1.2x P/BV entry point

[karthikpm]

The biggest "risk" I have seen with Berkshire is that pre -2010 ( when it was not in the index) , it had a beta of 0.4- now it's beta is roughly the same as the market

I was hoping for less correlation on the downside but it's evident that BRK trades in step with the market

 

[rb]

I love the higher correlation on the downside. It means more buying opportunities  :D

[Guest longinvestor]

I love the higher correlation on the downside. It means more buying opportunities  :D

 

Indeed it is. IMO, there is price discovery going on since about 2010. The only time it found direction (up) was right after the 1.1x and 1.2xBV buying intention was announced. The market has not figured out the new BRK yet. Buying opportunities that last a long time are most welcome. I believe that price will grow into the earnings, which will be copious. Screw the forward multiples, we will take actuals.

[thefatbaboon]

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?

 

 

 

 

[Guest longinvestor]

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?

 

+1. Buffett is already way conservative, valuing BRK with additional conservatism sounds elegant but is not optimistic but perhaps plainly wrong. The annual report has all needed information to estimate IV.

 

I've been trying to formulate how the market sees BRK today and have two hypotheses' sets being tested:

 

H-null: Nothing has changed

H-alt: Berkshire is at least the same if not better

 

H-null: Nothing has changed

H-alt: Berkshire has changed for worse

 

I believe the market is after the latter. The anchoring to BV likely relates to this. The longer the market takes to figure this out the better for buying opportunities. BV multiple is like a red herring.

 

I'm interested in the former and perhaps the single best variable to use for testing the former is earnings. In fact, every AR in the Intrinsic Business Value section over the recent past has this Charlie and I are more interested in the growth of earnings  versus the investment per share. in 2020, when they report this decade's earnings growth rate and the market sees that it is the same as the previous 4, attention will go to the right multiple.

[thepupil]

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.

 

 

I think most people focus on earnings of the operating companies which accounts for the low cost of debt by subtracting the low amounts of interest in order to get to earnings.

 

Railroads Utilities and Energy segment has equity of $91B.

 

Burlington Northern's separate financials show equity of $52B and Berkshire Energy's show equity of $33B (after adding back deferred taxes) = $85B (the difference is from additional holdco leverage not shown on the subs balance sheet I believe).

 

BNSF pretax income is about $6B. BE earnings are $3B pretax, so these are earning about $9B pretax on $85-$90B of equity. . LEt's throw a 20% tax rate on them and get $7.2B of post tax earnings power. What you think these are worth all depends on your required return. I should note that BNSF has $14B of goodwill related to the acquisition.

 

If you think these are worth 20X. These are worth $144B, 1.6X their DTL adjusted book. Berkshire trades for 1.1X DTL adjusted book, so if you are willing to pay market-ish multiple of 20X there is lots of value in BRK-B (for this portion of berkshire at least would be undervalued by the market). If you want to pay 15X, these are worth $108B, 1.2X DTL adjusted book, pretty much the current stock price.

 

It's hard to justify giant premiums to book because then you can buy things like UNP for much cheaper.

 

For example let's say you think BNSF is actually worth 25X $4.8B NI = $120B (2.3X book, 7.5X tangible book, remember a large portion of BNSF's book is goodwill) because its underearning or will grow or whatever (i actually think it may be overearning because of crude by rail but that's besides the point). Then you are paying $120B for BNSF when you can buy UNP for $72B, a 66% premium. UNP earns 33% more pre-tax than BNSF on similar amounts of tangible equity...a 66% premium is certainly not justified.

 

I don't think that even the conservative "modelers" think these businesses are worth book value. They are obviously worth more than book. But their capacity to carry low cost debt is already captured in their earnings, so as long as you take an earnings based approach for those subs, you are accounting for the debt in a way that does not mechanically subtract it.

 

What do you all think BNSF and BE are worth?

 

 

 

[treasurehunt]

Burlington Northern's separate financials show equity of $52B and Berkshire Energy's show equity of $33B (after adding back deferred taxes) = $85B (the difference is from additional holdco leverage not shown on the subs balance sheet I believe).

