vinod1
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Posts posted by vinod1
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I agree Berkshire is very attractive at the current price. I keep wondering why it is not above $150 already.
Vinod
Simple answer is the people investing in Berkshire. Shareholders of Berkshire are people who believe in Warren Buffett and value investing and so they want to invest at a discount. They also want to buy Berkshire at a discount. Would any of you pay full Intrinsic Value for Berkshire? I know I wouldn't. I bought Berkshire when I thought it was at a large discount. As long as the investors it attracts are Buffett style value investors Berkshire Hathaway will almost always trade at a discount to intrinsic value.
I am not so sure about that. As recently as 2007, BRK is traded at nearly 2x BV. With S&P 500 then at 1500, it was a tough call for someone choosing between Index and BRK.
Now with S&P around 2000, BRK at 1.3x BV was very attractive compared to S&P 500. It is at least to me seems to be an easy call.
For close friends for whom I help out with their portfolios, I have had them realllocate 10 to 15% of portfolios from market index to BRK. I was agonizing over that decision in 2007.
Presumably there are just as many investors interested in BRK now as in 2007. Hence, my skepticism about your explanation.
Vinod
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Vinod - I am a fan of your posts and analysis. I know you have studied BRK in depth, so keen to know the reasoning behind the gap not being more than 1%. The long term difference and the shorter term difference between the two are very interesting.
For fun, I ran the numbers on book value growth and market value growth. The numbers are interesting:
Case 1:
For the full 50 year period. The market value growth has exceeded book value growth by 1.79% per annum.
Case 2:
First decade of Berkshire:
Book value growth outpaced market value growth by 2.1% per annum.
Case 3:
Second decade at Berkshire. Market value triumphed book value by a whopping 8.4% per annum.
Case 4:
Market value beat book value by 5.8% per annum.
Case 5:
Book value beat market value by 2.6% per annum in fouth decade.
Case 6:
Book value beat market value by a slight 0.2% per annum in the fifth decade.
Case 7:
In the last two decades, book value growth has beat market value growth by 1.36% per year. An anomaly is the last five years where market value has beaten book value by 5.7% per year.
Case 8:
The next decade - looking at the closing prices of Berkshire shares and correlation to book value, the future looks definitely positive for the berkshire investor. If the widening of the gap from book value to market value is recognized by the market, things should get even better.
Yes - I think energy is generally tied to book value somewhere in the 1.6 - 1.9 times book. Insurance is another that is typically tied to a multiple of book - Gieco is probably an exception here.
There are several others that aren't tied as much - examples:
Lubrizol
Van Tuyl
Iskar
Marmon(?)
Fruit of the Loom
Brooks shoes
Sees candies
Retail(?)
PCP when it gets done
So I think the assertion of IV deviating to the higher side of book over time is correct.
BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example.
Vinod
I agree. Where we differ is in magnitude. I think the growth in IV/BV is somewhat slightly less than 1% per year while you think it is much higher than that.
Vinod
shalab,
Thanks for the kind words. You seem to have studied this quite in depth as well.
I might be giving a false impression about the precision of my estimates. I did two snapshot valuations one for year end 2009 and one for year end 2014, trying to keep everything the same (which is difficult in the best of circumstances). My central estimate of IV came out to be 1.55 BV in 2009 and 1.6 BV in 2014.
So the IV growth seems to be outpacing BV growth by about 0.6% annually. I do not put too much faith in this number myself, but is done more to get a very rough idea of the rate of the increase. I would not be too surprised if this growth is say 1% but much more than that seems unlikely.
I agree Berkshire is very attractive at the current price. I keep wondering why it is not above $150 already.
Vinod
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longinvestor,
As I mentioned above to shalab I do think IV/BV multiple is increasing each year. Buffett is pretty much also confirming that. So I think the buybacks would also be done at higher levels in future.
But at the current time, he also outlined very clearly what he thinks are reasonable prices and what are on expensive side.
Vinod
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Yes - I think energy is generally tied to book value somewhere in the 1.6 - 1.9 times book. Insurance is another that is typically tied to a multiple of book - Gieco is probably an exception here.
There are several others that aren't tied as much - examples:
Lubrizol
Van Tuyl
Iskar
Marmon(?)
Fruit of the Loom
Brooks shoes
Sees candies
Retail(?)
PCP when it gets done
So I think the assertion of IV deviating to the higher side of book over time is correct.
BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example.
