thepupil

Eric and petec, I think we all agree. The present hypothetical liquidation value is $0. Assuming berkshire estimates its liabilities correctly, then cash and FI of $80 - float of $80 = 0. And the discounted future streams of earnings is (normalized spread)*(float) + (value from growth in float). Petec, I think the two column method is a little optimistic, but whatever, let's move on. There are probably more interesting debates to be had and we pretty much agree with the main drivers.

I look at it as in insurance operation that has $80B of low risk assets and $80B of high risk, fat tail, liabilities. I don't think you can separate the two. As Frank Sinatra would say, "you can't have one without the ooooooooooooother!" I think taking on insurance risk is a very high risk activity. Ajit is a genius but he is not omniscient and I want to get paid a decent rate to bear the risks that he picks for me. Berkshire has made money every year in the last 10 underwriting, but I'll happily bet that won't happen in the next ten. This is why I use an equity multiple for the earnings generated by the spread between underwriting and interest income. Over the last 10 yrs, underwriting profits have averaged 3.3% of the float. I think 0-3% is a reasonable estimate for underwriting profits over time (some would even say 0% is optimistic given the capital flooding into reinsurance markets). I think that underwriting profits are correlated to rates (as in if rates go up, you would imagine underwriting profits would go down because competitors would write less profitable biz) So your key assumptions in valuing the insurance operation are 1) spread between interest rates and underwriting (I think of that as something like 1-4%, but in hard markets like post KAtrina it can be super high, look at 06-09 at General Re and BHRG) 2) multiple (10X pretax) 3) float growth over time (which would influence what multiple you'd want to pay) In the end, if i'm wrong and you are right and berkshire continues to always make money on the underwriting side, frees up more of its cash/fixed income, and continues to grow float over time, and berkshire is worth the full $80B more from adding back float, then Berkshires is worth 15%-20% more than i think it is and I am undersized in the name.

If you value the cash as cash because you own the interest, you are bearing equity risk (by owning Berkshire) to receive cash interest, when you could yourself just own cash. Cash and fixed income burdened by insurance risk and regulation will always be worth less than if it were unburdened. You are effectively saying "my discount rate is 1%". Let's say short rates go to 4% (something inhonestlye think won't happen for like 3-15 yrs). You would still be "paying" 25x earnings. You can't separately count the underwriting profits and then capitalize the interest income to the full value of cash. Let's imagine Berkshire's other assets did not exist. They only have the insurance operations which produce underwriting profits and losses, and the cash and fixed income. Let's say the insurance operations generate $3B /year in underwriting profits and then lose a low number like $10B on each 11th year (so they make $30B, then lose $10 for through the cycle earnings of $2B / year) Over a 10 yr period this operation would make $20B pretax. Now let's say short term rates average 1%, 3 % or 6%, so they either make $800mm, $2.4B, or $4.8B / year in interest. At 1%, $2B + $800mm= $2.8B At 3%: $4.4B At 6%: $6.8B At 10x pretax, this biz is worth $28B-$68B. At 15X pretax, it is worth $42-$102B. Only at very high levels of short term rates and high multiples is this business worth $80B. I think Berkshire will have an insurance disaster here or ther and will lose 11 figures in a few years so I don't think you should just capitalize underwriting profits and assume they happen year in year out. EDIT: the curve looked a lot different when Buffett introduced the two column method in 1995 http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=1995

And yes the profits generated from this deserve a low multiple, because it involves substantial risk. If you make $3B-$4B a year on underwriting profits and interest and then lose $20B in a bad cat year every 10 yrs, it is profitable and good, but not worth $80B today. If you don't think Berkshire can lose $20B or more in a bad year, you shouldn't own in it. They can and will and I actually long to see some nice big losses and some destruction (minus the human suffering part of course) since it would make Berkshire take share and harden the market.

