1.2x P/BV entry point

[Guest longinvestor]

long,

 

It might cause a run up but I think that it's only when you design your buyback the way Warren has.  If the buyback was just there in the background at a floating level with no fixed level then i don't think it has the same effect.  Imagine none of this hullabaloo about 1.1 or 1.2bv being "well below intrinsic value". Intrinsic value isn't so static.  One has to do something: build cash, buy out owners or add more business/investments. There seems no logical reason to pin oneself into a corner about only buying at x multiple of book. Just lots of questions by BRK's allocator in chief: Shall I buy IBM or BRK or build cash?  Shall I buy NV or BRK or build cash? Shall I buy PCP or BRK or build cash?  Repurchasing at 2.5 times book would have been better than buying Dexter Shoe. And I would guess with some of the recent buys (IBM, NV, Alta, PCP  (Not Heinz!)) we will find that the money would have been better spent on repurchases at say an average of 1.35 bv where it's been over the last 4 years.

 

Warren made a nonsensical morality play out of the buyback for no discernible reason.  He says he doesn't want to take advantage of a seller.  Except that a well executed buyback would achieve completely the opposite: his bid would HELP any seller get a better price.  And so long as he is not over paying, and thus damaging continuing partners, a share repo helps the seller get a better sale and the non seller get a better intrinsic value. I found his arguments in this area quite bizarre and I think it also damages his investees who he wants to encourage to repurchase their stock.  I mean what does it imply about IBM??  Hi IBM, I will write long paragraph in my AR about how great your repurchase is, and every year I will mention how great it is that KO, AXP et al increase my look through percentage of their earnings via repurchase BUT I will also write at length how I don't want to take advantage of my lovely partners by repurchasing BRK shares. 

 

Apart from the fact that he is simply wrong I find it quite rude to his long term investees!

 

Not sure about Buffett being wrong. Here's how I read what he says about IBM et al buying back shares; It is more gratefulness that BRK's ownership increased without any Omaha finger lifted, let alone not putting out incremental $. The biggest difference between BRK and IBM et al. is the universe of capital redeployment possibilities that exist.

 

Also, many posts back on this thread, it was pointed out that the lion's share(>50%) of BRK's recent capital deployments have gone into BHE and BNSF with very long term prospects. Surely, it'd be silly to think that they did not evaluate any possible buy back as they ploughed into the long lived assets.

 

I'm speculating here but I suspect they are holding out for when the 1.2xBV or what ever ratio they announce in the future, is truly a 50 cent dollar or better. It is a matter of when. Patience is all they need while they have not, in the mean time, run out of large investment opportunities either organic or inorganic. I'm good with another 10 years or more when they do decide to return capital to me.

[scorpioncapital]

The 1.2bv buyback seems to me a hybrid compromise between an opportunistic buyback and the stability of a dividend. It's quite interesting. As was mentioned, BV can bob up and down and it may not be worth it to the company to buy back at 1.2 as a fixed target... yet the stated policy is sort of a compromise to those who are screaming for a dividend and those who see a dividend as something to come later after all opportunities for deploying capital are exhausted. Kind of like this strategy, haven't seen it in many companies!

 

[Picasso]

It is silly to think that Buffett is wrong about capital allocation decisions regarding buybacks versus some other XYZ investment decision.  He has around 10 "Fortune 500" companies in his operating portfolio and has another 490 to go.  I think investors are looking way too deeply into this repurchase program at 1.2x book value. 

 

So what if Buffett or Berkshire is good at investing a dollar today to make you want to pay 1.2x, 1.3x, 1.4x, etc?  Why don't we all just buy $1 million of Berkshire Hathaway and go to the bank demanding a loan for $1.5 million against that stock since it is so obviously worth more than $1 million?  Let me know how quickly you get laughed out of there or better yet post the reaction on Youtube.  And so what if you want the market to value it at 1.5x book for you?  If you're in this for the long term it isn't going to make much of a difference where it trades around book value.

 

You're going to get your returns over time as Berkshire continues to compound their operating earnings and grow book value.  The 1.2x book value repurchase agreement  in 2012 was more of an indicator that book value was not giving proper credit to the "real" book value or much less intrinsic value.  Not really the case today.

 

 

[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!

 

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.

 

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.

 

hello my obese simian friend,

 

1. agree to disagree on incremental debt usage being a separate or quantifiable source of intrinsic value to berkshire. I agree it will and has helped grow IV, but I'm not willing to attempt to try to value that or consider it a separate component of growth in  value. 

