Swedish_Compounder

I would use owner earnings for BRK:s fully owned businesses. Doing that better captures the value of float increase and deferred taxes.

It is really interesting when thinking about the long term effects of these two layers of buy backs. Actually, Berkshires three largest stocks (Apple, American Express and Bank of America) seem committed to making large buybacks over time. Also, Berkshire seems to want to buy back 4-5% annually. I have been looking at the un-distributed earnings from stock component from 2011 to 2021E. I estimate that this component has increased by roughly 13% CAGR per BRK B share during those ten years when BRK simultaneously built a mountain of cash. If BRK had repurchased 4,5% of their shares per year, the figure would be more like 17% CAGR. And then the largest components of the 2011 stock portfolio consisted of IBM, Wells Fargo and Coca Cola, which were no great components. If Apple, Bank of America and American Express have a good operational performance the coming 10 years and continue buying back stock and BRK get the chance to buy back at 4% or more a year, the un-distributed earnings from investees component could have a much stronger development than it did the last 10 years. It is also not impossible that they get the chance to add another holding which consistently buys back it stock, further improving the new formula for success.

I am thinking something similar. If we think over the coming ten years, it could also be that they make one or two large acquisitions. I think we will see somewhere around 10-15% CAGR FCF per share increase over the coming 10 years. That is my investment thesis.

I remember he stated in an interview that he would like to buy back 4-5% of the shares outstanding per year. It seems that is what he is doing now. I expect the repurchases will continue unless the shares appreciate quite a bit from these levels in a short time. Buffett was unusually open with his views that the Berkshire share is cheap during the annual meeting this year. He is probably biding his time with the cash balance, keeping it at around 140 BUSD and waiting for a large acquisition, or something large to do in the equity markets.

Yes, it is great news that he signals large continuing buy-backs. It now seems probable that he will buy back 5% or so of the shares per year. I think he will continue to do so even if the valuation moves up a bit since there is a rather large distance to an over-valuation. I hope so. This should be very positive for the look through EPS development going forward. It also tilts the risk-reward proposition in a positive direction, further reducing the downside.

Right. Cash flow from ops will probably have more than doubled from 2010 to 2020. Only really large acquisition during those ten years was PCP I believe (BNSF consolidated from Feb 2010). So 7% CAGR the coming ten years seems achievable I think. Now, they have much more cash to begin with, which they could together with the incoming cash flows use for share repurchases if they decide to do so. If the excess cash stands still or goes down the coming ten years, that could mean they can both afford large repurchases and some acquisition activity. Note that this is not a forecast, but more a view of how it could look ten years from now. Forecasts are always difficult to make... I really hope they step up their share repurchases even if the price goes up some. BRK is still very cheap compared to the market and compared to what they need to pay for acquisitions and other stocks, especially when taking quality into account.

I would not be totally surprised if they buy back 4-5 percent of their stock per year the coming ten years. Stock portfolio could be worth 600-700 billion. Cash flow from operations 80 billion. Not an unlikely scenario in my view...

I expect that they buy back a lot of stock right now. Otherwise I will be disappointed.

There are lots of valuation and details indeed, but does he anywhere evaluate the company the way Buffett stresses more than once in this years letter that he evaluates companies attractiveness - by analyzing the returns on the net tangible assets required for its operations? Buffett writes that it is over 20% for the stock holdings, on a weighted basis. So one simplification could be to assign 20% to the stock holdings and also analyze the operating entities and in the process not forget to deduct excess cash not required to run the operations.

