thepupil

Tetragon

I would make an exception with regard to blogging about shorts. There are legal / personal security risks when dealing with shady management teams and no one want their livelihood attacked. They may be low probability, but it pays to be a little paranoid in my opinion. A lot of shortsellers distribute their theses through others who are more willing to bear that risk. Also, Greenlight sued that one blogger for disclosing that GL was building a stake in a company. They dropped it but I'm sure it wasnt' fun. Not sure if blogger figured it out or violated confidentiality. http://dealbook.nytimes.com/2014/03/24/david-einhorn-gets-his-blogger/?_r=0 There are risk to any public posting in my view.

waiting for the bonds to (hopefully) get cheaper...currently ~$85, 8.6% yield. like the odds of PSH NAV being greater than $1B, getting paid to write that tail risk.

there are some bizarre things in this post. Berkshire has a $63B deferred tax liability, not an asset. The goal is to not realize this. The best way to "monetize" it is to do nothing. I may be missing something, but what are you talking about? What does bank deposit share have to do with Berkshire starting an investment advisor? Can you point me to the "heavy investments" in Aussie banks? I see none. I know they have reinsurance exposure to catastrophes there (and New Zealand) and I know they own Aussie sovereigns, but I don't know of a material investment in an Aussie bank. As for the dividend, Berkshire shareholder would be no better off, at least in the short term since P/B > 1. Distribution of book leaves you with less, since the market values book @ 1.3-1.4. I didn't like PCP either, but don't agree with anything you said. EDIT: I googled around. Apparently he said he may want to buy some bank stock in Australia at some point when he did the deal with IAG. Is that "heavy" investing? What % exposure is there to Australia?

agreed, but for most it probably isn't a question of "berkshire or cash" but rather a relative value assessment against other companies' stocks and bonds, right? I mean is someone really out there saying "well i would invest 20% in berkshire, but since it's at 1.3X and not 1.2X, I'm going to sit on cash for the next 40 years". I doubt it. the relative value proposition of berkshire, all else equal, is very different at 1.8X versus 1.3X (or 1X versus 2X). I would think most people debating about what price to buy it at are not engaging in market timing, but are instead trying to assess relative risk / reward.

Hi Packer, can you explain what you mean by "expense ratio"? I'm sorry if I missed it being defined somewhere. thanks!

did you replace w/ cash? Or another stock. if so, which? curious on why you held pre-annual report and are selling now? price / value seems to have not changed much.

It's a pretty cool study in how Berkshire operates/used to operate. The investment started out as a $600MM Gillette takeover defense convertible with a fat coupon, then became PG stock when PG took over Gillette, Buffett trimmed the PG a few times along the way, then had $336MM of cost basis left and converted his PG stock (which was at a pretty high valuation for a low growth staples co) into Duracell and cash through the transaction. I don't think there's much to read other than they valued cash in hand plus a fully controlled slow decline/low growth business more than a deferred tax encumbered PG at close to 16X EBITDA. I interpreted this as a rare move down in quality in order to a) get a lot more cash flow under full control and b) tax efficiently monetize their PG. I know I would rather Berkshire own a just okay biz at 11X free cash flow than PG at 23X earnings. Along with having 3G dress up Heinz and issue stock at a very high valuation (like 3X where he bought it just a few years ago) for a stake in KHC, I think it's one of his more savvy moves of late. The man is a savvy monetizer of rich valuations despite his folky "I'm never gonna sell this and ideal holding period is forever blah blah blah". BNSF is worth like 20X more, so no need to really analyze the business in order to gauge risk/reward of BRK as far as I'm concerned. the history of the PG shares: here's the original gillette investment, which, unbeknownst to me, was actually a takeover defense convertible preferred at juicy coupon. The lifetime of this investment is just awesome. Buffett buys $600MM of Gillette 8.75% mandatory convertible preferred stock in 1989, earns a shit ton of carry for 6 years, then PG takes over Gillette, he rolls his Gillette preferred into common stock of PG, earns divvies along the way, trims PG a few times, then converts the balance into Duracell a slowly declining business at 7X EBITDA and 11X free cash flow when PG is trading 15.5X EBITDA and 23X earnings. What an awesome 25 year investment! http://www.iwarrenbuffettquotes.com/warren-buffett-gillette-investment-nyse-g/ http://articles.latimes.com/1989-07-22/business/fi-3487_1_warren-buffett