 

To your point, BNSF increased debt by $7.1B over 2012-2014, whereas UNP increased it by only $2.5B. BNSF now has ~$20B, while UNP has ~$13B. So either UNP is underlevered, or you are correct in that the Berkshire structure may allow for incrementally more leverage at the subs where the vast majority of the debt is located.

 

2. I'd like to say that much of talk about the astounding historical growth in operating earnings does not point out that Berkshire has used big chunks of the securities portfolio in order to grow these operating earnings (way back in the day issued shares for utility company, issued shares for BNSF, turned PG into Duracell, turned WaPo into earnings assets, PSX into Lubrizol add-on, etc.).

 

The growth in investments / share has lagged the market returns because of Berkshire's conversion to more of an operating company. Berkshire has been very good at monetizing the increase in value of the holdings and converting them into wholly owned operating earnings. also the securities portfolio historically ahs been MUCH larger than the operating businesses, so using the securities portfolio earnings to subsidize the growth of the operating earnings had a particularly large effect.

 

This will not be as powerful in the future as it has been in the past.

 

I'll be willing to wager anyone that growth in operating earnings per share is less than 14% over the next ten years, up to 20 shares of Berkshire (b shares that is) as the stakes.

 

To be clear i am referring to the $17.5B of pretax earnings from non-insurance non-investment biz (BNSF, Berkshire Energy, manufacturing and service etc.). You'll get PCP as a head start. 14% growth would imply pre-tax operating earnings of $65B. It is not completely impossible, but would be quite extraordinary.

 

If those talking about growth of the past being the norm for the future want to truly bet on it, I'm willing to take the other side.

 

Bet on! With some modifications.

 

How about for the period 2010-2019?  Because that is how the earnings growth is reported, by decade. Don't know how you picked the next 10 years? 5 more years is long enough of a bet for me. Because I was merely pointing out that with all reported earnings right up to the past quarter and all of the value building that is going on, there is no sign of earnings growth declining at all. To me, your detailed and complex calls about the future did not square up with reported numbers. The run rate in the first four years just makes it that much more difficult for your 14% prediction to come true this decade.  Moving the goal post to allow more time for yourself as you are staring down the barrel?

 

Also, how about a modified bet that is disproportional, (geometric?)like this: If the actual earnings comes in at 15% - Bet is doubled (40 B shares); 16% - Tripled from this (120 shares); 17% - Quadrupled from this (480 shares) and so on. This way, if you are correct, it is your bet to win. If you are very wrong, that is, history does repeat itself, you'd be paying disproportionately. For instance, if they pull off the 19% historic earnings growth rate, the bet moved into the A share category.

 

[adesigar]

Also, how about a modified bet that is disproportional, (geometric?)like this: If the actual earnings comes in at 15% - Bet is doubled (40 B shares); 16% - Tripled from this (120 shares); 17% - Quadrupled from this (480 shares) and so on. This way, if you are correct, it is your bet to win. If you are very wrong, that is, history does repeat itself, you'd be paying disproportionately. For instance, if they pull off the 19% historic earnings growth rate, the bet moved into the A share category.

 

Maybe I misunderstood this but

 

If BRK has higher earnings he has to pay increased no of shares which will also be valued at a higher price because of higher earnings. If BRK is lower he receives similarly increased number of shares but valued at lower prices because of lower earnings. Does that seem like a fair bet?

 

 

[thepupil]

No thanks to the modifications. it is precisely because of the spectacular growth from 2010 to 2015, that I'm willing to bet on it slowing and it being more difficult to grow. You are correct, there is currently no evidence of it slowing. Investment is a forward looking process.

 

It's my proposed bet so I don't understand how I'm "moving the goalposts as in staring down the barrel" (as a shareholder throughout most of the past 4 yrs I'm celebrating wih you, not staring down a barrel). Pre BNSF non insurance earnings were $6-7B, they bought Burlington when it was earning $3b, BNSF then doubled earnings (economy improved, shale and crude by rail ramped up), so BNSF basically doubled the non insurance earnings. That'd be a lot harder now that we're at $18B. That's all I'm saying.

[Guest longinvestor]

No thanks to the modifications. it is precisely because of the spectacular growth from 2010 to 2015, that I'm willing to bet on it slowing and it being more difficult to grow. You are correct, there is currently no evidence of it slowing. Investment is a forward looking process.