Vinod
I agree. Where we differ is in magnitude. I think the growth in IV/BV is somewhat slightly less than 1% per year while you think it is much higher than that.
Vinod
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Good discussion overall thanks guys for all the different opinions.
I think the IV is deviating from book more than 1% a year.
If we look at BNSF alone, the price on books is 34B. It is worth double that now in five years - even if we say it is worth $30B more, it has contributed to roughly 10% increase in market value at today's market cap. So 1.9% increase in IV just from BNSF. This is excluding the retained earnings that is paid out as dividend to the parent.
This doesnt even include other businesses which have increased in value since.
longinvestor,
If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.
Vinod
After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV but BV never gets revised upwards. The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.
My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.
"Berkshire has not gotten that worse". That is my bet, and it is in stock price growth.
I disagree with your interpretation of Buffett's comments in the annual report.
The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings.
He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value.
He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report.
So all he is saying is we need to use a multiple of book value now and not just 1x book value.
I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points.
Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV.
As I said before, I root for you to be right for my portfolio sake.
Vinod
BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example.
Vinod
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longinvestor,
If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.
Vinod
After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV but BV never gets revised upwards. The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.
My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.
"Berkshire has not gotten that worse". That is my bet, and it is in stock price growth.
I disagree with your interpretation of Buffett's comments in the annual report.
The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings.
He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value.
He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report.
So all he is saying is we need to use a multiple of book value now and not just 1x book value.
I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points.
Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV.
As I said before, I root for you to be right for my portfolio sake.
Vinod
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longinvestor,
If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.
Vinod
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A few thoughts
1. As long as the businesses with "temporary problems" have a strong moat and I have conviction in the moat, I find it easy to hold and even add on to the business as price drops. The key really is that moat is real. IMO there are only about a couple of dozen businesses with moats - all others are more riding industry tailwinds or operationally outstanding (which is not a moat). If you have several dozens of businesses then probably your definition of moat might not be stringent enough to give confidence.
So I would really be hoping the prices for these businesses to be going down more and more. I would give in general any business 3 years for the "temporary problem" to be fixed. If problem continues it is likely that its moat is impaired in some way.
2. As far a limiting problem businesses to a certain % of portfolio, I think it is better to avoid setting such guidelines top down. I used to do that but it never really worked in practice as I always violated the guidelines since opportunities in the market do not fit nicely with our top down preferences.
Some times there is an abundance of cheap high quality businesses, sometimes there is an abundance of 'temporary problem" businesses within your circle of competence. So it makes sense to go where opportunities are.
Three years ago I was entirely (2x or more notional portfolio exposure) to problem businesses (financials) because they are dead cheap. Now I have moved in a major way to high quality companies. So instead of a "problem business" at 0.6x IV, I would rather own 0.8x IV high quality business. But when I own mostly problem companies, I would have a higher percentage of cash to balance tail risks and/or have some hedges in place.
Vinod
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OK, here's a prior post of mine, coming at it from another angle. Stock price over the fifty years has roughly followed both earnings growth and bv growth; both ~20%
From the 10-K
Per-share pre-tax earnings (non-insurance, non-investment)growth rates
1970-1980:20.8%
1980-1990:18.4%
1990-2000: 24.5%
2000-2010: 20.5%
2011: 18%
2012: 15.7%
2013: 20.6%
2014: 19%
There is little evidence that earnings growth has materially changed in the past four years from the previous four decades. Buffett has been singing for many years that their focus going forward is on per share earnings, not on BV growth.
I don't see any number below 15%, not in 1-,3-,5- years, or over 5 decades; do you? I put the table of stock prices to show that the 10-20 period is different (world messed up, not BRK, they just went into a shell letting the cash pile up) than the most recent 3-5- and the older 20-30-40 year periods, when the capital was freely deployed. Stock price will follow. I think it is urban myth to project the 10-15 year history into the future. That one makes ZERO sense to me as the opposite does to you.
No, I don't agree with you. On the other side, not trying to convince you or anyone else about the future prospects of BRK.
I agree that intrinsic value growth (approximated by book value growth over time) can be measureed as the combination of the growth of investments per share and earnings per share. As such, it would be helpful for you to stare at not only the numbers above re earnings growth but also investments per share growth and book value growth. This would help our conversation and make clear to you that BRK will not grow intrinsic business value at 15% compounded going forward. Buffett said "focus" on earnings per share growth, not "only look at that" and ignore the other parts of the business which drive intrinsic business value - this is where you are erring.