Buffett on CNBC: Not to beat a dead horse, but this is why I don't apply the DTL to the stock holdings w/ big gains. They have no need to sell and I own Berkshire primarily for its earnings power (though I do obviously pay attention to Price /my estimate of NAV and base sizing decisions on that). The DTL does not hurt the earnings power of the stocks (which in the case of KO where he hasn't bought/sold in 22 years is simply a growing dividend). That's not the only "correct" way to view things. As Richard points out an equity portfolio without a DTL is better than one with one, ceteris paribus. So why would you ever not require some discount to the portfolio of stocks with a DTL.

While I know you are being sarcastic, alpha has been quite decent outside of the last 1 yr. Berkshire has a lot of characteristics that quanty folks love; typically lower peak to trough drawdowns than indexes over time, lower beta (though increasing as Graham points out), better gain to loss ratio than indices, better (more positive) skewness, good upside capture versus downside capture, blah blah blah; all saying the same thing different ways really. It likely does not matter to the vast majority of shareholders, of course. Annualized alpha against S&P, Russell 2000, DJ Financials* 1 yr: -9%, -6%, -8% 2 yr: +2%, +8%, 4% 3 yr: +2%, +8%,+3% 4yr: +3%, +9%, +4% 5 yr: +1%, +6%, +4% 10 yr: +5%, +7%,+9% * not equal to excess return http://markovprocesses.com/blog/2012/08/alpha-and-excess-return-not-synonymous/)

I cannot tell you why beta has increased. I would just offer that indexation/institutionalization is an alternative narrative to D/E. Berkshire was added to the S&P in Feb 2010; you'll notice we've been in a consistent move towards beta of 1 since early 2011; maybe coincidence, maybe not. I don't put a lot of faith/stock in this quantitative finance stuff and would encourage you to assess the business fundamentals in terms of risk and leverage, but I don't think there is much evidence to support increasing leverage or volatility.

For the exact verbiage, see the owner's manual (like longinvestor pointed out). They'd prefer it trade close to IV, which may explain why they've been less and less subtle about pointing out why current price is below their estimate of IV.

downside deviation relative to S&P seems to have peaked in the late 90's (when berkshire massively underperformed in the tech boom), overall volatility is decreasing. 1/1990 -12/2000, vol was 25.5% versus the S&P's 13.9%, downside deviation was 14.1% versus 8.8% 1/2001 - 12/2010, vol was 17% versus S&P's 16%, downside 11.5% versus 12.8% 1/2011 - 1/2016, vol was 13.2% versus 11.9%, downside 7.7% versus 7.5%. I don't see really see a pickup in the vol of berkshire that reflects an increase in leverage. Downside deviation (and upside vol) are in a long term decline. This makes sense for an ever diversifying conglomerate megacap that is in fact not levering up and has become much more staid. EDIT: I agree, the market isn't stupid, which is why volatility and downside deviation has decreased while the business has grown larger and more diversified, less levered and as regulated businesses have become a greater portion of assets and earnings. And beta (which is not exactly voll, but rather a measure of systematic risk, ie how much a stock's moves can be explained by market moves) is increasing as the shareholder base has become more institutional, the stock has been included in indices, etc. Attached Rolling 12M beta for reference.

The interesting thing is the beta trend since 2004 mirrors the quoted D/E - up about 340% vs 250% (beta was around 0.2 then vs 0.8 now). So BRK is in fact quite a bit more volatile relative to the market than it was historically - at record highs in fact. I haven't gone through all the subs for that whole period yet. But from my personal investing perspective whether a sub's operations are consolidated or not is irrelevant to the fact that that piece of the business has a certain amount of debt associated. The market isn't stupid - if I owned BRK and 50% of BRK was AXP, you can bet BRK would be tanking too. Whether you prefer to say that is because BRK's portfolio notched losses or because BRK was levered through its minority owned subs is more about who you choose to blame :) beta doesn't equal vol. Berkshire's beta to the market is indeed increasing (it's now an S&P 500 component, a large portion of XLF, an important megacap that will trade in line with markets). It's vol relative to the market is random in a given year but I don't see an upward trend. I'll need to update my monthly returns but I've attached a rolling 12M standard deviation of berkshire thru August 2015. Don't really notice an upward trend. Downside vol relative to the S&P doesn't appear to be increasing either. I don't think it's correct to say Berkshire has become more volatile / levered. Many would say the decline in the crazy high growth of book value seen in the 90s / 2000s is because it is no longer a pretty levered portfolio of stocks.

