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Stocks & Commodities V. 34:13 (811): When Is Berkshire Hathaway Stock Good Value? by Tushar Chande, PhD

Uncovering The Best Deals

A value player and a speculator will define value differently.

Regardless, both can still benefit from identifying value in
stocks. Heres a look at some quantitative methods that value
players and momentum traders can apply to identify good
value in stocks.
by Tushar Chande, PhD

hat is value? Warren Buffettwho is known as the

Oracle of Omahahas given value investing its
icon, and the trajectory of Berkshire Hathaway stock
has been unrelentingly upward for decades. So its
interesting to pose the question: When is Berkshire Hathaway
stock good value? I must provide fair warning, though, because
as the Oracle declared wistfully in 2008, Beware of geeks
bearing formulas.
The problem is that value is in the eye of the beholder.
We paraphrase Buffett himself from his 1979 annual letter,

in which he implicitly defines proper valuation as a good

business purchased at a fair price. There is little doubt that
Berkshire Hathaway (Buffetts holding company) itself meets
the Buffett definition of a good business; how do you find
the fair price for its stock?
We use Buffett for inspiration when he said in 1990, The
most common cause of low prices is pessimism and further,
... we like pessimism because we like the prices it produces.
He seems to be looking for market extremes, or at the very
least, extremes in sentiment, warning in 1986 to be fearful
when others are greedy and greedy only when others are
fearful. Presumably, valuations are most favorable at market
extremes. In a casual, hand-waving way, he has referred to the
19731974 market low in the S&P 500 as a good example of
pervasive pessimism. In quantitative analysis, we could use
the 19731974 low in the S&P 500 as the template. Moreover,
in trading terms, value investing may be visualized as buying
after significant declines in market prices, and trading with-

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dizain/Shutterstock

When Is Berkshire Hathaway

Stock Good Value?

Stocks & Commodities V. 34:13 (811): When Is Berkshire Hathaway Stock Good Value? by Tushar Chande, PhD

Identifying major market

bottoms in the S&P 500

I analyze the signature of the S&P 500

major market lows since 1950 by using
monthly data, a 36-month simple moving average (SMA36), and the 36-month
standard deviation of monthly closes
(SD36). Every month, I standardize
the monthly deviation () from the
36-month simple moving average of the
monthly close (Cm) as follows:

-1

-2

-3

-4

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

46

48

1974

2002

2008

Average

FIGURE 1: MAJOR LOWS IN S&P 500 SINCE 1950. Declines of two to three standard deviations around a
36-month average represent good value for a broad-based market index that is in a multi-decade uptrend. Can
this be used as a template to find value-based entry points into BRK.A stock?

Standardized declines below 12-month Simple Moving Average

The major lows are defined as those in which the lowest low
was more than two standard deviations below the 36-month
moving average. After aligning the lowest low month in the
major declines, I looked at several months of performance on
either side of the low (see Figure 1).
Note that the major lows in the S&P 500 since 1950 have
followed a remarkably similar pattern. The declines have been
on the order of two to three standard deviations below the
36-month moving average, with the significant lows taking 21
or 22 months to form, and taking 1014
months to stage a rebound to the moving
average. So can this or similar logic be
applied to the Berkshire Hathaway stock
3
to find value-driven entry points?

14

1970

=
SD36

The lesson from the S&P 500 analysis is

clear. Major bottoms form well below a
multimonth moving average. When you
apply a similar approach to Berkshire
Hathaway class A (BRK.A) share prices
going back to 1980, you find that due
to a massive uptrend, there have been
too few declines below a 36-month
moving average to allow even a modest analysis. Hence, you resort to using
similar logic, but step down to using a
12-month simple moving average and
12-month standard deviation, precisely
because the stock has been in a massive
uptrend. There were just eight bottoms
using the 12-month moving average

12

Time around major lows (months)

(Cm - SMA36)

Identifying major
bottoms in Berkshire
Hathaway

10

(see Figure 2), still too small a number for good analysis.
However, broadly speaking, the pattern of low formation is
similar to that found in the S&P 500 major low from 1974.
In the table in Figure 3 you see the subsequent 12-month and
24-month returns after the lows. A value buyer finding the
exact low would have done quite well, though the magnitudes
of the returns seem to have declined after recent lows. So you
could use declines below the 12-month moving average as a
working definition of value for BRK.A stock. This approach
follows the generalized guidelines from Buffett himself for
identifying significant lows (that is, similar in principle to
quantifying the 1974 market lows), but the main challenge is
that the occurrence of such lows is quite infrequent.

