Berkshire Stock Surges After Joining S&P 500

BERKSHIRE HATHAWAY’S CLASS B SHARES have gotten a boost, rising 5 points, or 7%, this morning to 73 after Standard & Poor’s announced late yesterday that it will be finally adding the stock to the S&P 500 index.

Since the news, Wall Street firms have been trying to estimate the amount of Berkshire stock that will need to be purchased by index funds that seek to track the index. There appears to be some debate about the matter, with estimates ranging from 110 to 160 million of Berkshire’s class B shares (ticker: BRKB), which are the ones that will be added to the S&P index. Berkshire’s better-known class A shares (ticker: BRKA), now trading at $109,575, up $7,824, are also up 7% today.

Whatever the total amount of index buying, it’s a lot relative to the recent volume in Berkshire’s class B shares. That accounts for the sharp rise in Berkshire stock this morning. Ultimately, the big question is whether Berkshire shares hold gains following the closing of its purchase of railroad operator Burlington Northern, expected around Feb. 11.

Since the 50-for-one split last week, Berkshire’s class B shares have traded more than five million shares a day. That’s up from the equivalent of one to two million shares prior to the split. S&P had long kept out Berkshire from the S&P because of its low liquidity and concerns that index buying would drive up the share price if Berkshire were added to the index. S&P’s index committee chairman, David Blitzer, said yesterday that with the stock split and higher Berkshire trading volume, liquidity isn’t an issue.

Still, indexers will have to buy a lot of Berkshire stock relative to its recent, elevated trading volume in the next two weeks. S&P didn’t set a specific date for the addition of Berkshire to the index, but it’s likely to occur around the time that the $34 billion Burlington deal closes.

S&P weights companies in the S&P 500 by their public float. That means that Berkshire’s weight will be about 67% of its total outstanding shares, or about 1.05 million class A shares, or 1.6 billion class B shares. That will be about 1.1% of the S&P index. Berkshire has about 1.55 million class A shares outstanding (when the class B stock is converted on an equivalent basis). Each class A share equates to 1,500 B shares. Public float is less than the total Berkshire shares outstanding largely because of CEO Warren Buffett’s sizable holdings.

If indexers own about 10% of the S&P 500, they would need to buy an estimated 160 million Berkshire B shares, which is about $11.6 billion of stock. However, that buying may be offset by Berkshire stock that indexers will receive for their Burlington shares. Indexers may receive 15 million to 20 million Berkshire shares as consideration in the merger.

Berkshire is using a 60%/40 mix of cash and stock. Burlington has about 340 million outstanding shares. Any Berkshire stock received for Burlington would reduce the amount that indexers need to buy. Burlington will leave the S&P when Berkshire is added.

A mild offset to the index buying in the coming days could be selling by arbitragers who hold Burlington stock. The pricing period for the Berkshire stock is due to start today and continue for the next 10 trading days.

The index addition is good news for Berkshire holders because it likely will mean that the company will issue less stock to Burlington holders than it appeared when the deal was announced in late October. Berkshire’s class A shares then traded around $100,000.

Buffett suggested recently in an interview with Bloomberg that Berkshire shares were undervalued and that he wasn’t crazy about using stock in the Burlington deal but had little choice in order to get the deal done.

Berkshire’s fans also think the stock is attractive, now trading for about 1.3 times our estimate of Berkshire’s year-end book value of $84,000 a share.

Berkshire stock could continue to trade higher in the next two weeks ahead of the Burlington closing. The big issue is whether the gains stick after the index buying ends. Berkshire might stay strong because active money managers, who own little Berkshire, will have greater incentive to own it or risk trailing the S&P 500 if Berkshire stock does well. Active managers may decide that Berkshire’s attractive business mix, substantial earnings power and strong balance sheet are too good to ignore. There is little analyst coverage of Berkshire, whose ownership is dominated by individuals.

The index buying of Berkshire could depress the S&P 500 index around the time it is officially added to the index because indexers will have to sell the other 499 stocks in the index to make room for Berkshire. The index selling could total $8 billion or so.

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