The Berkshire bump the market is missing

Berkshire Hathaway's upcoming stock split may allow it to join the S&P 500. So why are shares falling?

By TheStreet Staff Dec 8, 2009 6:39PM

TheStreetWarren Buffett. Image credit: © Chip East/ReutersBy Eric Rosenbaum, TheStreet


Warren Buffett's planned acquisition of Burlington Northern Santa Fe (BNI) has stoked market chatter about Berkshire Hathaway's (BRK.B) likely addition to the S&P 500 Index. Should short-term traders get ready for a profit opportunity if the company joins the benchmark?


Berkshire Hathaway announced this week that it will hold a Jan. 20 shareholder vote on a 50-1 stock split in its B shares. If approved as expected, the move would help Buffett's investment company meet the S&P 500’s trading volume requirement, a mandate it has never been able to satisfy.


Joining the S&P 500 would be a historical achievement for which Warren Buffett has voiced ambivalence, if not outright reluctance. Still, many index mavens are expecting the S&P 500 inclusion to be a fait accompli once the stock split is executed.


If so, could Berkshire Hathaway's shares be viewed as cheap when you consider the likely price bump it would receive from S&P inclusion? At least one person thinks the answer to this question is “yes.”


Eric Lin, an assistant professor of finance at California State University, says short-term traders, in particular, will see an opportunity to profit if Berkshire Hathaway joins the S&P 500. He and John Kensinger of University of North Texas have written a soon-to-be-published research paper on the S&P price bump.


Lin says trading would pick up for Berkshire stock if Standard & Poor's decides to include the company because index fund managers and institutional investors would have to buy the stock to mimic the composition of the index.


Stocks added to the S&P 500 typically return more than 5% on the day of announcement. Traders (or speculators) would buy on the announcement and sell on the effective day to capture profits, Lin says.


Investors would gain access to Berkshire's legendary portfolio, which includes a 12.8% stake in American Express (AXP); 9.4% in Kraft Foods (KFT); close to 7% in Wells Fargo (WFC); about 1% of Wal-Mart (WMT); close to 9% of Coca-Cola (KO); and almost 4% of ConocoPhillips (COP).


Is it a fait accompli that Berkshire will be the next S&P 500 component?


"Given Berkshire's current market cap of over $150 billion, there is a chance that the company could be the next to be added to the index,” Lin says. “The S&P 500 usually adds large companies with significant market representation industry leadership into the portfolio. When that happens, I expect to see a significant increase in price, trading volume and volatility.”


Paul Howard, analyst at Janney Montgomery Scott's Langen McAlenney division -- and one of the few analysts who cover Berkshire -- said the 50-1 stock split will be a huge step toward S&P 500 inclusion. "Berkshire is well on its way to the volume requirement that has been the big hindrance in years past," Howard says.


The recent performance of Berkshire’s B shares run counter to Lin and Howards’ arguments. The shares dropped close to $175 in the past two weeks, and have been falling since the Burlington acquisition was announced.


"If you think of the ETFs and the S&P 500 index funds, not to mention the closet indexers, it's a lot of money that is going to have to chase this thing,” Howard says. “It doesn't look like anyone is factoring this in.”


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