 

It's my proposed bet so I don't understand how I'm "moving the goalposts as in staring down the barrel" (as a shareholder throughout most of the past 4 yrs I'm celebrating wih you, not staring down a barrel). Pre BNSF non insurance earnings were $6-7B, they bought Burlington when it was earning $3b, BNSF then doubled earnings (economy improved, shale and crude by rail ramped up), so BNSF basically doubled the non insurance earnings. That'd be a lot harder now that we're at $18B. That's all I'm saying.

 

Fair enough.  Used too strong words to mean "you may end up eating your words" . I was responding to your choice of "jacked up" when you were talking about my observation that north of 15% is what we're actually seeing. And nothing changing for the worse. I did not put a timeframe because it is difficult to do with BRK giving itself a complete makeover. FWIW, I've challenged folks right on this very board since about 2010 who'd been saying that BRK is slowing down. Actuals tell a different story. I'm used to napkin type calculations when trying to value BRK. I believe that where the major difference in valuations is in the multiple. Nothing has changed, when it does I'll take the then-actuals.

[rb]

Pupil,

 

I'm not going to take your bet because I only make bets when there's a margin of safety involved and there's no margin of safety in you bet. Sorry.

 

You make some very good points about the sustainable rates of growth moving forward. My own view (and this may be in line with your thing) is that the float supported a lot of the growth. And while the float growth has been simply amazing there's no way that the float will grow along the op earnings so it won't provide as much support going forward. There just aren't that many opportunities in insurance.

 

Also a lot of the growth in op earnings is not organic but artificial - through acquisitions and tons of oversized capex. I'm not complaining it has been and will continue to be a very financially fruitful experience.

 

But I don't really understand what's the argument here. I propose an alternative view. Let's look at the operating business not as if they're part of Berkshire. Instead let's look at them as we would at any other company. So what would be owner earnings? BRK had 17.5B in pre tax op earnings. PCP had 2.4B. Let's call it 20 together. BRKs cash taxes have been around 19%. Let's say 20%. So that's 16B after tax.

 

Now, Berkshire's businesses are really good businesses. They will have growth. But let's assume a much more pedestrian rate of growth (without BRKs extraordinary CAPEX juice) of 5%. It's clear that even at that growth rate the economic depreciation at BRK is higher than the accounting one. So accounting depreciation is at 6.3B. Let's bump that to 8.5 - that would take down owner's earnings to $13.8B.

 

Now using a simple DDM with a 5% growth rate and a cost of equity of 8.5%, that gives a value to the operating side of 414B - 29% above the market cap plus you get the insurance business and the investments for free. If you want to use a 10% cost of equity (though that would be insane) then the operating business is worth 290. Either way you look at this thing it is severely undervalued. And this is based on just 5% growth rate. If the growth rates will be anything close to what you guys are fighting about there will be oceans of money to be made. So let's stop fighting and enjoy the amount of money we're all about to make on this thing.

 

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

[thepupil]

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.

 

 

 

[JBTC]

Hi, I am new here but thought rb asked a relevant question that demands a thoughtful answer - how come BRK has remained undervalued even though Buffett has been universally considered the best investing mind for decades and the long-term record of BRK is clear for all to see.

 

I recall hearing Michael Price sort of laughing at the idea that BRK is cheap and saying along the lines that how can it be cheap when tens of thousands line up in Omaha to worship Mr. Buffett year in and year out.

 

I own the stock and I am not questioning if BRK is undervalued. I am more curious about what factors may have led to the market choosing to neglect the stock so often despite its apparent merits.

 

[vinod1]

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

[Guest longinvestor]

Pupil,

 

I'm not going to take your bet b................... is that the float supported a lot of the growth. And while the float growth has been simply amazing there's no way that the float will grow along the op earnings so it won't provide as much support going forward. There just aren't that many opportunities in insurance. 1

 

Also a lot of the growth in op earnings is not organic but artificial - through acquisitions and tons of oversized capex. I'm not complaining it has been and will continue to be a very financially fruitful experience #2. ...................p plus you get the insurance business and the investments for free#3 ...............nd enjoy the amount of money we're all about to make on this thing. #4

 

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough. #5

 

Agree about not arguing with owners. Nothing to argue about while making money. Just have some additional thoughts about some of the points you raise

 

#1: Buffett wrote a few years back about the insurance float flattening off or slightly declining over the coming years/decades. That was before the Specialty Ins business was created under Eastwood/Jain. Float is growing again, though it is early and small (only at BRK is 3B small!). They've planted these specialty insurance seeds in new geographies and markets. Plus they've made deals like the one down under. The Aussie partner appears to have diverse source of float. They operate all over Asia already. Capital will not be the limitation! Besides all of this, what's to keep Ajit from acquiring a major insurance company? There has been past talk about european re-'s.

