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Berkshire Hathaway Could Have Made $800 Million on Snowflake

·4 mins read

- By Rupert Hargreaves

Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) may have just made one of its best investments ever. A few weeks ago, it was announced that Warren Buffett (Trades, Portfolio)'s conglomerate was planning to invest around $500 million in cloud computing group Snowflake Inc. (NYSE:SNOW) during its initial public offering.

The announcement that the Oracle of Omaha was involved with the business (whether or not he decided to pull the trigger himself is up for debate at this point) sent traders into a frenzy.

Surging price

On its market debut, shares if Snowflake surged 111% to about $253.93.

This implied that Berkshire had earned $800 million on its investment in the business based on initial indications. The group was planning to invest around $500 million in the company based on its proposed IPO price.

However, as the IPO approached, demand increased substantially. This allowed Snowflake to increase its original IPO price estimate from $80 to $90. It finally hit the market at $120. This suggests Berkshire invested a total of $730 million in the business.

In a furious day of trading, shares in the newly public business hit a high of $319. If Buffett's conglomerate had decided to offload its position at this level, it would have booked a profit of $1 billion.

Yesterday's events showcased why Buffett has tried to stay away from IPOs in the past. By committing to buy a set number of shares at the IPO price, without guaranteeing a set price, Berkshire left itself open to market euphoria.

The very news of its involvement had a tremendous impact on demand for Snowflake shares and, as a result, the group had to cough up an extra $230 million more to meet its purchase obligations.

At the time of writing, we don't have any insight into why Berkshire made this trade, who proposed the deal and the exact numbers involved.

What is clear is that the group now owns a stake in the business worth around $1.6 billion.

At the end of trading on Wednesday, Snowflake's market capitalization was $70 billion, and it generated $242 million of revenue in the first half of 2020. That is roughly $484 million on an annualized basis, implying shares of the company are changing hands at 140 times sales.

That makes the company easily one of the most expensive large-cap stocks in the world, even though shares tumbled over 10% on Thursday.

For some comparison, Shopify (SHOP) shares are changing hands at less than 60 times sales. The company is considered to be one of the most overvalued businesses in the tech sector.

Sign of the times

Is this a sign of the times? Over the past 60 years, Berkshire has now gone from owning some of the market's cheapest stocks to investing in the most expensive. Even though it is widely believed that Buffett himself did not pull the trigger on this investment, it does undermine some of his teachings.

Over the past few decades, he has warned investors repeatedly about paying premium multiples for stocks. In one fell swoop, he has pushed aside these warnings. This trade seems to suggest that buying high-priced stocks is now acceptable. He's also warned against buying IPOs because the market tends to get swept up in euphoria. That's exactly what has happened here.

So, despite warning investors for decades about the perils of buying IPOs and expensive tech stocks, Buffett's Berkshire is now doing just that.

Buffett once said, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." Based on this latest trade and his dealings with airlines over the past few years, I don't think it's unreasonable to say the Oracle of Omaha is at risk of falling foul of this rule. His actions seem to suggest previous advice on value investing no longer applies.

Disclosure: The author owns shares of Berkshire Hathaway.

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This article first appeared on GuruFocus.