Attention Berkshire Hathaway shareholders!

The U.S. stock market has just had its biggest two day drop since June, falling more than 3% in three days.  Berkshire Hathaway shares, on the other hand, have risen roughly 7% during the same time frame.

Here’s why:

Berkshire Hathaway bought Burlington Northern Santa Fe railroad in November. …more info

Choosing to pay for the railroad (they bought the entire railroad) in cash and Berkshire stock, they were left with a potential dilemma.  Let’s assume that you owned $3000 worth of Santa Fe stock.  Well, you wouldn’t have the option of being bought out in Berkshire shares because Berkshire Hathaway’s cheapest B shares were trading at roughly $3,200 each.  As a result, you would have to take cash instead Berkshire shares.

Buffett felt that this favored wealthier Santa Fe shareholders, which he didn’t think was fair.

For this reason, he decided to “split” Berkshire B shares 50 to 1.  This means that if you owned 1 Berkshire share at $3,200, you’d now own 50 of them at $64 per share.

The end result is the same: you’d still own $3,200 in Berkshire Hathaway shares.

Long term, this is a non issue.  A company like Berkshire will trade at or close to its intrinsic business value over time.  If the business’ profits increase by 300% over the next 15 years, the stock price will likely do something similar.

Short term, as mentioned at the start of this post, Berkshire shares have jumped 7% in two days.

Why?  There are a couple of reasons:

1. Most investors don’t understand how stocks work.  They think that Berkshire shares are now cheaper.  It’s hard to believe, but the average person believes that a $10 stock is cheaper than a $100 stock.  But you know that a stock’s expensiveness is related to how many shares are on the market and what the business’ earnings are.  Berkshire IS NOT cheaper than it was two days ago.  Yes, today it might trade at $72.72 per share. … more info 

But it’s more expensive than it was yesterday, when it traded at around $3,300 per share.

Imagine someone selling you something at a grocery store, and they say, you can pay me with twelve one dollar bills or one ten dollar bill.  Most stock investors think that twelve one dollar bills is a better deal.

 2. Because of Berkshire’s class B stock split, it will now have a higher amount of trading volume, and as a result, will likely meet requirements for acceptance into the S&P 500 index.  It’s not like this is a coveted club Berkshire has wanted membership in, but it’s likely to be entered.  As a result, S&P 500 index funds will have to buy Berkshire shares to add to its index.  This will temporarily push the price up.  The 7% increase in Berkshire’s price is a result of those likely “anticipating” these future purchases.  The speculators will likely sell as the indexes buy Berkshire, thus stabilizing the price.  Playing games like this isn’t recommended, because stock prices, short term, are nearly impossible to figure out.

Your accounts—and how this might affect you:

Long term, this won’t have an effect on Berkshire shareholders.  But if you look at your brokerage account statement, you might notice that your brokerage has not kept up with the stock split.  My brokerage just hasn’t kept up with the split.  Likewise, yours might not have either.  So if your online account suggests that its value has dropped significantly, take solace in knowing that it hasn’t.

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