 

What do you all think BNSF and BE are worth?

 

ThePupil,

 

Where do you see equity of $52B for Burlington Northern? Looking at the latest 10-Q, I see equity of $34.7B: http://www.bnsf.com/about-bnsf/financial-information/form-10-q-filings/pdf/10q-llc-2q-2015.pdf

 

Goodwill + intangibles is about $15.3B, so tangible equity is $19.4B. Pre-tax earnings for the last six months are $3.2B, which annualizes to $6.4B (not sure if seasonality is a big factor). Pre-tax ROTE works out to 33%.

 

UNP has equity of $21B. I don't see any goodwill or intangibles, so tangible equity is presumably around $21B as well. Pre-tax earnings for the last six months are $3.8B, or $7.6B annualized. Pre-tax ROTE works out to about 36%.

 

Looking at these numbers, it seems Burlington and UNP are pretty comparable. Maybe Burlington's value is 80%-90% of UNP's? If UNP is fairly valued at the moment, Burlington is worth $60B to $67B. If it's on Berkshire's books at $34.7B, there is a big gap between book value and fair value. If it's on the books at $52B, not so much. But I haven't found this $52B anywhere yet.

[thepupil]

Sorry if not clear, I think of everything in terms of adding back DTL. Burlington = $34B equity plus $18B DTL, Berkshire $240B equity + $60B DTL, etc.

 

[vinod1]

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

[treasurehunt]

Sorry if not clear, I think of everything in terms of adding back DTL. Burlington = $34B equity plus $18B DTL, Berkshire $240B equity + $60B DTL, etc.

My mistake. I blithely ignored your parenthetical comment explaining that the $52B equity number was after adding back deferred taxes. Given this, I have nothing to add to your post. :-)

[rb]

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.

[KinAlberta]

Any thoughts on this:  When Buffett first announced that BRK would buy back shares, people were saying that he was putting a floor under the price. My immediate argument was that that may still not be a great time to buy because sellers could overwhelm any amount of buying by Berkshire Hathaway. (Which would be a great thing as Buffett would be getting an even better deal on his buybacks.).

 

Then Buffett came out and said* he'd be buying "aggressively" if the price fell below the criteria (whether it was 1.1 or 1.2 I can't remember). That statement had me thinking that he was deliberately putting a much firmer floor under the price. 

 

So now I wonder what it might take for any buyback floor to collapse under selling pressure.  For instance, right now the price has fallen, and Buffett is still going strong. Should Buffett suddenly drop dead in a market like we had last week how far could it fall...

 

 

* in term of why he'd have said "aggressively", I think this is in keeping with Buffett's practice of hinting to shareholders when BRK is too highly or too lowly valued. Knowing that he might drop dead, he's deliberately trying to put a floor under the price to limit volatility and harm to existing shareholders. Otherwise, let it collapse to the benefit of future shareholders.

[rb]

Any thoughts on this:  When Buffett first announced that BRK would buy back shares, people were saying that he was putting a floor under the price. My immediate argument was that that may still not be a great time to buy because sellers could overwhelm any amount of buying by Berkshire Hathaway. (Which would be a great thing as Buffett would be getting an even better deal on his buybacks.).

 

Then Buffett came out and said* he'd be buying "aggressively" if the price fell below the criteria (whether it was 1.1 or 1.2 I can't remember). That statement had me thinking that he was deliberately putting a much firmer floor under the price. 

 

So now I wonder what it might take for any buyback floor to collapse under selling pressure.  For instance, right now the price has fallen, and Buffett is still going strong. Should Buffett suddenly drop dead in a market like we had last week how far could it fall...

 

 

* in term of why he'd have said "aggressively", I think this is in keeping with Buffett's practice of hinting to shareholders when BRK is too highly or too lowly valued. Knowing that he might drop dead, he's deliberately trying to put a floor under the price to limit volatility and harm to existing shareholders. Otherwise, let it collapse to the benefit of future shareholders.

Kin, I may be a bit harsh in this post and I don't know if you deserve it or no. Maybe you do. But oh well take the better with the bitter.