Let's not get hung up on 15% though. If you are saying the next 10-15 years may look better than the last 10-15 years for BRK (especially relative to the S&P) as the driver of intrinsic value is shifting more and more from growth in investments per share to pre-tax earnings growth - and not everyone has figured that out yet - then I completely agree with you. And this is counter-intuitive to a degree because you would not expect this result after the business has become larger.
12% on the high end may be doable because of this point I think you are making. Just forget about 15%.
+1
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Or, you can take Buffett comments in this year's AR.
If an investor’s entry point into
Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares
have occasionally reached – it may well be many years before the investor can realize a profit. In other
words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire
is not exempt from this truth.
Purchases of Berkshire that investors make at a price modestly above the level at which the company
would repurchase its shares, however, should produce gains within a reasonable period of time. Berkshire’s
directors will only authorize repurchases at a price they believe to be well below intrinsic value.
He is practically giving you his valuation. At 1.2 P/B it is unambiguously cheap. At P/B of 2.0 it is expensive.
If you estimate "well below intrinsic value" to be 25%, then IV is around 1.6 P/B. Very hard to improve on this.
Vinod
Vinod,
I think you hit the nail squarely on the head. Their explanation fit very nicely with my estimate of Berkshires IV. But this was the most clear estimate of Berkshire's IV yet from Buffett and Munger. I was shocked to see it spelled out so clearly when they've been playing can and mouse games for years regarding the IV.
Just to share another insight. It was an off the cuff response from Buffett at an annual meeting a few years ago. There were questions about the value of the smaller BRK subs. Buffett came out and said that they're worth about 14x pre-tax earnings. I was shocked to hear such a direct answer about their value - it was late in the meeting so maybe he was tires. Then I went home and dove deep and found that it's true.
I think these days maybe they're trying to obfuscate the valuation of the smaller subs by combining them with insurance.
rb,
Can you share any insight into what subs Buffett is talking about? This is the first time I am hearing about this, so any additional info you can share around this would be great.
Vinod
Vinod,
Sorry to get back to you so many pages later in this post but real life intervened. I went back to my notes and that comment was at the 2012 meeting and he was referring to the small subs so ex BNS, BHE, Finance, Insurance, Lubrizol, etc. Basically he was saying the "Other" divisions were worth 14x pre tax.
rb,
Thanks for the info.
Vinod
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You need to estimate what the likely growth rate of book value would be giving the equity hedges and portfolio positioning if we just muddle through with low economic growth, weak stock markets and low bond yields for a long time. In such a scenario, Fairfax would be growing book value at an unattractive rate.
If you believe in major deflation or an economic catastrophe, it look very attractive. Otherwise, not so much.
Vinod
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I found this site which lists the CPI index in Japan. Since fairfax is betting on CPI indices in US & Europe I thought this was relevant. You will have to tweak the graph to get the long term numbers but except for brief periods there has been no deflation, as measured by the CPI, in Japan except for brief periods. Certainly the type of decline that would be needed for the FFH CPI bets to pay off hasn't occurred. So, we would need a deflationary event greater than what has occurred in Japan in order for these things to hit.
http://www.tradingeconomics.com/japan/consumer-price-index-cpi
I looked at official Japanese data as well and it also does not indicate the amount of deflation that Fairfax was referencing in their AR. Fairfax used World Bank or some other global org data (I cannot recollect) which showed a much higher deflation amount than official Japanese figures. Do not know why.
Vinod
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I own the stock, rb. I think we are on the same page. I think the company is very undervalued, just laid ou some reasons why I think operating earnings won't grow at the rate they have. The funny thing abou Berkshire is we're basically arguing whether or not this company has 30-40% upside to re rating or 100%, either way the stock is a buy and a half.
I/we spilled a lot of ink about this and that because I'm an argumentative disagreeable person online and had an opinion that I wanted toe express and but you're right, who cares? We're all getting to buy a great company at a good (or awesome if you are more bullish) price. Other threads are arguing over whether x co's earnings are real or this or that. We are arguing whether op earnings growth will be 10 or 12% or 18%. In either scenario Berkshire's is a great stock to own and will provide a more than adequate return without a lot of risk.
+1
I was thinking of the same. The heated argument seems to be (a) we make a lot of money (b) we make a heck of lot of money.
Not to distract anything from the quality of the discussion but it is funny.