I am saying that if you add back the float entirely, you are not acknowledging that a very large portion of the float will have to always be in bonds and cash and that you don't "own" those in that you can't just dividend them out or use the whole $80B for an acquisition*. Now you do own the profits generated from underwriting and the interest income from that pile of cash/bonds. But that number hasn't been worth the full value of the float in years. Bonds may be overvalued, but it isn't relevant here because Berkshire holds cash and very short term fixed income with little credit risk. It's almost as if they hold $80B of cash ($60b after they buy PCP) To increase the profits generated by the float ( and make the two column method and its inherent assumptions more appropriate) 1) short term rates have to rise substantially ( the earnings power of cash and short fixed income would have to increase to a level where you could say all that stuff they have to hold is earning a lot) 2) it could also work if regulators became less stringent and gave Berkshire credit for all its equities and wholly owned businesses and allowed them to use more of that cash and fixed income to buy businesses. As non insurance Berkshire becomes bigger in relation to insurance Berkshire, this may happen, though I wouldn't want to count on that.* *berkshire will use $20B for PCP deal and buffet publicly stated this out them out of the elephant hunting game for a while. If he could use all of the $80b as he saw fit, then this would not be the case. *i feel like I suck at explaining this; does anyone agree / disagree / get what I'm saying?

macro is hard, right? as for oil, we will see. I'm on this board a lot. On every oily thread there seem to be at least a couple bears or naysayers, even back in the initial $100-$80 move, it seemed like there were a few guys warning of more pain. I don't think there is a very strong pro-oil bias here.

Yep, wasn't recommending it or anything but as far as an easy to put on and track "quality index" that has a real world track record, it's the best I can come up with. Maybe some vanguard funds too like Windsor or dividend appreciation could be considered.

GMO Quality institutional mutual fund may be what you are looking for. It is actively managed, but it is oretty slow moving and its approach is based on ROE, leverage, margins, and stability of ROE and margins. It attempts to give exposure to the "quality" factor.

The assets are related to the liabilities because the $80B or so of cash and short term high quality fixed income that berkshire keeps around is effectively to collateralize the float. Brooklyn investor speaks about it more eloquently than I can in the other links. Unless you think some of that $80B is excess capital and can be freed up (which may be the case, if so adjust for that), then shareholders don't effectively own that cash as it is required to run the business. Instead they own the spread between what that cash and fixed income earns and the cost to obtain it. Since that spread is not high enough to justify a value that effectively adds back the whole float, I think investments / share is inherently flawed.

Hi longinvestor, I think investment / share will overstate BRK IV http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/i-hate-this-post/msg213620/#msg213620 http://brooklyninvestor.blogspot.com/2013/03/value-of-investments-per-share.html http://brooklyninvestor.blogspot.com/2011/12/so-what-is-berkshire-hathaway-really.html I'm confused by the concept of retained earning being a separate component of value. When you are valuing investments / share & the current estate of operating businesses, does not the value thereof include the PV of their reinvested earnings? Isn't an earnings multiple simply a shorthand DCF with an implied growth rate? The growth comes from reinvested retained earnings, right?

One scenario to consider if you are young and make decent money (or just know of a time in the future where you won't make a lot of dough) is doing regular 401k and then roth conversion in a low income year (such as grad school or when starting a business or traveling or something). a few of my friends have done regular while being single high income NYC finance or tech (no mortgage or wife to lower the tax rate) and then did or are planning on doing roth conversions in business school.

Should be called "how to buy Berkshire and a bunch of blue chips at 20% discount to NAV with a 1.7% expense ratio that pretty much justifies the full discount assuming an 8% rate of return and no tax discount"

No, it's because loans will be priced something like this 3mL+300 w/ a 100 bp libor floor. Because of the floor that loan would be charging 400 bps (100 bp floor + 300). When 3mL goes up from current level of 29 bps, this loan won't pay anymore until libor goes above 100.

these guys can be a lot bigger. their avg market cap is $141B, and they own things like FFX, JPM, MSFT, JNJ, and VOD. And they are long only. Asset growth here is not an issue. Portfolio Characteristics5 Security % of Assets Fairfax Financial Holdings 5.7% JP Morgan Chase 5.4% Microsoft 5.3% Johnson & Johnson 5.3% Vodafone PLC 4.9% Past performance is not indicative of future results. Disclosures are included on page 2 of this presentation. EQR S&P 500 Price/Earnings* 14.4 27.7 Debt/Capital % 25 52 Avg Market Cap ($B) 141.0 133.6 Dividend Yield % 2.3 2.0 Avg Net Debt ($B)# 0.8 Alpha (10 yr) 4.72 Beta (10 yr) 0.73 R-Squared (10 yr) 0.75 *Price/Earnings: based on normalized