 

#2: Don't know about your choice of "artificial". You just described the choices they have in deploying oversized capital into a growing pool of earning streams. The amazing thing about this is that there are many others' within BRK who get to deploy this capital, many who are not part of the staff of 25 at Omaha. Just one such, Wertheimer @ ISCAR who is far away from the mother ship. I'm somewhat familiar with the tooling industry and was stunned at the number of businesses they've tucked in since becoming part of BRK. That kind of tooling business is good biz that is likely to contribute to earnings for a while longer. Are there any elephant potentials in this field? Of course there are. We are talking about the new Berkshire. 

 

#3: Ins + investments for free: That is mind blowing!

 

#5: The dumbest thing to do is not be buying.

 

[Jurgis]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

[thefatbaboon]

Hi, I am new here but thought rb asked a relevant question that demands a thoughtful answer - how come BRK has remained undervalued even though Buffett has been universally considered the best investing mind for decades and the long-term record of BRK is clear for all to see.

 

I recall hearing Michael Price sort of laughing at the idea that BRK is cheap and saying along the lines that how can it be cheap when tens of thousands line up in Omaha to worship Mr. Buffett year in and year out.

 

I own the stock and I am not questioning if BRK is undervalued. I am more curious about what factors may have led to the market choosing to neglect the stock so often despite its apparent merits.

 

I think you can see from my ranting posts on the topic that I think the Book Value anchors valuation! So,

 

1. Book value heuristic

 

2.  Warren is old. Charlie is old.  Jain isn't exactly young.  No matter if you and I are ok with BRK after WEB, many people aren't.  And while I'm not that concerned I am a bit. Also old people tend to go wrong slowly and he may remain in control while his skills decline.  The idea of a conglomerate working well beyond the death of the founding generation requires a leap of faith.

 

3.  I think there is a supply demand issue.  Berkshire was a core holding, often comprising an unusual percentage of net worth, for a number of very rich who are now old or dying.  Heirs and charities are likely to diversify.  And charities anyway have to sell down min 5% p a for their tax status.  On the other hand I don't imagine there are loads of new guys with a few hundred million or a billion or two who are calling up their bankers and saying put 90% of the portfolio into BRK.

[rb]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

[karthikpm]

Hi, I am new here but thought rb asked a relevant question that demands a thoughtful answer - how come BRK has remained undervalued even though Buffett has been universally considered the best investing mind for decades and the long-term record of BRK is clear for all to see.

 

I recall hearing Michael Price sort of laughing at the idea that BRK is cheap and saying along the lines that how can it be cheap when tens of thousands line up in Omaha to worship Mr. Buffett year in and year out.

 

I own the stock and I am not questioning if BRK is undervalued. I am more curious about what factors may have led to the market choosing to neglect the stock so often despite its apparent merits.

 

I think you can see from my ranting posts on the topic that I think the Book Value anchors valuation! So,

 

1. Book value heuristic

 

2.  Warren is old. Charlie is old.  Jain isn't exactly young.  No matter if you and I are ok with BRK after WEB, many people aren't.  And while I'm not that concerned I am a bit. Also old people tend to go wrong slowly and he may remain in control while his skills decline.  The idea of a conglomerate working well beyond the death of the founding generation requires a leap of faith.

 

3.  I think there is a supply demand issue.  Berkshire was a core holding, often comprising an unusual percentage of net worth, for a number of very rich who are now old or dying.  Heirs and charities are likely to diversify.  And charities anyway have to sell down min 5% p a for their tax status.  On the other hand I don't imagine there are loads of new guys with a few hundred million or a billion or two who are calling up their bankers and saying put 90% of the portfolio into BRK.

 

+1 on the book value heuristic.

 

The ownership trends of BRK A suggest there will be more institutional ownership as we go along.

[Charlie]

"Agree about not arguing with owners. Nothing to argue about while making money. Just have some additional thoughts about some of the points you raise

 

#1: Buffett wrote a few years back about the insurance float flattening off or slightly declining over the coming years/decades. That was before the Specialty Ins business was created under Eastwood/Jain. Float is growing again, though it is early and small (only at BRK is 3B small!). They've planted these specialty insurance seeds in new geographies and markets. Plus they've made deals like the one down under. The Aussie partner appears to have diverse source of float. They operate all over Asia already. Capital will not be the limitation! Besides all of this, what's to keep Ajit from acquiring a major insurance company? There has been past talk about european re-'s.

