Munger_Disciple

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying. The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward. Your’re capitalizing retained earnings rather than distributed earnings. The value of $10 in earnings growing by 6% a year depends on how much has to be reinvested to produce the 6% growth. Your economic assumptions ($10 initial earnings, 100% retention, 6% growth) and your valuation assumptions ($10 initial earnings, 0% retention, 6% growth) are not the same thing. Using your 10% discount rate, you get the following present values for Berkshire’s operating earnings (i.e., the value of Berkshire excluding cash and securities): (a) $10 earnings, 100% retention, 6% growth (using your terminal year of 24): ($40.49/.10) / 1.10^24 = $41.11 (b) $10 earnings, 0% retention, 6% growth (in perpetuity): $10 / (.10-.06) = $250 Under your economic assumptions of 100% retention, 6% growth and a 10% discount rate, Berkshire would be destroying value. In fact, each dollar retained would be worth only 60 cents. Here’s another way to look at it: If Berkshire needs to retain 100% of its earnings to grow by 6% a year, they’re earning 6% on equity. Berkshire is levered 2:1 and the liabilities cost zero (roughly). You’re therefore assuming Berkshire will earn just 3% on the asset side. Of course, assets that produce operating earnings only make up half the balance sheet, but you get the idea. +1 It is really dumb for a company to retain 100% of earnings and grow at a lower rate than its discount rate (alternately, the opportunity cost for shareholders). Such a management action destroys shareholder wealth. This is the main reason Buffett said the condition for earnings retention is to be able produce more than $1 of market value for each dollar retained.

<i> In 24 years, for example, it will be earning $40 per share according to the model.</i> Ok, what is your estimate of intrinsic value then? Please show the steps you use to arrive at it. You cannot use the standard DCF model because there are no cash flows that accrue to the owner during the 24 years; they are reinvested back in the company.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

+1

A good op-ed piece in Bloomberg by Bill Dudley, former President of the Federal Reserve Bank of NY: https://www.bloomberg.com/opinion/articles/2020-06-22/fed-s-balance-sheet-heads-to-10-trillion-to-support-u-s-economy Dudley's description of the inner workings of the Fed parallels the posts by wabuffo. He seems to imply that despite the rapid expansion of the Fed balance sheet, it can control the inflation by raising the interest rate paid on bank reserves. Does this mean the Fed will drive the ST treasury bond yields to 0% while at the same time raise the rate paid on bank reserves to control inflation if needed? Seems weird.

Recent Forbes article about Fisher: https://www.forbes.com/sites/noahkirsch/2019/10/21/unearthed...

Thanks wabuffo and Cigarbutt for your detailed responses to my question. Also additional thanks to wabuffo for his many educational posts regarding Fed/Treasury operations.

I have a question on this fiscal/monetary macro stuff. My knowledge is rudimentary at best in the area so I apologize in advance if this is an ignorant question. Consider the following hypothetical situation and tell me what is wrong with it. Suppose trade deficit is zero and the govt runs a fiscal deficit equal to 10% of GDP every year. As soon the treasury issues debt, the fed immediately buys all the debt by printing money. So in this situation by using wabuffo's analysis, private domestic savings =10% of GDP every year. So to increase domestic private savings, govt can simply run massive deficits and the fed can just monetize the govt debt. Naturally something is wrong with this scenario.

Why exactly is it assumed that the Maintenance CAPEX will roughly equal the D&A expense? There is no such relationship and it should not be assumed. You REALLY need to understand the business behind the numbers. Maintenance CAPEX and its relationship to D&A depends on the business; to me that is obvious. For railroads, maintenance CAPEX routinely exceeds D&A. For other businesses like real estate the opposite might be true. For some others the two might be roughly equal.

Berkshire didn't sell any WFC stock during Q1 2020. We know this from Q1's 10-Q filing.

There is a very good comment posted by a reader below this Barron's article:

I am assuming you know he cannot plunk down the entire $130B because of insurance liabilities. Even if does so with most of the "free" cash, that is no guarantee BRK will beat the index. That depends on the performance of operating subs.

I thought this was the best question of the annual meeting. In the pre-meeting interview, he said the gap between FAANGM stocks & others actually widened in the crisis because (except for Netflix) they don't need capital to grow. It is hard not to reach the conclusion that Warren now thinks it is much harder and less optimistic about BRK's chances to beat the index than he used to even a couple of years back. I used to think Warren was low balling shareholder expectations in the past annual meetings, but I am not so sure now.

I thought this bit about derivative contract liabilities was interesting: Substantially all open contracts as of March 31, 2020 will expire by February 2023. The weighted average life of unexpired contracts at March 31, 2020 was approximately 1.5 years. Future payments, if any, under any given contract will be required if the prevailing index value is below the contract strike price at the expiration date. We received aggregate premiums of $2.5 billion on the contract inception dates with respect to unexpired contracts as of March 31, 2020 and we have no counterparty credit risk. The aggregate intrinsic value (the undiscounted liability assuming the contracts are settled based on the index values and foreign currency exchange rates as of the balance sheet date) was $2.0 billion at March 31, 2020 and $397 million at December 31, 2019. Intrinsic value of liabilities is now $2.0 billion, still in the money by $500M (but barely) with an average life of 1.5 years left.

I think Buffett is a great teacher, phenomenal business leader, one of the greatest investors of all time, and a great philanthropist. I find him to be an inspiring teacher who has an amazing ability to simplify seemingly difficult concepts for his audience to understand. He is also a decent, honest and trust worthy (managing) partner. A great American treasure. His painting Berkshire is likely to last a long time.

Speaking of PE, Dan Rasmussen (smart guy) points out major problems with the industry in this interview FWIW:

I wonder if WB & CM soured on banks too in addition to airlines given that NIM will be in the toilet for a very long time. We know they sold a slug of Bank of NY, and probably continue to sell WFC.

I think they are not required to until 2021.

No. An amended 13G is only filed once a year. Berkshire filed the 2020 amendment in Feb and they are not required file another until 2021.

https://www.bloomberg.com/news/articles/2020-04-03/u-s-airlines-apply-for-government-aid-with-sales-in-freefall?srnd=premium

+1 Berkshire owned >10% of both the airlines, so they had to report transactions immediately. Now that they are below 10% of each, they no longer have to. For all we know, Buffett could keep selling and be out completely in the coming days. We wouldn't know if that is the case until Aug 15th when the Q2-2020 13-F comes out.

Berkshire selling Delta & Southwest: https://www.sec.gov/Archives/edgar/data/27904/000120919120023250/xslF345X03/doc4.xml https://www.sec.gov/Archives/edgar/data/92380/000120919120023268/xslF345X03/doc4.xml That was a quick roundtrip!

Sad to see Bill G leave the board. Perhaps Berkshire can now buy back stock from Gates Foundation w/o any insider conflict of interest issues.

When BV was the metric until recently, Buffett used to discuss the performance of Berkshire BV change vs. S&P 500. It seems odd that the 2019 annual letter never mentioned Berkshire's stock performance which is now the new preferred metric and its comparison to the index at least in a long term sense and future expectations for the performance.

+1