 

In your post you talk a lot about floors and prices and levels. Nowhere do you talk about value. Buffet also said that they may not do buybacks at 1.2 book. Basically they will do whatever the hell they want. By the way the whole price floor concept is some wall street bullshit. I have yet to see a buyback program that puts a floor under any stock.

 

Over here we get to a community of people that want to build value. You're concerned by price floors. I don't care. If BRK is worth 1.6 book and they buy back at  1.2 they create a lot of value and I get richer. If the market busts through that level and BRk can buy back at 1.1 or 1.0 book I get even richer so why should any of the shareholders care too much about price floors? I pray that there is no price floor. I like 70 cent dollars especially when you can buy them in bulk.

 

The thing is that one of the key reasons why Berkshire was so successful is because it had a shareholder base that was never concerned by the issues you raise. They were more concerned about value than price. If it was the other way around Berkshire could very well have half the market cap it has today.

 

[Picasso]

I don't think KinAlberta is suggesting gaming the buybacks, I think he/she is asking whether the market price will reflect the ability for Berkshire to buy at 1.2x book.  Given the age of WEB, it impacts how much or when you want to buy the stock regardless of the long-term.  Unless of course you just buy it at a fair price and care less about the volatility of seeing the stock fall under $120 in short order.  And KinAlberta even references how much better it is to see Berkshire buy more shares even more cheaply.

 

It's like how I think of IBM.  If Berkshire sells their stock in IBM, I don't think traditional valuation metrics or buybacks will really matter.  The stock is going to take it in the chin, no?  That kind of impact whether I want to buy at 1.2x book or 10x EPS, or whatever.

 

The last time Berkshire announced a buyback plan the shares shot up and they weren't able to buy any shares (or maybe a few I can't remember).  If Berkshire goes down a lot I suspect we have a market where WEB is finding ways to increase intrinsic value to Berkshire much better than buying shares of BRK.  So I don't put much faith in the buyback floor other than it's WEB saying that what he thinks the low side of intrinsic value is.

 

Based on what I gathered from his personality from reading Snowball, maybe it gives him pleasure to say "we'll buy the stock at 1.2x" and see the stock stay above those levels.  A bit of an ego thing that highlights the quality of his investor base to trust his judgement and ability to access value.  That's speculative but based on his focus outside of share buybacks I think it's a possibility.

 

[Charlie]

"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"

 

+1 

 

It is probably too simple, so people don´t want to use it.  ;)

[Guest longinvestor]

"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"

 

+1 

 

It is probably too simple, so people don´t want to use it.  ;)

Can't stop chuckling!

[vinod1]

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

[KinAlberta]

I don't think KinAlberta is suggesting gaming the buybacks, I think he/she is asking whether the market price will reflect the ability for Berkshire to buy at 1.2x book.  Given the age of WEB, it impacts how much or when you want to buy the stock regardless of the long-term.  Unless of course you just buy it at a fair price and care less about the volatility of seeing the stock fall under $120 in short order.  And KinAlberta even references how much better it is to see Berkshire buy more shares even more cheaply.

 

It's like how I think of IBM.  If Berkshire sells their stock in IBM, I don't think traditional valuation metrics or buybacks will really matter.  The stock is going to take it in the chin, no?  That kind of impact whether I want to buy at 1.2x book or 10x EPS, or whatever.

 

The last time Berkshire announced a buyback plan the shares shot up and they weren't able to buy any shares (or maybe a few I can't remember).  If Berkshire goes down a lot I suspect we have a market where WEB is finding ways to increase intrinsic value to Berkshire much better than buying shares of BRK.  So I don't put much faith in the buyback floor other than it's WEB saying that what he thinks the low side of intrinsic value is.

 

Based on what I gathered from his personality from reading Snowball, maybe it gives him pleasure to say "we'll buy the stock at 1.2x" and see the stock stay above those levels.  A bit of an ego thing that highlights the quality of his investor base to trust his judgement and ability to access value.  That's speculative but based on his focus outside of share buybacks I think it's a possibility.