Vinod
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I don't think it's really necessary at this time. The past year has mainly been about bringing the company away from the brink and setting a foundation for the future. Not much is really discussed in the current PDH thread other then people in the US trying to figure out which broker to use to buy shares.
Some great insights in that thread but until the company starts having more news flow I think the existing thread is just fine.
Besides, I don't plan on nit picking every single thing the company does and really don't care about what time everyone's lunch break is :)
I would suggest that CONeal is absolutely correct here!
I was asked to speak to some engineers at Google, and I said that I don't deserve to speak at Google until I've done something noteworthy.
I've seen other managers write books about how to be like Buffett, yet their funds or businesses flounder or fail.
I've seen a manager I praised highly fall mightily in terms of ethics and respecting shareholders.
Shareholders will see us announce many new things over the next 5 months, next 5 years and as long as I can run the company. You are just at the very tip of the beginning...the 1st batter, of the 1st inning of a 9 inning game.
Let's get through the first few innings before you think I deserve any sort of section for Premier. I'll do my best to get one though! ;D Cheers and thanks for your support!
Parsad,
You are such a level headed and honest guy that I have the utmost confidence in your success. Wishing you the very best in your efforts.
Charlie Munger I think talks about deserved success and I cannot think of a better person who qualifies.
Vinod
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Or, you can take Buffett comments in this year's AR.
If an investor’s entry point into
Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares
have occasionally reached – it may well be many years before the investor can realize a profit. In other
words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire
is not exempt from this truth.
Purchases of Berkshire that investors make at a price modestly above the level at which the company
would repurchase its shares, however, should produce gains within a reasonable period of time. Berkshire’s
directors will only authorize repurchases at a price they believe to be well below intrinsic value.
He is practically giving you his valuation. At 1.2 P/B it is unambiguously cheap. At P/B of 2.0 it is expensive.
If you estimate "well below intrinsic value" to be 25%, then IV is around 1.6 P/B. Very hard to improve on this.
Vinod
Vinod,
I think you hit the nail squarely on the head. Their explanation fit very nicely with my estimate of Berkshires IV. But this was the most clear estimate of Berkshire's IV yet from Buffett and Munger. I was shocked to see it spelled out so clearly when they've been playing can and mouse games for years regarding the IV.
Just to share another insight. It was an off the cuff response from Buffett at an annual meeting a few years ago. There were questions about the value of the smaller BRK subs. Buffett came out and said that they're worth about 14x pre-tax earnings. I was shocked to hear such a direct answer about their value - it was late in the meeting so maybe he was tires. Then I went home and dove deep and found that it's true.
I think these days maybe they're trying to obfuscate the valuation of the smaller subs by combining them with insurance.
rb,
Can you share any insight into what subs Buffett is talking about? This is the first time I am hearing about this, so any additional info you can share around this would be great.
Vinod
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Vinod,
On point #1 I fully agree with you with shades of gray. That was kind of the point I was trying to make when I was talking about mark to market. I probably didn't express the point very well. Why BRKs market investments may be worth more than book is because they are leveraged with the float. But at this point the float is going into so many places that I would probably just mark the securities to market and leave it at that.
Good point. I did not think of it because I am not used to thinking of Berkshire in this way.
I try to value Berkshire segment by segment by segment as well as other methods. I use P/B more as a short cut from the values derived from each of these. So if segment by segment method comes to a value of $160 per share, then as a short cut I would use 1.6 P/B as fair value. This way I need go through the detailed calculations every quarter or year. Then after a couple of years, I refresh my estimates and again convert it into a P/B ratio. This is more for ease of use.
I did a detailed write up 5 years back that pretty much remains the model that I use for subsequent years.
http://vinodp.com/documents/investing/BerkshireHathaway.pdf
I have updated one for this year but it is not in a publishable state.
#2, and #3 I'll take them together. Yes the goodwill that BRK carries for the acquisitions shouldn't result in a large P/B attached to them. Especially in the near term. Now I'm going to get into a bit of murky conceptual valuation stuff so bear with me a bit.
The way I see it is that with certain big acquisitions: Mid-American, BNSF, and PCP Buffett actually acquired growth platforms. Companies which have a large opportunity set of projects that carry high rates of return by virtue of their economics or industry they are in. The kind of rates of return which are scarce outside of these companies. So instead of Buffett having to look for a stock to buy that will return 12% with the flip of a switch he can dump capital into MidAmerican and get 12%. This way he can reinvest the rivers of cash flowing into Omaha at high rates of return.