Major lows in BRK.A (19802015)

-1

-2

-3
1

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Time (months)
1982

1987

1990

2000

2003

2008

2011

Average

FIGURE 2: MAJOR LOWS IN BERKSHIRE HATHAWAY CLASS A STOCK (19802015). The pattern is similar
to the 1974 low in the S&P 500, which Warren Buffett had often mentioned as a good example of extreme market
pessimism. Declines of two to three standard deviations below a 12-month average seem to represent good
value for BRK.A stock, broadly similar to the pattern in Figure 1.

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MICROSOFT EXCEL

out a trailing stop, so the position can

be held for many years, or at least until
optimism returns. So if your bottomfishing entry was too early, you might
have to hold onto a losing position for
some time.

Normalized declines below 36-month simple moving average

Major lows in S&P 500 index since 1950

3

Stocks & Commodities V. 34:13 (811): When Is Berkshire Hathaway Stock Good Value? by Tushar Chande, PhD

Low date

Return
12 months later

Return
24 months later

07/01/1982

100%

161%

11/02/1987

62%

184%

09/04/1990

51%

60%

09/01/1999

17%

27%

02/03/2003

53%

46%

12/01/2008

3%

25%

07/01/2011

14%

56%

FIGURE 3: BRK.A RETURNS AFTER MAJOR LOWS BELOW 12-MONTH SIMPLE

MOVING AVERAGE (SMA). A value buyer finding the exact low would have done well,
though the magnitudes of the returns seem to have declined after recent lows.

Does speculation pay in

Berkshire Hathaway?

Warren Buffett does not favor breakout trading strategies or

trend-following ones, even though such trends could persist for
years. In 1992, he warned that consciously paying more for
a stock than its calculated valuein the hope that it can soon
be sold for a higher priceshould be labeled speculation.
However, it is worth asking whether speculators in BRK.A
stock would have done at least as well as value investors in
BRK.A stock.

A rising stock blesses both

value and momentum strategies.
Momentum traders and value
players will be rewarded by a
strong trend in the stock.
To answer this question you need to calculate the normalized
deviation every month from the 12-month moving average
and then look at the 24-month forward return. In Figure 4
you see a scatterplot for 24-month forward returns and the
corresponding location above or below the 12-month moving
average. Note the large amount of scatter in the data, which
implies that value strategies were not the only entry points into
obtaining strong two-year returns. Using price levels based on
momentum strategiessay, one standard deviation (or more)
above the 12-month averagecould yield strong returns, just
as using value strategies with prices one standard deviation
(or more) below the 12-month average did. In other words, a
rising stock blesses both value and momentum strategies.

The best value of all

In summary, although value may be difficult to define, and

good businesses hard to find, a quantitative approach can
be used to easily define points of extreme pessimism in the
market. For BRK.A, value players may use the 12-month
moving average and declines of more than, say, 1.5 deviations
below that average as good entry points.
Historically, momentum traders have also
been rewarded by the strong trend in the
24-month-ahead return (%) vs. deviation from 12-month SMA
stock. Quite simply, a strong uptrend in a
stock is the best value of all.

250

Tushar Chande, PhD, MBA, has two decades

of experience trading the futures markets as
a CTA and hedge fund head of research. His
many popular technical indicators are included in all industry-standard commercial
programs. At his website, ETFmeter.com,
you will find a full trend analysis of more
than 1,200 ETFs, stocks, and international
indexes, and the user can build and rebalance risk-managed ETF portfolios.

24-month return (%)

200

150

100

50

Further reading

-50
-3

-2

-1

Normalized deviation from 12-month simple moving average

FIGURE 4: 24-MONTH-AHEAD RETURN (%) VS. DEVIATION FROM 12-MONTH SIMPLE MOVING
AVERAGE SINCE 1980. The stock has been in a major uptrend. The data shows that there is no meaningful relationship between two-year forward returns and the current deviation above or below the 12-month
moving average. In other words, momentum strategies were just as profitable as value strategies in trading
or investing in BRK.A stock due to the powerful upward trend in prices.

Chande, Tushar [2015]. Align Your Analysis

& Trading Persona, Technical Analysis
of Stocks & Commodities, Volume 33:
December.

Copyright Technical Analysis Inc.

www.Traders.com

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