Interesting post. I personally think that if they introduce a large regular dividend for some years which is slowly increasing year by year, this is the most likely trigger for higher valuation, since the market likes safe and increasing dividend companies and tends to put high valuations on those. I think this is more likely to happen after Buffett's departure, since he is probably more likely to make large irregular one time dividends if he needs to distribute cash via dividend. I believe he mentioned that in some interview. I think it is un-likely that the general market will understand how to value Berkshire other than via the dividend power, since it is composed differently than any other company, does no marketing efforts and try to report as conservative profits as possible in order of minimizing tax. Most people tend to over-simplify or over-complicate the valuation method in my view. Regarding your #7, Buffett says that these variations flowing through the P&L should be disregarded. One simple way to look at the expected value increase / earning power of BRK is to take: a) the earnings excluding unrealized and realized profits from sales of stocks but including underwriting income and investment income such as received interest and dividends (say approx 25 BUSD) b) add your own epectation of the expected annual increase in the current stock portfolio value net of tax. If you expect 8% on a 250 BUSD portfolio you here have 20 BUSD c) this is heavily debated, but if you want to include some of or the full expected annual cash flow received from float increase you can do this. Add between 0 and 8 BUSD Thus, from the above assumptions the earnings power can be estimated to approximately 45-53 BUSD (very rough approimation). But will the market use this methodology to value Berkshires earnings? Most likely not because it is not precise, contains assumptions and even unusual components such as the float increase. Their large excess cash makes it possible to probably add 7-10 BUSD to that number if they find the right acquisition target and borrows some money to fund the acquisition. The Danish insurance company TopDanmark is an interesting example to study in my view. They had not paid any dividend for many years, but used all cash flows for share repurchases. Once it was in the spring of 2017 declared that they would change policy to instead pay dividends, the share price increased something like 50% within a year or so and seems to have stabilized on higher multiples than before, at a level yielding 4,5% dividend or so. It is though not certain that the increased share price was due to the change of cash distribution policy. If others have more examples of how the aluation changed for stable companies that went from buy-backs to dividends, it would be interesting. I personally have lost any expectations for changes in the valuation multiples of Berkshire, at least short term. I mainly use Berkshire as a low risk component to balance the high potential cases in my portfolio, since it gaves me a feeling of safety to keep some Berkshire. In the next major market downturn it is possible that I sell all my Berkshire shares if they do not decline so much and I find bargains in the market. So, it is for me also a "potential dry powder" component. However, if I run out of good ideas in a strong market it is possible that I put all my money in Berkshire until I get new good ideas. This is the way Dynamic works and that makes a lot of sense to me.

One should also keep in mind that the tax rate has changed. If the pre tax multiple was 12x with the 35 % tax rate it should be 14,5x now I suppose.

Interesting. Ackman keps it simple and values the company based on look through PE ratio. He considers the company to be undervalued with its low teen P-E and sees potential for mid teen EPS growth in the medium term. That must mean that he sees potential for 15 percent CAGR stock price for several years if the gap to intrinsic value closes.

Hi there John, No, my post was not about book value. It was about intrinsic value. I do not value companies based on book value. I know there are many technicalities which could be discussed, such as the value of float and float increases and the value of deferred taxes. I also know that maintenance CapEx is a bit higher than depreciation. However, who said that those factors are not discounted properly when valuing that cash flow at 14x for a great set of assets when other great companies such as CostCo, UNP, Coca Cola, P&G etc are valued north of 20 times free cash flow?

Well, if you read what I am writing, I am not forecasting 15% CAGR. It is a possible high case scenario. It is not my base case scenario. So I will also take the bet you propose that actual growth will be below the high case scenario.

Jurgis, yes,and that is because the stock is under-valued today. What I tried to convey was that with share repurchases, acquisitions and stock additions it could be worth four times more per share in 2028 (I wrote market cap, but meant value per share). What it will trade for might be different than hat it is worth though. Imagine that they do two USD 100B acquisitions during the coming five years, which will each provide USD 12B cash flow ten years from now (not impossible) then cash flow ten years from now would instead be USD 61B. Assume they can add USD 100B of equity holdings over the years, which grow in value to 200B, then the stock portfolio will grow to USD 550B (possible / likely scenario, to be honest I also Think the existing holdings will grow more than 6% a year given many if the larger holdings very strong balance sheets and heavy repurchase activity). Assume they repurchase 3,5% of outstanding shares each year, which would decrease the share count by 30% (not so likely maybe given the recent snail pace). If these things would happen and we value the operating earnings at 14 times cash flow, we would get a value of ((61*14)+550)/0,965^10=2005, which is rougly four times the current market cap. Given recent comments from WEB, I do not think the repurchases will be that large, but if they get lucky, the acquisitions could be larger than assumed above. I Believe the "Buffett sleeps for ten years" scenario is a low case and the above possibility is a high case. The outcome will probably be in between with value probably being a triple from todays market price. This makes it a very safe stock to own and even recommend to long term oriented family and friends in my opinion.