To see this change in strategy you can look at BRK investments up to the 2000s. They were mostly asset light companies that spit out a lot of cash. Coca Cola, P&G, Gillette, American Express. After 2000s you see asset heavy companies that can suck up a lot of cash: MidAmerican and BNSF. I think PCP will turn out to be some sort of roll-up like NOV was.
Now my question is. Since these growth platforms are acquired to reinvest Berkshire's cash at high rates of return for years into the future, and Berkshire is sure to make lots of cash in the future, when is the a lot of value actually created? When the cash is deployed or when the growth platform is acquired?
I'd love to hear your thoughts on this, especially since I may be getting a bit aggressive with mine. Thanks.
Agree completely. This is exactly the way I view this too. Buffett has made sure that his successors have the option of deploying huge amounts of capital at good to great rates of return. So one less problem for them and importantly growth with low risk.
I struggle too with this as the value of a truly exception business is going to be pretty high. It depends on how far you want to look into the future. 10 years? 30 years? I am inclined to look at 10 years, knowing fully well that IV is going to be higher that my estimate. This way I would not be so conservative as to miss out on the opportunity but also give myself some margin of safety.
Vinod
vinod and rb,
I wanted to continue with the discussion on IV to BV and strains/changes//tendency etc. Your discussion is very interesting and I think it possibly gets at the heart of an interesting matter: that this anchor onto BV has become a coil that keeps tightening, providing persistent buying opportunities, with the likelihood of a rerating upwards at some point in the future.
Maybe I can throw a couple of questions into the pot for consideration vis a vis the liabilities that get subtracted from equity book:
LIABILITIES.
BV is calculated after subtracting debt, deferred taxes and float liabilities. Sometimes modelers value the insurance business and add something back for its incredible track record of underwriting profits. Sometimes modelers add back some of the deferred taxes liabilities. No one discounts debt. What if much of this is too pessimistic?
Float: IF, and obviously it is an if, the insurance business performs in the future like it has in the past then the float has zero liability. ZERO. Indeed, if the underwriting result is net cash flow positive, the insurance business has a net positive present value in addition to the float having no liability.
Debt: Debt that is tax deductible and costs 2, 3 or 4 percent does not have the same time/value characteristics as Berkshire's assets. For example, imagine i set up a little company into which I put $1m equity and I borrow $1m long term at 3% and I use the money ($2m) to buy a power plant that makes $200,000 annually. The equity book value is $1m, $2m of assets minus $1m of debt. But is that a fair reflection? My equity of $1m is making a 17% return. If the debt is sustainable and both the debt and equity are very long term one can make the argument that far from the $1m of debt being equal to the $1m of equity, that, in fact the equity is worth more than 5 times as much as the debt (17%/3%). And that is static debt, the discrepancy is more pronounced where one can add to a growing debt.
No modeler that I have ever seen ascribes any value to BRK's operating businesses ability to carry debt, or add incremental debt to maintain a debt ratio. Good growing stable businesses can create FCF out of thin air because they create opportunities to add debt capital to simply maintain leverage ratios. Malone is a genius at this. But the same applies to quite a number of Berkshire businesses although Buffett is far less aggressive than someone like Malone. All the book value estimators I have seem always subtract 100% of the outstanding debt and no one I have ever read has ascribed a positive present value to a predictable grower's ability to constantly add incremental debt.
Deferred taxes: Nearly everyone subtracts some of the deferred taxes. Most of the portfolio is in WFC, KHC, BAC, KO, IBM, AXP which I doubt are ever sold. So what exactly is the liability? Eventually these businesses will end up 100% owned and in the meantime the dividend is paid without any of the dividend going as interest to the "deferred taxes funding" (there is dividend tax of circa 15% but that is in line with what you or I would pay owning these companies directly). IF, and obviously it is an if, the positions are not sold then there is no deferred tax liability and owning these businesses through BRK is the same as owning them direct.
Now obviously there were some "ifs" in there...but all the "ifs" are the "actuals" of the last twenty years. Perhaps we should see BRK as stack of solid return assets funded by a blend of liabilities that, if the future resembles the past, don't exist?
It would be better to come up with an IV estimate based on look through earnings and expected growth in IV. This way you incorporate all the relevant factors, growth in float, growth in investments, growth in subsidiary earnings, etc. Then you can derive what P/B would match with IV. Otherwise it is difficult to quantify exactly what P/B would be fair value.
