1.2x P/BV entry point

[original mungerville]

Why are you looking back to 2010? (A low point? - helps your case?)

 

Book value per share has grown by around 10% for the 15 years from 2000 to 2014. (Probably peak to peak in the stock market and probably similar highs for the business cycle - not that the Fed lets us have any of those anymore but that's a different issue). So now you expect that to increase by 50% to 15% compounded over say the next 10 years? On what basis?

 

Thought about it a little more and 15% is too high because of their cash drag. I think all of their assets might do 15% but if they have 10% in cash then the return is 10%*0% + 90%*15% = 13.5%

 

12% to 13% is probably a reasonable high point with a low probability they do above this but they would need a healthy amount of financial engineering/leverage to do it either from acquiring with debt or levered PE investments or warrants.

 

Agree on the high point and I generally agree with longinvestor as well - I just can't get to 15% in terms of longer term IV growth of the business (its a relatively minor difference - ie I can see 12-13% whereas longinvestor can see 15%; where we both agree is that earnings/BV growth has the potential to be higher than the last 10 years even though BRK is now bigger and this is the most interesting and counterintuitive point). I would also say the following:

 

1) My above statement assumes relatively normal inflation - if currencies devalue significantly, the growth in IV on the high end could be higher than 12-13%;

 

2) Certainly BRK's stock price could rise 15% annually over the next few years in a normal bull or flat market as it reprices higher towards its fair price (this would add to any growth in the business);

 

3) BRK will beat the S&P 500 in my view over the next 10 years (although I expect the S&P 500 to do badly - at least in real terms);

 

4) In the shorter term, relative to the S&P 500 which has much greater exposure to foreign markets (where currencies and economies are weakening significantly and will drive earnings down in the next quarter or two) BRK should do well. For what it is worth, I do expect ugly markets for the next little while and so, in the short-term, I feel much more comfortable betting on BRK relative to the S&P 500. I would then take my hedges off if and when the Fed decides to do QE4.

[Guest Grey512]

Despite the optically 'undemanding' PBV multiple, is anyone else kinda not excited about BRK at this levels?

 

On one hand:

+ BRK will probably continue compounding book value at 5-8% p.a.

+ BRK will take advantage of any huge market drop to buy accretively

+ Classic reasons: best capital allocators, best operators

 

On the other  hand:

- 5-8% RoE at 1.3x PBV... I don't know. Does not scream cheap

- If I want to buy 'disaster insurance', there are other alternatives, e.g. SPACs or blank check companies. E.g. Wilbur Ross has a publicly traded vehicle.

- I am at a point where I trust my own judgement much more  than I trust other people's, and I now can at times go short (or long) names that have very smart, well-known investors on the other side of the trade. If the S&P heads to 1200, I expect that I will be able to identify names that would outperform the S&P over the following 36 months

- The 'Buffett-risk' is increasing each year. We all know the actuarial tables

 

When I read 13Fs and see big BRK holdings among well-known value investors, I inevitably start wondering whether there are biases involved due to familiarity and an emotional attachment to Buffett.

 

I recently sat down and questioned myself: am I long BRK because I am a Buffett-fan, reading Buffett & Munger changed my life, etc? Am I long BRK because I was lazy and looked for somewhere 'safe' to park some money? Am I long BRK because on some level, humans have a desire to 'belong' (e.g. why do people associate themselves with certain sports clubs or fervently support certain sports teams?) and holding some BRK made me feel like I am aligned with value investors? Or am I long BRK because I believe BRK is the best investment opportunity offered by Mr Market at these times (even with a long-term, tax-efficient perspective)? I could not frankly say to  myself that it was the latter. So I sold a big chunk of BRK and deployed the proceeds elsewhere.

[thepupil]

5-8% ROE?

 

$240B equity

 

$19B pretax non insurance earning + $5B pretax investment income +- underwriting income/ loss = $24B assuming no underwriting profit / loss

 

10% pre-tax, tough to see how you get down to 5%. And that's while holding $60B of cash and $27B of fixed income. Look at the cash tax rate the past few years.

 

THEN add another 1-2% of other comprehensive income (not included in ROE but certainly a component of total increase in value)  from stock portfolio price appreciation over time.