 

#2: Don't know about your choice of "artificial". You just described the choices they have in deploying oversized capital into a growing pool of earning streams. The amazing thing about this is that there are many others' within BRK who get to deploy this capital, many who are not part of the staff of 25 at Omaha. Just one such, Wertheimer @ ISCAR who is far away from the mother ship. I'm somewhat familiar with the tooling industry and was stunned at the number of businesses they've tucked in since becoming part of BRK. That kind of tooling business is good biz that is likely to contribute to earnings for a while longer. Are there any elephant potentials in this field? Of course there are. We are talking about the new Berkshire. 

 

#3: Ins + investments for free: That is mind blowing!

 

#5: The dumbest thing to do is not be buying."

 

+1

 

I bought more today.  :)

 

I think it is too cheap to ignore. Some months later we will probably have some people on this message board who will regret that

they have not bought it. The stock market decline has been a wonderful thing for Berkshire shareholder.

 

I like this sentence from Buffett from a recent interview:

 

"BUFFETT: STOCKS ARE GOING TO BE HIGHER AND PERHAPS A LOT HIGHER 10 YEARS FROM NOW, 20 YEARS FROM NOW I AM NOT SMART ENOUGH TO PICK TIMES TO GET IN AND GET OUT IF YOU ARE IN SOMETHING THAT IS GOING TO BE A LOT HIGHER OVER TIME. IF YOU THOUGHT YOUR HOUSE WAS GOING TO GO DOWN 5% IN PRICE YOU WOULDN'T SELL YOUR HOUSE AND HOPE TO BUY IT BACK 5% CHEAPER. THAT'S NOT MY GAME. MY GAME IS TO OWN DECENT BUSINESSES AND OWN THEM AT DECENT PRICES AND YOU ARE GOING TO MAKE A LOT OF MONEY OVER TIME IF YOU DO IT BUT I THINK THE ABILITY OF PEOPLE TO DANCE IN AND OUT OF MARKETS IS QUITE LIMITED AND IN MY CASE IT IS ZERO."

 

http://www.cnbc.com/2015/08/10/cnbc-transcript-berkshire-hathaway-ceo-warren-buffett-on-cnbcs-squawk-box-today.html

[Jurgis]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

 

Because I want to have 10-15% return.

Hurdle rate == return rate.

[Hielko]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

 

Because I want to have 10-15% return.

Hurdle rate == return rate.

What you want to make shouldn't have a place in a discussion about what fair value is. If possible I would like to make 100% annually, but I'm not going to call something that is expected to return less overvalued.

[wachtwoord]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

 

Because I want to have 10-15% return.

Hurdle rate == return rate.

What you want to make shouldn't have a place in a discussion about what fair value is. If possible I would like to make 100% annually, but I'm not going to call something that is expected to return less overvalued.

 

Fair value is always relative to what you want to earn. Of course one generally should accept a lower return on investments with less risk.

[TheAiGuy]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

 

Because I want to have 10-15% return.

Hurdle rate == return rate.

What you want to make shouldn't have a place in a discussion about what fair value is. If possible I would like to make 100% annually, but I'm not going to call something that is expected to return less overvalued.

 

Fair value is always relative to what you want to earn. Of course one generally should accept a lower return on investments with less risk.

 

No, one shouldn't necessarily do that, but one might have to. It's an important difference, and there are many instances of lower risk investments having higher returns.

 

Fair value is in relation to your hurtle rate, which makes it suggestive. You can have a hurtle rate of 100% before you take the risk of equities if you want, and that definitely changes fair-value.  I might consider that asinine, but there are no rules here.

 

Edit: I miss-read you, realized you were saying basically the same thing.

[rb]

I think a more appropriate topic of debate would be how such a large and stories company with a fantastic track record can be this undervalued! I don't understand it - but then maybe I'm not smart enough.

 

Not that it's the right way to value BRK, but if you take $16B of earnings as CF and run a 5% growth for 10 years DCF, your hurdle rate is only 7% to make current price cheap. If you use 10-15% hurdle rate, it is quite overvalued.

 

That's why you have to bring other parts into equation to persuade yourself that it's rather cheap. Or just go with P/B. ;)

Why would you use a 10-15% hurdle rate for BRK?

 

Because I want to have 10-15% return.

Hurdle rate == return rate.

Jurgis, I realize what hurdle rate is. The whole idea of my post was to look at how much BRKs operating subs as they are now may be worth outside of BRK under say average leadership. That's also why I didn't use more realistic growth rates.