Or, you can take Buffett comments in this year's AR.
If an investor’s entry point into
Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares
have occasionally reached – it may well be many years before the investor can realize a profit. In other
words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire
is not exempt from this truth.
Purchases of Berkshire that investors make at a price modestly above the level at which the company
would repurchase its shares, however, should produce gains within a reasonable period of time. Berkshire’s
directors will only authorize repurchases at a price they believe to be well below intrinsic value.
He is practically giving you his valuation. At 1.2 P/B it is unambiguously cheap. At P/B of 2.0 it is expensive.
If you estimate "well below intrinsic value" to be 25%, then IV is around 1.6 P/B. Very hard to improve on this.
Vinod
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Vinod,
On point #1 I fully agree with you with shades of gray. That was kind of the point I was trying to make when I was talking about mark to market. I probably didn't express the point very well. Why BRKs market investments may be worth more than book is because they are leveraged with the float. But at this point the float is going into so many places that I would probably just mark the securities to market and leave it at that.
Good point. I did not think of it because I am not used to thinking of Berkshire in this way.
I try to value Berkshire segment by segment by segment as well as other methods. I use P/B more as a short cut from the values derived from each of these. So if segment by segment method comes to a value of $160 per share, then as a short cut I would use 1.6 P/B as fair value. This way I need go through the detailed calculations every quarter or year. Then after a couple of years, I refresh my estimates and again convert it into a P/B ratio. This is more for ease of use.
I did a detailed write up 5 years back that pretty much remains the model that I use for subsequent years.
http://vinodp.com/documents/investing/BerkshireHathaway.pdf
I have updated one for this year but it is not in a publishable state.
#2, and #3 I'll take them together. Yes the goodwill that BRK carries for the acquisitions shouldn't result in a large P/B attached to them. Especially in the near term. Now I'm going to get into a bit of murky conceptual valuation stuff so bear with me a bit.
The way I see it is that with certain big acquisitions: Mid-American, BNSF, and PCP Buffett actually acquired growth platforms. Companies which have a large opportunity set of projects that carry high rates of return by virtue of their economics or industry they are in. The kind of rates of return which are scarce outside of these companies. So instead of Buffett having to look for a stock to buy that will return 12% with the flip of a switch he can dump capital into MidAmerican and get 12%. This way he can reinvest the rivers of cash flowing into Omaha at high rates of return.
To see this change in strategy you can look at BRK investments up to the 2000s. They were mostly asset light companies that spit out a lot of cash. Coca Cola, P&G, Gillette, American Express. After 2000s you see asset heavy companies that can suck up a lot of cash: MidAmerican and BNSF. I think PCP will turn out to be some sort of roll-up like NOV was.
Now my question is. Since these growth platforms are acquired to reinvest Berkshire's cash at high rates of return for years into the future, and Berkshire is sure to make lots of cash in the future, when is the a lot of value actually created? When the cash is deployed or when the growth platform is acquired?
I'd love to hear your thoughts on this, especially since I may be getting a bit aggressive with mine. Thanks.
Agree completely. This is exactly the way I view this too. Buffett has made sure that his successors have the option of deploying huge amounts of capital at good to great rates of return. So one less problem for them and importantly growth with low risk.
I struggle too with this as the value of a truly exception business is going to be pretty high. It depends on how far you want to look into the future. 10 years? 30 years? I am inclined to look at 10 years, knowing fully well that IV is going to be higher that my estimate. This way I would not be so conservative as to miss out on the opportunity but also give myself some margin of safety.
Vinod
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Good pt.
I guess it's a little tough though. If Warren retains a dollar and puts that dollar towards railroad growth CapEx, the BV didn't increase but assuredly the IV did. It's going to get tougher and tougher to think about IV relative to BV as time goes on.
Well the spread between IV and BV will widen. I don't know if it's right to think that it will be tougher to think of BV vs. IV. My view is that at some point maybe not too far away it will become wrong to think of BRK in terms of IV.*
I'm a bit encouraged by the use of debt in the PCP acquisition. Maybe they're starting to use the balance sheet a bit. We'll see if that turns out to be true.
I am usually too abbreviated on the internet. Obviously the link between IV and BV will be easy to think about b/c people have their estimate of IV and BV is a known number and they can compare the two. I was more thinking of the change in each. Will a 5% increase in BV be roughly equal to a 5% increase in IV etc.? It won't be a useful heuristic.
