Warren Buffet

Warren E. Buffett, 2005

For several years in a row, Berkshire Hathaway (Berkshire) had undertaken the uneasy task of identifying an appropriate acquisition opportunity that would allow it to increase its net worth significantly. The search came to an end on May 25th, 2005 when the company’s CEO, Warren Buffett, announced that MidAmerican, a subsidiary of Berkshire, would acquire the electric utility company PacifiCorp for $5.1 billion in cash and $4.3 billion in liabilities and preferred stock. PacifiCorp was a leading, low-cost energy producer and distributor that served 1.6 million customers in six states in the western United States. It had merged with Scottish Power in 1999.

The deal once again spurred public curiosity about Warren E. Buffett’s personality and his long-term value-based investment philosophy.

Key principles of Warren E. Buffett’s investment philosophy:

1. Investing behavior should be rational and based on information, analysis and self-discipline, not on emotions.

2. Investment decisions should depend on the economic performance at the level of the business rather than on accounting values that do not reflect essential information, i.e. information on intangible assets.

3. Intrinsic value, the discounted value of future cash flows, is the only logical way to evaluate the attractiveness of an acquisition. Book value does not provide a precise measure of intrinsic value so it may not truly reflect the economic performance of the business. Furthermore, the gain in intrinsic value measured as the value added by a business above its cost of capital is the real indicator of long-term economic performance, not accounting profit.

4. When determining the intrinsic value of a business, unlike what the capital asset pricing model suggests, a relatively risk-free discount rate, such as the rate of return on long-term US T-bonds, should be used. The rationale behind this approach is that Hathaway uses almost no debt financing...