Question

Berkshire Hathaway’s 13-F filling for the third quarter of 2010 reported that warren Buffett had reduced his stake in Nike, Inc. by $224 million, bringing his holding to 7.62percent of the 480 million outstanding shares. Nike reported a core return on net operating assets (RNOA) of 32.7 percent in its annual report for the year ended May, 2010. A summary of its balance sheet at fiscal-year end follows:

Net operating assets $5,318 million

Net financial assets 4, 436

Common equity $9754 million

In mid-July, at the time that the annual report was published, Nike’s shares traded at $68 each. By the end of September, the price had risen to $81.

Calculate the expected return from buying at the market price in mid-July with a forecast that Nike can grow residual operating income at 4 percent per year. Now make the same calculation for the September price. Do you see why Buffett may have sold?

Answer 1

For month of July :

• Equity price= $ 68
• Outstanding shares = 480 M
• Equity value = 480 × $68 = $32,640 M

Enterprise price= Equity price – Net financial asset =$32,640 – $4,436 = $28, 204 M

Enterprise book-to-price=Net operating asset / Enterprise price = 5,318/28,204= 0.189

Expected return with growth in growth of 4% in RNOA

= (0.189 × 32.7%) + [(1 - 0.189) × 4%] = 6.18% + 3.24%= 9.42%

Month of September:

• Equity price= $ 81
• Total Equity value = 480 × $81 = $38,880 M

Enterprise value =Total equity value - net financial asset = $38,880 – 4,436 = $34,444 M

Book-to-price= 5,318/34,444 = 0.154.

Expected return with growth in growth of 4%

(0.154 × 32.7%) + ((1-0.154) × 4%) = 5.04% + 3.38%= 8.42%.

Expected return goes down due to high price of share in market