- The debt is not guaranteed by Berkshire, so that's one reason - OP was asking why D/E is rising/ is that sustainable, and the answer is "they own two large businesses that have 70% of the debt". Decide for yourself if those businesses can handle that debt. - It isn't more or less accurate, but when looking at "how levered is Berkshire" or just trying to value Berkshire, I find it much more useful to pull out its two largest businesses and value the equity stakes in those businesses. To take it to an extreme, Would it help or hurt you if you consolidated 9.8% of Wells Fargo's balance sheet or 15% of Amex's into Berkshire's financials? Wells fargo has $1.8 trillion of assets and $1.6 trillion of liabilities and Berkshire owns 9.8% of it. Obviously it would seriously muck up the analysis. Rather than do that, you'd simply value the stake in the equity and stress that for risk assessment purposes. You might say "BNSF is worth $30-$90B or BHE is worth $25-$50B" or something like that, and incorporating that into your bear/base/bull case. In my opinion that would be the better way to view things. Disaggregation versus consolidation is generally more enlightening. - When you only look at a single consolidated quantitative metric (like debt / equity), it doesn't really tell you anything. A consolidated Berkshire balance sheet is a much more un-analyzable. But BNSF and BHE have separate public financials and publish K's and Q's and are independent debt issuers. We should use that to help us analyze the company. - with any holdco, I'd look at the holdco debt and put it in the context of the equity stakes it owns. Does LUK have $1B of debt or $30B? Well it owns JEF which has $30B of liabilities and the equity stake in JEF could be wiped out by that debt, but it isn't guaranteed by LUK. So in my opinion, LUK owns a $3.8B tangible equity stake in a bank (JEF), which is 10X levered. That to me is a more accurate way of portraying things than saying "LUK has $46B of assets and $35B of liabilities, wow debt / equity has increased DRAMATICALLY over the past 10 years". - in a a crazy hypothetical, if Bernie sanders nationalized the railroads and utilities of the U.S. (I realize that isn't what he is saying he'd do, but just for illustrative purposes), would you a) deduct $165B from Berkshire's assets and adjust equity ($255-$165) or would you deduct the assets and the corresponding liabilities, in other words just the equity ($265-$63B). It would be more accurate to just deduct the equity because Berkshire would have $200B of equity after that event, not $90B - the least an equity stake could be worth is $0, whereas if you consolidate, your stressing may give those business's negative value (which wouldn't happen, excepting some crazy scenario where debt not guarantee by Berkshire became guaranteed) Just remembered we actually discussed this very topic already BNSF has a book value to Berkshire of $34B. Using a simplistic analysis of the decrease in market value of BNSF (simply saying the "right" multiple has gone from 20X to 14X), then BNSF went from being worth $90B to $56B, from 2.3X GAAP book to 1.6X GAAP Book. It would be incorrect to say NSC is down 30%, Berkshire has 44% equity/ assets, ergo Berkshire's interest in BNSF is worth 60% less. BNSF is simply "worth" a less giant premium to book than before. That premium moves up in down in an unlevered fashion because Berkshire's equity stakes in BNSF and BE are not themselves levered like that. Interesting, thanks.