I believe they have a lower P/B because of the lower growth opportunities plus the regulatory overhang. For better or worse, when you buy the megabanks you get big asset management, wealth management, and investment banking arms, so I think they are different animals. Obviously some of the regionals and community banks have division like this (PNC owning 20% of BLK comes to mind), but I'd argue it's to a lesser extent. When you go mega you get a more diversified business model less dependent on good old deposit taking and lending. Some may see this as a negative and others as a positive. All else equal I'd rather own JPM with JPAM and the I-Bank than Chase (I don't currently own), even with the inevitable, occasional London Whale fiasco or GS with GSAM and BAC with Merril etc.

if you really want to bet on deflation, or perhaps more precisely, bet on a decline in nominal interest rates, then go for the long term government bonds. You'll get the most duration for the buck. You'll also be subjecting yourself to very meager and most likely negative nominal and real returns should the desired scenario not occur, but if you want to make that bet there's no need to introduce other risks to the trade. Just go for the purest form of duration: long term government bonds

With the below margin rates which are incredibly uncompetitive relative to interactive brokers and others, there is no way that it is cheaper to have a margin account at ML, unless you aren't borrowing on margin. If you aren't borrowing on margin, then why have a margin account? I guess one scenario is where you want to be short uncovered options or spreads (this would require a margin account but not borrow cash at the margin rates), but still I can't imagine the Thundering Herd ever being cheaper or better than Interactive Brokers or fidelity. Re the credit card, just get a city double cash card and get 2% on everything for no annual fee (or if you go to Fido, they have a 2% Amex). Are you getting more cash back than 2% with the bonus? Also, ML's execution was terrible when I had them. I fill orders at Fido and IB that I just don't think would happen at Merrill Edge, but if you deal in only liquid stocks that probably doesn't matter. The ML Base Lending Rate (BLR) is 5.250%. Margin interest rates range from 4.500% - 8.625%. Loan amountMargin rateEffective rate $10,000,000+Base -0.7504.500 $5,000,000 - $9,999,999Base -0.500 4.750 $1,000,000 - $4,999,999Base 5.250 $500,000 - $999,999Base +0.625 5.875 $100,000 - $499,999Base +0.875 6.125 $25,000 - $99,999Base +2.250 7.500 Less than $25,000Base +3.375 8.625

Can you be more specific? I went through your last 100 post history and all stocks mentioned there have a lot of discussion. For example, yesterday, ItsAValueTrap asked if anyone was interested in AAMC/RESI. I explained why I was not, but no one else chimed in with an opinion. AAMC is down 85% from peak and RESI is at 77% of tangible book. Even though I have my issues and reservations with both, I would think someone else would at least have an opinion. I tried to get people to look at Forestar ( an owner of energy assets, timber, and lots of real estate that is down a lot at a decent discount to book and undergoing activism), but there didn't seem to be much traction. I personally find it compelling but am waiting for a little more clarity and progress to size it up. No one cares about ACAS, a BDC at 70% of book (75%) after adjusting for full dilution, it will split into parasite co and host co (asset manager and yield pig BDC) this year. No one cares about Tetragon, 50-60% of book (undiluted and diluted), 6% dividend, decent mix of assets, No one cares about Equity Commonwealth, cheap office REIT chaired by Sam Zell The reality is that several of these are either not spectacularly cheap, have shitty or greedy (or both) management, and there isn't a ton to discuss about them so my expectations should be low. I just think the 1/10 of posts on BH and SHLD (which i still read and sometimes contribute to the problem) should maybe make it to other ideas. I will say I often don't have much to say about small cap australian companies or this or that so it's not like I'm part of the solution. EDIT: And there are much better more interesting ideas posted by others that get little discussion, didn't mean to make this a personal rant

I get frustrated with the lack of discussion on the stocks I post about and have interest in. My takeaway is they must not be good enough ideas or they need to be cheaper to be more interesting to people.

Ask and Ye Shall Receive. Interpret these however you will. In my opinion they aren't overly useful and it's easier to just look at what FFH owns and the bets they have on and how that might work out in a number of scenarios (which is what everyone here is already doing).