 

Thanks for coming to my defence. My talk of price floors and ceilings isn't my invention. At the time of the buyback, discussion boards and media alike talked about the 1.1 creating a price floor suggesting that BRK was a 'safe' buy at that price. Since people's idea of the long run is often at most only 5 or 6 years, falling for the idea that the price couldn't fall much further below IV seemed misguided. 

 

Basically, one reason Buffett has been successful is because of market pricing inefficiencies. So, while buying safely below IV should be the main consideration, non-believers in the EMH count on fear and greed swinging prices above and below IV. So at times some pretty pessimistic scenarios become more probable and some irrational pricing can thus become more probable. That said, people have to ask themselves now, why on earth is BRK pricing close to 1.2 vs fair estimates of IV?  To me, there's a possibility that people are treating the 1.2 as a price ceiling and more like IV than a price with a good margin of safety built in.

[KinAlberta]

BTW - This is me (Albertasunwapta)...

 

Lol wait a second. I remember something from this weekend. Stupid coincidence but still...

 

 

15. AlbertaSunwapta says on Sep 23, 2011 at 3:47 PM:

 

Only twice in 14 or 15 yrs with my current brokerage have I ever been put on a long hold. So it's a funny coincidence here: On a Friday in March of 1999 at the very height of the internet bubble when people were dumping quality companies to buy crap, I went to buy BRK.B shares and for the first time was put on hold - a long hold. It was those pesky speculators taking up time. I gave up waiting and decided to call back on the next Monday. That weekend Buffett announced that he'd consider buying back shares. I missed by a day, getting BRK at that great low point.

 

Well, today, I again went to buy BRK.B shares and for the first time in since 1999, I was again put on hold. :-) I hope Buffett is on vacation. I have a limit order in for Monday.

 

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http://www.gurufocus.com/news/146183/berkshire-hathaway-is-now-traded-at-the-lowest-valuation-in-decades#146504

 

Lol, what are the odds, poor guy.  :D

 

(It was 2000 btw and not 1999 but oke.)

http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/brk-buying-back-stock-110-of-bv!!/20/

[thepupil]

That said, people have to ask themselves now, why on earth is BRK pricing close to 1.2 vs fair estimates of IV?  To me, there's a possibility that people are treating the 1.2 as a price ceiling and more like IV than a price with a good margin of safety built in.

 

I'll take a stab

 

1. Berkshire was VERY undervalued for a long time,  it started to re-rate towards some level of fairness in the early part of this year...then...

 

important proxies for big parts of BRK's SOTP fell such as

 

a) UNP is down 28% YTD

b) XLU is down 12% YTD, S&P down 7% or so, Berkshire most correlated to XLF which is down 6% or so YTD and about 8% in the past month, BRK/A is a big component of XLF and they trade together

c) the stock portfolio hasn't been spectacular,  although Kraft Heinz is a giant write-up

d) insurance earnings were giant the past two years last year as were derivative gains which make for tougher comps

e) I think some are disappointed in the choice of elephant in terms of timing and the actual company PCP

 

I think that's pretty much it. haven't seen or noticed anything else.

 

I've added a little in the recent swoon since KHC added value and the price fell a bit so price/value got a lot better on the move from 150-130.

 

 

EDIT: Industrials are also down 10% YTD (which you can kind of sort of not really call a proxy for the smaller subs). My whole point is things across the board have gotten a touch cheaper/less expensive, so we should expect Berkshire to get a little cheaper too. As a 26 yr old net saver, I'm all for it.

 

[thefatbaboon]

Pupil,

 

 

On the debt, first I should have been clear that for me this is the most questionable and smallest of my points about liabilities; DTL and Float are more obviously compelling, and they manifestly do not exist if the future resembles the past. That said,  I have developed a view on debt that growing incremental debt capacity has positive value for equity where one has the very high conviction in the following three points:  a talented capital allocator in charge, a predictable business, and a growing business.  If any one of the three are lacking debt becomes a liability.  There are very few companies that I've been willing to ascribe this value to because there are very few where I'm confident in the three characteristic pertaining long term and the costs of getting this wrong are massive because one swings from debt being an asset to debt being a liability, a double whammy effect.  It's therefore possible that ceteris paribus I might be willing to value BNSF higher than UNP or Discovery higher than Time Warner or Davita higher than Fresenius on the basis that I can make a predictions regarding the present value of incremental debt capacity (there may of course be other reasons as well).  That being said I would never argue too much with someone who did not agree on this point.