as a follow up and using the 10-K instead of the old Q's, if you peeled out the BNSF and BE, you'd take away roughly $165B of assets and $102B of liabilities (1/2 the DTL is related to those) Assets would be $552-$165 = $387B Liabilities would be $293-$102 = $191B And you'd have $63B of equity in the utility and railroad. If, hypothetically those traded @ $90B (not heroic valuations for either of those, $60B = 0.9UNP since BNSF earning = 0.9UNP Earnings and $30B = 15X earnings for BHE), you'd have $477B of assets and $191B of liabilities and $286B of equity and Berkshire would look less levered than ever. So it may appear to have fast growing debt because it happens to have two capital intensive regulated companies on the balance sheet but if it owned these companies in stock form you wouldn't notice the leverage at all. Hope that helps. EDIT: So ex-BNSF and BHE, you'd have $191B of liabilities. $30B of that is DTL related to stock price appreciation (0% interest loan from government) and only $25B is interest bearing debt (the rest being float and operating liabilities). Pre-PCP, the insurance co holds $61B of cash and $27B of fixed income, $88B total of liquid, high quality paper. After PCP, the debt figures will obviously go up (by about $14B) and the cash will go down (by $20B), but the earnings power will go up and they'll re-load the gun within a year or two. In short: it isn't that levered when you disaggregate the balance sheet.

For better or worse, I think you'll have a tough time finding a Berkshire shareholder who makes a "levered beta calculation". I'm in the "for better" camp. The trouble is it does matter. D/E is a good predictor of how much a stock will "crump" when the general market tanks. This has nothing to do with cost of capital per say, it just reflects the fact that for a given change in EV the MC takes a bigger hit. If BRK is more levered than it was in 08-09, it will crump harder. If so, that will give some of us better buy prices. And the stock will be spring loaded for heftier gains afterward. - Berkshire has never been less levered. - Look at the balance sheet of consolidated subs BNSF and BHE https://www.bamsec.com/filing/93461215000028?cik=934612 https://www.bamsec.com/filing/108131615000018?cik=1081316 These two have about $160B of assets and $56B of equity and have $57B / $82B (~70%) of Berkshire's debt. They also have $30B of the $60B DTL (50%). so they've got 70% of the financial debt and 50% of the DTL despite being ~29% of the assets. They are where the leverage resides. The two have assets/equity of 2.85 versus Berkshire's total of 2.1, so they are more levered than the rest of Berkshire. Now imagine if instead of wholly owning these, Berkshire owned $90B of stock in them ($60B of BNSF and $30B of BHE), they would just be an asset on the balance sheet and you would say Berkshire is not really all that levered. Also, consider the beta of utility equity. It is low. I'm sure railroads' beta is decently high though. I'm not going to put a to of effort into the calculations of seeing what it would look like if they held them as stocks instead of consolidated subs, but I think you get my point. Berkshire isn't any more levered than it was in the past and has only gotten stodgier and less levered with time. Also, if you care about beta and all that stuff, wouldn't the beta calculated from Berkshire stock movement be more useful? I believe it's about 0.8.

For better or worse, I think you'll have a tough time finding a Berkshire shareholder who makes a "levered beta calculation". I'm in the "for better" camp.

well i'd obviously rather the DTL not exist ($100 KO w/ no liability is better than $100 KO w/ the DTL), so, as you point out, that is an inconsistency. But I don't think it really matters in the grand scheme of the $30B of cash being deployed / year and the value creation occurring. The DTL does not prevent the constant refreshing of the business mix, the excellent growth in operating earnings, etc. My argument has more to do with the fact that the DTL does not inhibit the cash generation and earnings growth, which is what will drive the stock. When Berkshire was more of an insurance co / investment operation, I would care more about the frictions created by the DTL in terms of constantly allocating capital to the best risk / reward. Clearly, as Buffett himself has admitted, mistakes were made and the tax tail may have wagged the investment dog. But Berkshire looks a lot different now. I think you are saying the full discount is not correct and to ignore it is not correct. While I agree with you, I think the "correct" approach is MUCH closer to ignoring it than counting it in full. Also, it's obviously an important component of valuation, but at today's market cap of $325B, the $30 odd billion DTL related to appreciated stock will result in a valuation difference that is, at maximum, 9% of the current stock price. So if you think 50% of the DTL is the "correct" accounting of it and I think 0%, then we'll come up with a 4.5% difference in current valuation and it won't really affect either of our growth/earnings expectations so looking out several years it really becomes not material. Not trying to be dismissive of the discussion, just putting it in context.