Dynamic has a very valid Point. It seems that the market does not appreciate the fact that they committed USD 10B to OXY during Q2. I was thinking about where Berkshires numbers will be 10 years from now if Buffett takes a 10 year long nap and basically does nothing during those 10 years. Stock portfolio: If the existing stock portfolio of around USD 200B is well composed and increases in value by 6% per year, it will be worth USD 358B, Before tax liability. Cash flow: 2018 cash flow from operations minus depreciation (removed depreciation to adjust for growth CapEx) was USD 28B. If we assume that it grows by 3% per year, free cash flow 10 years from now will be USD 37B. Cash position: Around 320 BUSD of cash will have been added to the current balance of around 130 BUSD. Thus, the cash balance will be around USD 450B. What do I want to say with this? I am not sure. Probably that Berkshire is a low risk investment and that two or three major acquisitions together with increased repurchases and additions to the stock portfolio could lead to a value four times the current market cap 10 years from now.

I do know of an example where a company in the real estate / consultancy business wanted to spread ownership in advance of a stock listing. Therefore, they issued stock at a big discount to equity value to their 20.000 members who had "savings accounts" where they could save to invest in future properties. These savings accounts could be very small. They did not put a cap to how many shares could be subscribed by each saver and one guy had shortly before the share issue become a "home saver" and subscribed so many shares that he got to own almost 10% of the whole company. This was made possible because the other "home savers" did not subscribe to enough shares to fill up the share issue. The year after the stock listing, he sold his shares at a 700% profit.

I think that he would be looking at share issuances in poorly marketed very small companies where it would be possible to find opportunities. For example Peter Lynch S&L strategy where you would need to open up accounts in the S&L:s to be allowed to participate in the share issuance taking palce far below market value. There might from time to time be similar situations in other companies, such as real estate companies etc, where you would need to have a savings account to participate. He might try to oversubscribe the share issuance in a huge way, which might be fruitful if it is poorly marketed. He might not be inclined to describe these sorts of situations, because there can be cases when the issuer does not expect someone to subscribe for 1.000 times more shares than everyone else and even though it is not illegal, it can be perceived as un-ethical, since it is against the intentions of the issuer. There would also be share redemption situations where it can be possible to make 20-30% in a few weeks in a very safe way. I have encountered one such situation myself in a very small stock with no analyst or mutual fund coverage and made lots of money from it. If I did not have a regular job and was planning to put 1 MUSD to work, I would probably try to read everything I can find in order to try to find these kinds of situations and bet hard when I find them.

My guess for this quarter is 1,5 BUSD. I believe that he wanted to distribute the annual letter explaining how to value Berkshire before initiating buybacks in a big way. He has probably bought lots of JPM during the quarter. I would not be surprised to see annual buybacks of between 20-30 BUSD going forward, unless he makes major acquisitions that requires the cash on hand, because they will probably always go first, even if there would be more value in buybacks.

When discussing that Berkshire has not performed that well compared to S&P since 1998, I also think it is important to keep in mind that Berkshires valuation has come down tremendously since then. In 1998, the look-through earnings were 2 BUSD or so. In 2018, it was at least 35 BUSD (operating earnings + earnings from investees). There has not been much dilution since end of 1998 (around 10%). Look through EPS has grown almost 15% compounded during those 20 years. My point is that EPS has increased 15-fold, but the stock has increased less than six-fold during the last twenty years. Berkshires valuation multiples have contracted significantly compared to the market valuation.

The Investor - I am happy to see that you have made your homework and studied Buffetts and Mungers words on how to look at Berkshires float, which can not be compared with most other major insurance companies float. We must conclude that there are no restrictions on the future float increase for the foreseeable future. Therefore the normalized float increase should be added to the free cash flow generation capacity of BRK. What is the right number? USD 8 Billion was mentioned by Buffett relatively recently if I remember correctly (I think it was during the annual meeting 2018). This is unique and that is probably why many people have difficulties grasping it. Thus no complicated formulas for how to value the float increases are needed ;)

What I take with me regarding the buybacks is that Warren and Charlie consider that BRK is undervalued at 207 USD. We do not know the reasons for why they did not buy back more. Perhaps they still prefer to buy other companies and only want to consider buybacks when the cash level gets too high. They appear to have bought other equity securities for 18 BUSD or so during the quarter, which is a lot...