*You mean BV where the asterisk is above?
Obviously it is nice to have a neat multiplier on BV to get to IV and that worked nicely in the past. What I'm getting at when I'm saying that the relationship between IV and BV is breaking down is the company has changed to much from the past. In the past it was mostly a financial company and a lot of the assets would be marked to market so BV would be tracking IV. That relationship is breaking down because so many of the assets aren't marked.
This gets to your thoughts about relative changes in BV and IV. For example if the investment portfolio goes up by $1 then IV goes up by $1. In this case IV will grow by less in % terms rather than BV. However if BV of BNSF or PCP goes up by $1 then IV may go up by $4. Looking at it in a different way, if earnings go up by 10% in a year at BNSF we can infer that BNSF's IV went up 10%. That's a lot of value created and added to Berkshire's IV but very little of that would show up in the BV. So I don't think that even changes in BV and IV are correlated that much anymore.
Great points and I largely agree. A few minor quibbles:
As operating companies make a larger proportion of Berkshire compared to investments, the IV as measured by P/B multiple should creep up. But I think the P/B creep is very slow. If Berkshire fair value was say 1.5 P/B five years ago, it is probably 1.55 P/B now. So I think to a first approximation P/B is a pretty decent measure of estimating BRK's IV.
There are many different factors that are influencing P/B multiple
1. When Berkshire makes say investments in the stock market, those are worth pretty close to book value. They are worth a bit more than book value due to the strong possibility of beating the market, but again they face taxes on dividends which reduces some of the premium. If Berkshire consisted of nothing but $120 billion worth of stocks, then I do not think fair value would be anywhere as high as 1.5x Book value.
2. When Berkshire purchases operating companies, it typically pays a premium to the underlying companies book value and the total price paid becomes the new book value on Berkshire balance sheet. Sure they are worth more under Berkshire's umbrella but in aggregate, fair value for these would be closer to say 1.2x price paid or something around that.
PCP on which I think Berkshire got a particularly good deal is probably worth 1.3x at the high end to what Buffett paid for that company. But this is unusually attractive deal (much to my irritation as a PCP shareholder).
3. When Berkshire deploys capital internally say in BNSF or Energy or in any of its subs, that is where a larger premium of say something like P/B of 2 would be justified. So reinvested earnings are worth 2x book or maybe even higher. This is the part I disagree a bit with your comments. When BNSF increases its earnings by 10%, it is associated with a corresponding increase in equity or book value of BNSF. Othewise you are assuming that BNSF would have continuously increasing ROE - no growth in book value as earnings increase. While ROE might increase a bit, most of Berkshire's recent subs are likely to have a stable ROE, thus they would need growth in book value to increase earnings.
#1 and #2 pull P/B multiple down while #3 increases the multiple. So overall, if you do a point in time IV estimate and translate it into a P/B multiple, it is remarkably stable - although increasing by a very small amount each year.
There are a few other minor factors as well but for brevity let us ignore them.
Vinod
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It did achieve higher than teens growth in earnings power
1) converting cash and stocks to owned businesses, generally in a way that was immediately accretive
2) benefitting from a cyclical upwind in the economy from BNSF (bakken plus other) and lots of housing related businesses
vinod, you are looking at equity value which has grown at a lower rate because of the DTL (which decreases the growth from stock appreciation by 1/3 and also likely understates the growth in cash generation from BNSF and Berkshire Energy).
The guys that are jacked up saying mid teens returns are saying they expect earnings to keep growing at that clip. You are saying book value hasn't grown at that clip so why would it ramp up. They are different things.
I think you all are talking past each other.
I think you are correct with respect to the value of stocks and bonds and securities that berkshire owns. No way that grows at mid teens. It will grow at s&p +/- 3%.
But operating earnings can continue to grow at a rate that exceeds the growth rate of the securities portfolio. I don't think it would be wise to say "15% / year for 10 years" or something like that, but I think we all agree they'll do okay.
I used book value growth as a rough proxy for IV growth which incorporates both book value and earnings power growth. So I am really focusing on IV growth.
For my own estimates, I tried to model growth of various components that drive IV - float, investments, reinvestment rates, etc. I get a range of 9% to 10% and if I really stretch I can get to 11%. But beyond that I just cannot see how IV growth can be much higher.
As I said above, I was wrong before in underestimating growth rate and would be really happy to be wrong again!