 

Re the things you mentioned just now that are negatives ytd...one could add also Geico that has had two bad quarters and has probably got two more ahead till the new pricing takes effect across most policies.

 

 

[Guest longinvestor]

This whole thread is possible because Buffett openly announces when they will buy back shares. No other company does this, they simply state "we will buy back when we want to".Correct me if I'm wrong. So others may be playing games with buybacks, not BRK.

 

Buffett has explained why he does this. It is to let those selling shares to the company know what they are giving up. So it is about keeping a level playing field for all shareholders, those that are leaving and staying. The company does not want to take advantage of any shareholders. It is a high fiduciary standard. 

[james22]

BTW - This is me (Albertasunwapta)...

 

Lol wait a second. I remember something from this weekend. Stupid coincidence but still...

 

 

15. AlbertaSunwapta says on Sep 23, 2011 at 3:47 PM:

 

Only twice in 14 or 15 yrs with my current brokerage have I ever been put on a long hold. So it's a funny coincidence here: On a Friday in March of 1999 at the very height of the internet bubble when people were dumping quality companies to buy crap, I went to buy BRK.B shares and for the first time was put on hold - a long hold. It was those pesky speculators taking up time. I gave up waiting and decided to call back on the next Monday. That weekend Buffett announced that he'd consider buying back shares. I missed by a day, getting BRK at that great low point.

 

Well, today, I again went to buy BRK.B shares and for the first time in since 1999, I was again put on hold. :-) I hope Buffett is on vacation. I have a limit order in for Monday.

 

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http://www.gurufocus.com/news/146183/berkshire-hathaway-is-now-traded-at-the-lowest-valuation-in-decades#146504

 

Lol, what are the odds, poor guy.  :D

 

(It was 2000 btw and not 1999 but oke.)

http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/brk-buying-back-stock-110-of-bv!!/20/

 

Funny.

 

I bought the day of the last buyback: http://www.early-retirement.org/forums/f44/brk-again-64054.html

 

 

[thefatbaboon]

"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"

 

+1 

 

It is probably too simple, so people don´t want to use it.  ;)

Can't stop chuckling!

 

I really do object to this book value stuff!  It's a useful shortcut and it's been promoted by Buffett and I've spent years and years using it myself but still, I find it is precisely this entrenched usage that is leading to BRK being persistently undervalued (especially the insurance operation). 

 

What do you guys think of the following simple valuation for the ultra longterm equity investor:

 

1. The stock portfolio (plus Heinz, Bac, converts, preferreds etc) is worth what it's worth.  The cash and IG fixed income is worth 50% of gaap but in any case the discount to be a minimum of $25bn.

 

2. Total operating income has the interest, dividends, gains derived from the above assets removed.  All of the remainder (including an averaged number for the insurance underwriting gains) is then capitalized at a rate that makes sense to the investor keeping in mind that with full retention of earnings BRK has historically grown these earnings at a CAGR of 20%, about double the long term returns of the market.

 

1 + 2  are then added together and are the total equity value for shareholders.  (No subtractions of DTL or Float.)

 

*Note on Float.  If float grows over time then the above undervalues the company.  And If float declines Buffett wrote in this year's report that it would do so very gradually and probably not any more than 3% per annum.

 

 

 

[karthikpm]

Have you all looked at http://www.creativeacademics.com/finance/IV.html to play around with valuation of BRK?

 

I doubt WEB and CM are using any complicated analysis to get to their IV

 

Munger:  “Warren often talks about these discounted cash flows, but I’ve never seen him do it"

 

“It’s sort of automatic. It ought to just kind of scream at you that you’ve got this huge margin of safety.”

 

I think Berkshire belongs in the " sort of automatic" category for me.