of the "stamp of approval" variety in which Berkshire gets very favorable terms in exchange for Buffett's implicit or explicit approval of management and its strategy. These deals have been common since the financial crisis. (2) Deals where the sellers care more about the business than maximizing the proceeds from the sale because of Buffett's reputation to "hold forever" and allow existing management to continue operating the business without micromanagement from headquarters (although capital allocation always has been up to Buffett after acquisitions).

In terms of relative importance to Berkshire's intrinsic value, the first "stamp of approval" category is arguably more important because there are fewer deals that "move the needle" in the second category given Berkshire's current size. It is possible that the next CEO will also have a strong reputation but his stamp of approval is not going to be worth anything remotely close to Buffett's stamp of approval, at least not for a very long time.

The question that started this thread was regarding the Buffett "premium". The answer to this question is that Berkshire's intrinsic value will indeed be lower when Warren Buffett is no longer CEO. However, as long as Berkshire's market value remains far below an estimate of intrinsic value and as long as that estimate of intrinsic value does not bake in any "Buffett Premium", this is really a theoretical exercise. I think it makes much more sense to calculate IV without explicitly factoring in the special skills of Warren Buffett and treating any incremental value created over (hopefully) many more years to come as an added bonus.
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