That is the core of the matter. There is no other major insurer like BRK. Therefore, the same methods can not apply. What Buffett says is that their float should not be discounted at all, since it is expected to grow and it comes at a negative cost. He also makes the example that he would not be willing to give up his float for good if receiving the corresponding amount in cash. Thus, the float is worth more than the corresponding cash amount (in Berkshires case).

I realize that some members might be tired of the question how to value float and float increases that comes up from time to time. I just wanted to share WEB:s Words on the topic, since it shows that his opinion is that float is worth more than equity (as long as it costs less than zero and grows) and therefrom must be concluded that float increase must be worth more than profit. It is central to valuing BRK:s look-through profits, which is the reason I bring it up again. Under question 27 on the link below is written a nice explanation: https://buffett.cnbc.com/video/1998/05/04/morning-session---1998-berkshire-hathaway-annual-meeting.html "27. Berkshire insurance float has a negative cost WARREN BUFFETT: Zone 8. AUDIENCE MEMBER: My name is Hutch Vernon. I’m from Baltimore, Maryland. My question has to do with float. You said in the annual, and you’ve said in the past, that float has had a greater value to Berkshire than an equal amount of equity. I wondered if you could clarify that statement. Is that because the float has been generated at such a low cost relative to an imputed cost for equity, or is there something else behind that statement? WARREN BUFFETT: No, it’s because the float, which is now, we’ll say, 7 billion, comes to us at a negative cost. We would not make that statement if our float was costing us a couple percent a year, even though float would then be desirable. Highly desirable. But our float is even better than that, or it has been, and so it comes to us with a cost of less than zero. It comes to us with a profit attached. So if we were to replace — if we were to get out of the insurance business and give up the 7 billion of float and replace it with 7 billion of equity, we would have less going for us next year than under the present situation, even though our net worth would appear to be 7 billion higher. And I have said, if we were to make the decision — if we were offered the opportunity to go out of the insurance business, and that 7 billion liability would — as part of that decision — would evaporate from our balance sheet, so that our equity would go up 7 billion, with no tax implications, we would turn down that proposition. So obviously we think that 7 billion, which is shown as a liability, when it’s part of a — viewed as part of an insurance business, is not a liability at all in terms of real economic value. And of course, the key is not what the float is today, and not what the cost is today. The key is what is the float going to be 10 or 15 years from now, and what is the cost going to be 10 or 15 years ago. And, you know, we will work very hard at both increasing the amount of float and keeping the costs down somewhere close to our present level. That makes it a very attractive business when that can be done. GEICO’s a big part of doing that, but we’ve got other things, other insurance operations, that’ll be important in that, too. And we may have others besides that in the future. Charlie? CHARLIE MUNGER: Yeah. If the float keeps growing, that is a wonderful thing indeed."

I remember that interview you refer to. My take is that he did not want to talk up the price, but I did not interpret that as meaning that he would not buy back higher than at 1,27. Yes, he threw the P/B yardstick out of the window and he had for a long time not valued the company based on that. It was only the repurchase critera that was tied to P/B and that confused people. I think he wanted the stock to move with as little volatility as possible, which was accomplished that way, since P/B does not move so dramatically. I think that what changed was that they now wanted to include repurchases in their tool-box. Before, the repurchase limit was merely there reduce volatility for the stock. Now, since they have not found other ways to deploy all their cash flow for a while, they decided to distribute money to the owners, meaning that they need to value BRK properly, since they need to decided whether to pay a dividend or repurchase shares. I hope this means that they will from here on always value BRK vs other opportunities when deciding what to spend money on, because I think they should have bought BRK instead of some of the acquisitions they made if chosing between the two. Probably, repurchases would have been more value creating than the PCP acquisition for example, even though that was probably not a poor acquisition. BRK was just cheaper.