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No. of Recommendations: 17

Here are a few excerpts (with permission) from Paine Webber's take on Berkshire's 3rd Quarter results. Although most owner/partners have learned not to make investment decisions on short-term news and events, the report does give long-term investors some interesting insights.

1. “The stock is discounted approximately 25% to intrinsic value.”
2. “Book value appears likely to end the year at least level with 1998.”
3. “Updating our valuation model for current interest rates, float level and other assumptions, it appears that our estimate of Berkshire's value will have declined approximately 10% in 1999. This change is due almost entirely to the impact of rising interest rates, which similarly affects the value of the market as a whole (an impact that has shown up dramatically in the prices of interest-sensitive financial stocks, but not in all affected sectors or the market averages).”

4. “In a quarter that would not seem to lend itself to new investing activity, Berkshire put nearly $3 billion of new capital to work by adding more than $500 million to its equity portfolio”
5. “Also noteworthy is the $36 billion of cash and fixed income securities that remained on the balance sheet at September 30. The company therefore was still positioned defensively,”

6. “Float increased 7.5% to $24.5 billion from $22.8 billion”

7. “The results being reported by General Re are likely to improve, but only gradually unless there is a significant improvement or “turn” in industry pricing, which we don't expect to occur within the next year.”
8. “General Re's business model and franchise are very strong, and we believe the business is not “broken” as some investors have suggested, and can return to its former levels of profitability.”
9. “General Re's underwriting results can't be compared easily to those of peer companies, because peers may be reporting more optimistically as well as using reinsurance to smooth results”
10. “We are aware that some investors, especially those not used to the leveraged and cyclical nature of the insurance industry, believe that the General Re acquisition is a failure. Without defending the underwriting results General Re is currently reporting, it's important to remember that insurers are in the volatility business, and the impact of inadequate pricing and underwriting have a magnified effect over short time periods compared to other industries. Short-term results are therefore not necessarily a reliable indicator of long-term performance for a reinsurer.”
11. “Berkshire's third quarter operating earnings of $103 per share declined 52% from 1998. Primarily the decline was attributable to a $384 million total underwriting loss by General Re that cost $164 per share. Included in this result is the impact of a loss General Re ceded to National Indemnity of $46 per share that would have been assumed by Berkshire even if it had not acquired General Re. Adjusted to exclude the $119 per share net underwriting loss from General Re ($164 less $46), Berkshire's operating earnings would have increased 4.1% in the quarter.”

12. “To understand the impact on GEICO's near-term earnings and long-term prospects of high growth, consider that for a typical insurer it costs $1.30 for every dollar of premium received to acquire a new customer. Thus, the insurer reports a 30% underwriting loss on first-year policies. However, in subsequent years the customer is more likely to run at a profit of 10-20%. Present-valuing the earnings stream over the average life of a policy explains why GEICO can create significant economic value through high growth even though that growth reduces short-term accounting earnings.”
13. “Allstate has moved from being a relatively weak competitor of GEICO to being a more serious competitor, but it is the independent agency companies that are most threatened by this move, rather than GEICO.”

14. “National Indemnity's catastrophe reinsurance business had an extremely good quarter from a loss perspective, especially considering the high level of industry catastrophes in the quarter.”

15. “Flight Service segment is growing 35-40%”

16. “General Re integration, insurance cycle, capital markets volatility, dependence on key management, excess capital.”

This material is copyrighted to PW and has been reprinted with written permission.

Contact your local Paine Webber office for a copy of this insightful 14-page 3Q report on Berkshire.

PW still rates Berkshire attractive.
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