Green is rolling 12 month correlation to the S&p500, blue is to the All Country World index

Agreed. Vinod's quantitative approach would certainly miss an inflection point in the quality of the business and large chunky gains. I don't know Fairfax well but there does seem to be a lot of optionality and growth (and risk!) in the form of the the insurance businesses in emerging markets, being the GP of FIH, wholly owned businesses, distressed workouts, etc that would certainly be close to impossible to model in a spreadsheet. Also, to add a little bit of quantitative finance modern portfolio theory mumbo jumbo (otherwise known to some value investors as quasi-science bullshit) to the conversation, Fairfax does exhibit strong diversification benefits to a stock portfolio over time and has periods of very low or negative correlation to general markets. Fundamentally we know this because they have lots of hedged and made beaucoup money on the CDS contracts, but if I knew nothing about that and just looked at the monthly returns of the stock, I'd agree with those saying "I like FFH for its diversification benefits"

I actually think those are the worst forms of cash because they don't take advantage of being small. I am an individual looking to keep cash measured ok tens of thousands not tens of millions or billions. Therefore, I can use CD's and I-savings bonds to earn returns that are not only above those of cash but are also above those of most IG credit (and certainly on a risk adjusted basis). I buy $10K of I-bonds / yr so that the ones I bought a year ago become cash (you are locked in for the first year but may redeem thereafter for a small penalty ( I think it is 6 months interest). I do use leverage to keep my exposure up to reduce the opportunity cost of holding all those, so that kind of defeats the purpose but I am trying to build a substantial I-bond position and it takes time with the $10K limit) And if you need more than $10k / yr in cash, I suggest the next best thing is a 5 yr CD with a redemption penalty that allows you to get your money back any time. The GE one used to be 2.5% and had a 9 month penalty. So the way I looked at it was it had FDIC type credit risk, had a capped duration (the ability to redeem for a 1.8% penalty acts as a interest rate payer swaption that protects you) and paid more than intermediat term invesent grade credit which had more credit risk and duration of 5-6. EDIT: If you want to build an i-bond position without much opportunity cost you can do something like this: Instead of owning 300 shares of Berkshire($43,000), you could own $30K of i-bonds and 3 $110 Jan 2017 calls for $4000 / contract ($12K). you pay $40 per call and lose $5 of premium over 18 months, $3.33 / yr, so it cost you about 3% annualized in premium but you get a 24% OTM put and a call option on inflation. When I did this it was like 1.5% / yr which made it more attractive (and Berkshire was at $110 and I was buying $80 calls). But my point still stands, you don't have to sacrifice net exposure and have too much cash to build a nice i-bond position over time since leverage (either margin or non-recourse call option) can be used to replicate exposure. This is probably beyond the scope of the thread, but I just wanted to point that out since when I tell my friends of the joys of i-bonds (0% pretax real return with no duration or credit risk , woooohooooo!!!) they point to the long term opportunity cost of building such a position.

Vinod was calculating the rate of book value growth. His estimate is 5-12%, with a base case of, call it, 7%. His base case calls for stock market returns of 5% (not unreasonable by any measure). His base case says Fairfax will grow at a greater rate than the market and is therefore "worth" at least book to "the market". What it is worth to frommi or Jurgis or vinod is an entirely different story. What something is worth to the market under reasonable assumptions under today's conditions is different than what something is worth to any one of us with an XX% hurdle. My takeaway from Vinod's thorough analysis is in order to own FFH today, you either must have higher compounding rate expectations (like Gio does, not trying to argue with you Gio, I just know you expect greater things from FFH than 5 or 7%) or pretty low return requirements. I have no strong opinions either way and have never owned FFH.

all i have to add here is i got a 100% LTV, 5 yr @ 2% cash-out refi from my previously unencumbered 6 yr old 50K mile automobile from my credit union. No bank would have given me that. I asked them to price out various terms and 1- 5 yr all had the same rate of 1.99%, which I thought was odd. No varying it up for increased duration? (it got higher at 6 yrs and out but even 8 yr was something like 3%). the 5 yr treasury was like 1.2% when I took that puppy out (I recognize a 5 yr amortizing loan has a lower weighted average life than a bullet bond and so the comparison is not apples to apples). I would never keep my money there beyond that which was necessary to secure their below market terms (like $50). Credit unions are strange animals