it's clear to me you understand the rationale behind "investments / share", the power of tax deferral, etc. I disagree with you in that I don't think it is "rational to discount that figure by the DTL". because the DTL is so concentrated in a few investments that are not going to be touched and because the cash to be reinvested elsewhere keeps pouring into Berkshire. In your hypothetical, where a holdco only owns 1 stock, then I agree with discounting by a DTL, because in order to invest elsewhere, the tax must be realized. I think this dynamic is seen in the real world with closed end funds that have existed for a while or conglomerates concentrated in a highly appreciated stock (like Yahoo!). T The deferred tax liability in Yahoo's case creates a friction in terms of capital allocation and the market slaps a big discount on it (I personally think in that particular instance the discount is too high and they'll find some way to work around it but some discount is warranted. In Berkshire's case, the embedded gains don't prevent optimal capital allocation and the investments w/ a big DTL are able to be monetized through divvy's. Going back to YHOO/BABA, the embedded gains arguably do prevent optimal capital allocation, distract management from the core business, and cause all kinds of problems that prevent the market from giving full credit to YHOO for its BABA shares. Because Berkshire has many other ways of raising cash (either by sitting on its ass and watching the ~$4B of investment income come in or by owning a bunch of operating businesses or by raising debt on very favorable terms or by writing insurance), there aren't any real issues or suboptimal decision making being caused by the DTL. I mean taxes may have prevented Buffett from selling KO when it traded at 50X or whatever, but that's water under the bridge and happened like 15 years ago. So I don't see the "rational" reason for applying a discount. But that's what makes a market. From your memos, you clearly understand all the mechanics at play and are free to discount what you wish to and not discount what you don't wish to. I personally still have a hard time adding back the float or capitalizing underwriting income. That to me is more aggressive than DTL. But that's been debated without end for a while other threads. People will have different valuation techniques and come up with different prices that they are willing to own/buy at.

Per share investments exists in order to add back deferred taxes and float (and account for debt by deducting interest); it's a quickhand way to try to account for Berkshire's liabilities and get rid of the ones that historically have 0 or negative cost. I personally think that adding back deferred taxes is more conservative than adding back float. the DTL really is a quasi permanent 0% interest loan, and when it comes due is completely under Berkshire's control. Berkshire has no problem monetizing investments through dividends and increased equity base over time (which allows them to underwrite more risk) without having to sell stocks. Also the DTL is pretty concentrated in a few stocks and every purchase of a new stock increases the aggregate cost basis of the equity portfolio (so for example if Berkshire wanted to raise cash they could sell a loser like IBM and generate an offsetting loss to harvest gains in KO or WFC or AXP without paying a giant tax bill)* The float on the other hand is of shorter duration and acts more like a "revolver" to use the word used in the letter today, with inflows (premiums) and outflows (claims) being a large % of the float in any given year. It can also yield negative surprises outside of control or prediction. The DTL is a simpler, lower risk loan that is much cleaner to add back. Even the CFA folks argue for adding back a perpetual DTL to equity, so it's not like Buffett pulled that out of his ass; it's standard industry practice. Not that that makes it right, just saying that it isn't exclusive to Buffett devotees, whereas adding back float is pretty Berkshire specific and more aggressive. *I think, though I'm not an expert if that's how corporate taxation of equity investments held at an insurance company works, so don't quote me.

Book Value Gain > MV Gain, therefore it was superior Simple Definition of superior : of high quality : high or higher in quality : great or greater in amount, number, or degree : better than other people

while this is true, it is not 1 for 1. because of the counter-cyclical deferred tax liability and because Berkshire holds a lot more other assets than stocks, the sensitivity of the book value relative to the change in equity portfolio is about 0.3

never received a refund before (realized investment gains), and am full on these anyways... the cost of my strategy (which was to replicate long equity exposure with LEAP's and use the cash saved to max out i-bonds so that i can build a nice i-bond position) is increasing with higher implied vol in options. for example let's say i wanted to buy me some of that berkaberk, I could buy $10K i-bonds and a $100 Jan 18 call for $36. paying about $9 of premium over 2 years (that's like borrowing at 4% a year). When I did this a few times before it was closer to 1.5-2%, so I could buy the i-bond and the berkshire LEAP and my expected 2% inflation yield would pay for my premium so i'd get a free put and free inflation optionality and start to build a material portfolio of i-bonds. this is not as attractive today (one could still use margin though). probably more than you wanted to know. most people would just fully fund the purchase of 100 shares of berkshire with cash and be done with it.