Vinod
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Also agree that 10% is a good conservative return estimate. I think that if Warren wanted to be more aggressive with the balance sheet, then low teens would be easy and he may even do better but it seems like the company isnt shooting for the stars anymore.
Over the last 5 years (2009 YE to 2014 YE), Berkshire did not achieve low teens growth, arguably with strong tailwinds (equity market recovery from crisis lows, benefiting from opportunities created by the crisis, etc) over the last 5 years. Assuming the balance sheet is managed in the same fashion as before, neither more conservatively nor more aggressively, what factors would drive higher returns than the past 5 five years?
BRK is my largest allocation, but not seeing the growth you guys are expecting.
Vinod
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Agree with thepupil regarding growth. Growth in book value anywhere near teens is unlikely.
I did a detailed write up on BRK in early 2010 and did an update and postmortem on where my estimates have deviated from actual results. None of the growth factors have changed all that much over the past 5 years, except that equity portfolio is more likely to have lower returns going forward than in the past years.
Here is the section:
Over the last 5 years (from 2009 YE to 2014 YE), Berkshire has compounded shareholders equity from $131 billion to $240 billion, at a compound annual rate of 12.9%. I had estimated in early 2010 that shareholders equity is likely to compound at about 9.6% to $207 billion. Shareholders equity increased by $33 billion more than my estimate. What happened?
I underestimated growth in two segments
1. Equity Investment Returns: Berkshire had an equity portfolio of $57 billion at 2009 YE. I estimated a price return (excluding dividends) of 6% on equity portfolio. Actual S&P 500 price return (excluding dividends) over the same period is 13.0%. If Berkshire equity portfolio matched S&P 500 returns, equity portfolio would be $105 billion at end of 2014, compared to my estimate of $76 billion. This accounted for $29 billion of the underestimate.
2. BNSF Earnings: I estimated earnings over the last 5 years of about $10 billion. BNSF reported earnings of $16 billion over this period. This accounted for $6 billion of the underestimate.
My estimates for underwriting profits, investment income, annual gains from investments (equities, bonds, preferred stocks, etc.), and financial products earnings are close to actual results. Utilities and Manufacturing, Service & Retail came in above my estimates but not significantly.
If equity returns instead averaged 7% over the last 5 years, book value would have compounded at 10.4% annually instead of 12.9%.
Going forward I think it is more likely that growth rate would be between 9% to 10%.
Vinod
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I envy you guys. I was at Busch Gardens today and yet managed to miss the excitement.
JPM at $50! I am pissed.
Vinod
Very few got JPM at $50. My Fido order filled at $58 I think.
You are right. It looks like the $50 price is a one off.
Vinod
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I envy you guys. I was at Busch Gardens today and yet managed to miss the excitement.
JPM at $50! I am pissed.
Vinod
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So I've been reading the 5th edition of Valuation by McKinsey and I have a question. In Ch 2 Fundamental Principles of Value Creation - Cash flow risk pg 36.
Deciding how much cash flow risk to take on What should companies look out for? Consider an example, Project A requires an up-front investment of $2000. If everything goes well with the project, the company earns $1000 per year forever. If not, the company gets zero. (Such all or nothing projects are not unusual). To value Project A, finance theory directs you to discount the expected cash flow at the cost of capital. But what is the expected cash flow in this case? If there is a 60 percent chance of everything going well, the expected cash flows would be $600 per year. At a 10 percent cost of capital, the project would be worth $6000 once completed. Subtracting the $2000 investment, the net value of the project the investment is made is $4000.
This is probably a basic question to most of you. Trying to understand everything slows me down a lot in trying to figure how these stuff works.
How did he get $6000? Is 10 percent cost of capital the same as the DCF discount rate in this case?
Yes. Cost of capital is essentially the same as discount rate or required return.
Cost of capital is from the company perspective while discount rate or required return is from investors point of view. Assuming all equity funding, they become one and the same.
So $600/0.1 = $6000
Vinod
1.2x P/BV entry point
in Berkshire Hathaway
Posted
To me long term the more likely risk is management succession at subs. All these companies that have sold themselves to Berkshire, have owners who have personal loyalty to Buffett. They are willing to work for probably lower salaries than they could get outside just because they love doing what they are doing and basking in Buffett's praises. As these owners die off or retire, the next generation might have less personal attachment to Buffett's successor. That is when problems could start coming up with "Management bordering on negligence".
Vinod