 

All that being said, despite the fact that the idea of a hurdle rate sounds very good in theory, I think it's deeply flawed. And allow me a bit of rope here to tie it around my neck by making some points.

 

First of all a hurdle rate is applicable to mainly long term investments. By setting your own rate arbitrarily of market you cannot tell is something is undervalued and miss out on relatively quick and significant gains as prices of securities converge on fair value.

 

Secondly, if you set the rate too high you can even miss out on very profitable long term investments. For example, if you were to say that you are looking for a 15% hurdle rate today you are basically saying that you are looking for Berkshire's in 1970. There's not a lot of those around. To be totally honest, I don't even thin Berkshire back then would have passed that test since (I'll channel Munger here) you could not have anticipated all those Lollapalooza effects. And in the meantime you end up holding cash while you're waiting for that lollapalooza home run and even if you get it you end up with less money in the end compared to if you accepted lower hurdle rates earlier on.

 

Thirdly, I find it useful to think about investments from multiple points, of view. Intrinsic value vs. market value, IRR, hurdle rate, etc. That way I get a more complete picture.

 

I should end by saying that this is not all about your post. These discussions help me organize my thoughts about these things. I'm weird like that :)

 

[Jurgis]

Thirdly, I find it useful to think about investments from multiple points, of view. Intrinsic value vs. market value, IRR, hurdle rate, etc. That way I get a more complete picture.

 

Yes.

[thepupil]

FWIW, when i updated my numbers recently for the market movements and PCP, here's kind of where I stand after deciding I was being too punitive on the cash and fixed income requirements of the float, which added $33B to my rough valuation (I previously assumed cash & fi = float and now assume FI + $20B cash = float, what rb suggested in the other thread).

 

I see Berkshire as very positively skewed in terms of its price / value.

 

Earlier in the year when it was at $370B and I was ~$30B lower in all my valuations, I thought it was a 90 cent dollar. Now I'm back to thinking it's a 70 cent dollar since the stock is off 13% since then and my value is higher. Thus, I've greatly increased my position. You all can laugh at me for trying to "trade" in and out of berkshire, but i do try to re-balance amongst my other holdings according to best risk/reward and p/v. I know this may be heresy for the more devoted.

 

$130B equity portfolio (per bloomberg)

$8B Heinz pref

$22B other (BAC, Wrigley, Dow etc.)

 

$160B Listed equity and other

 

$60B of cash - $20B PCP - $5B Heinz equity injection = $35B cash - $20B working capital requirement = $15B dry powder , as I said on the other thread i'm being less punitive going forward

 

I get to $19B of recurring pretax earnings after PCP (note that I'm deducting non-allocated interest and a projected new holdco interest from $10B of additional debt taken on for PCP).

At a cash tax rate of 25%, that gets us to $14.25B post tax earnings

 

Insurance

 

$83B of float

$27B of fixed income + $20B of cash

This "division" has -$36B of book value. Using 1% yield on investments and 3% UW profit gets you to about $3B of "expected" pre-tax profit.

 

We can say that's worth positive $25B, for our bear case, we'll use the "due tomorrow" book value method

 

 

All in all:

 

Bear (recession*) : 30% discount to investments ($112B) + Dry Powder ($15B) + 12X Operating Earnings ($171B) + Insurance Book ($-36B) = $262B  (18% downside, 110% of current book)

Base (normal**)  : investments @ market ($160B) + Dry Powder ($15B) +18X Operating Earnings ($256B) + Insurance ($25B)                    = $456B  (42% upside, 190% of current book)

Bull/BlueSky        : maybe say the operating earnings are worth 25X? which would add 7X 14B = $98B                                                        =  $554B  (72% upside, 230% of current book)

 

 

*Note I did not impair the earnings in the bear case which may be appropriate, but I think using 12X though is punitive enough, but I could see arguing for a little more stressing.

**Why 18X? Well that's where the S&P trades and reasonable growth should be expected. When i put together my numbers after 2013 i got to $15B pre-tax non insurance earnings and now i get 19B after PCP, about 10% growth over the two years, which is kind of what i expect...you could argue S&P growth much lower than 10%, ergo berkshire worth more, but I'll leave that for the bull case

 

[no_free_lunch]

Thank pupil.  Great analysis.  Based on your analysis it looks fairly compelling at these prices.

 

Looking through it, the only thing I see is you use a tax rate of 25%.  I see a 30% rate on the company as a whole, just wondering why you chose 25%?