In: Finance
Berkshire Hathaway's 13-F filing for the third quarter of 2010 reported that Warren Buffett had reduced his stake in Nike, Inc. by $224 million, bringing his holding to 7.62 percent of the 480 million outstanding shares. Nike reported a core return on net operating assets (core RNOA) of 32.7 percent in its annual report for the year ended May, 2010. A summary of it balance sheet at fiscal year end follows:
Net operating assets $5,318 million
Net financial assets 4,436
Common equity $9,754 million
In mid-July, at the time that the annual report was published, Nike's shares traded at $68 each. By the end of September, the price had risen to $81.
Calculate the expected return form buying at the market price in mid-July with a forecast that Nike can grow residual operating income at 4 % per year. Now make the same calculation for the Setember price. Do you see why Buffett may have sold?
All financials below are in $ million, nos. of shares are in million and share price is in $ / share
Book value of operating assets = BVA = 5,318
Mid July situation
Market value of equity, MVE = Price per share x Nos. of shares outstanding = 68 x 480 = 32,640
Market value of operating assets = MVA = MVE - Net financial assets = 32,640 - 4,436 = 28,204
RNOA = 32.7%
g = growth in residual operating income = 4 % per year
If expected return form buying at the market price in mid-July = R then,
(R - g) x MVA = BVA x (RNOA - g)
Hence, (R - 4%) x 28,204 = 5,318 x (32.7% - 4%)
Hence, R = 4% + 5,318 / 28,304 x (32.7% - 4%) = 0.093924039 = 9.39%
September situation
Market value of equity, MVE = Price per share x Nos. of shares outstanding = 81 x 480 = 38,880
Market value of operating assets = MVA = MVE - Net financial assets = 38,880 - 4,436 = 34,444
If expected return form buying at the market price in September = R1 then,
(R1 - g) x MVA = BVA x (RNOA - g)
Hence, (R1 - 4%) x 34,444 = 5,318 x (32.7% - 4%)
Hence, R1 = 4% + 5,318 / 34,444 x (32.7% - 4%) = 0.0843115 = 8.43%
We can see R1 = 8.43% < R = 9.39%
As the share price has increased, the expected return has come down by nearly a 1% in just 2 months.
This might have led Buffet to believe that expected RNOA and expected growth in residual operating income may also change (decrease). It's the decline in expected RNOA and growth rate going forward, that might have prompted Buffet to sell.