 

And ROE will only increase as goodwill as a percentage of businesses decreases over time. BNSF 14% of book has an 18% pretax ROE, in 10 yrs the lubricants, building supply, and industrial widgets conglomerate that is non insurance non rail non utility Berkshire will earn higher ROE as the acquisition premiums paid in the past few years become a smaller percentage of the value of companies.

 

The s&p has an ROE of like 16%, Berkshire owns a portfolio of good U.S. Based  businesses. Over time ROE of the portfolio that isn't stocks (where equity gets repriced upward for increase in earnings powe) will only increase (assuming you think coroorate earnings will grow)

 

I agree there are cheaper stocks out there. But a Buffett managed 70 cent dollar (or Buffett successor managed)  is exciting and i really don't think " 5-8% ROE" is a meaningful or accurate way to think about it given the Drag of the securities portfolio on ROE (which will only include interest and dividend income since tax affected capital appreciation falls under other comprehensive income).

 

 

[Guest Grey512]

I look at after-tax ROE using net income. Net $20b divided by around $245b of equity is about 8%.

After-tax ROE in the past 36 months averaged around 8%.

 

Why am I assuming ROE will be lower in the next 5 years? 1) Capitalism (i.e. competition, increasingly efficient public and private markets, large amounts of capital entering the reinsurance industry, etc) 2) BRK's increasing size.

 

The 5-8% is just a conservative assumption on my part. Capitalism works.

 

The 10% (with your adjustments) makes me feel better but it too will feel the gravity of competition & capitalism, and in general I avoid these adjustments because I evaluate most other investments without any adjustments and want to keep things as simple as possible.

[thepupil]

So then you must be short the S&p500 which has enjoyed an increasing ROE since the 1970s and has 2x the ROE of Berkshire? Because capitalism works.

 

Do you know what other comprehensive income is and why Berkshire growth in book value is greater than otherwise implied by its ROE? Do you understand why ROE is not reflective of the change in value of a securities portfolio?

 

Do you know why Berkshire pays such a low cash tax rate and why GAAP net income may not be reflective of earnings power or free cash flow?

 

you're looking at a somewhat complex beast of a company (though more understandable if you divvy it up in 3-5 parts) and using 1 statistic (ROE) to say it isn't exciting. You need to do more work to come to that conclusion (or explain your work better)

 

 

 

 

 

 

*not really fact checked but I know to be generally true. Also the s&p actually is probably earning unsustainably high margins which is one of the reasons it's roe is so high

 

 

[Guest Grey512]

Thepupil,

 

Re S&P: yes, I'm kinda short. Not outright, but via puts.

 

Re other comprehensive income: sure, I understand it. And I don't know about you, but the cash flow statement sure does spit out around $20b of cash flow, not $24b.  People have long said to me, about various investments, "but..but...but..but the numbers do not reflect the real earnings power of the business!", and my response has usually been "well, then, show me the money in the cash-flow statement". And in BRK's case, with or without adjustments to the numerator or the denominator, the rate of return has not exceeded 10%.

 

Besides simplicity, the reason I am not too inclined to follow your adjustments is because OCI / investment return feels a little 'ephemeral' to me. We are in the 7th year of a bull-market. To my knowledge, BRK does not engage in meaningful shorting or hedging. In the long-run, your adjustment makes more sense than for the next 5 years.. In the next 5 years I think there is a meaningful probability that what we will see is a market that moves side-ways or even down. So, it is my expectation that OCI earned in the next few years will be significantly less meaningful than in 2009-2015YTD.

 

[jay21]

I look at after-tax ROE using net income. Net $20b divided by around $245b of equity is about 8%.

After-tax ROE in the past 36 months averaged around 8%.

 

Why am I assuming ROE will be lower in the next 5 years? 1) Capitalism (i.e. competition, increasingly efficient public and private markets, large amounts of capital entering the reinsurance industry, etc) 2) BRK's increasing size.

 

The 5-8% is just a conservative assumption on my part. Capitalism works.

 

The 10% (with your adjustments) makes me feel better but it too will feel the gravity of competition & capitalism, and in general I avoid these adjustments because I evaluate most other investments without any adjustments and want to keep things as simple as possible.

 

You think the mean reverting ROE is 5%? Crazy, no one would deploy capital at those levels (in an inflationary environment).

[Guest Grey512]

So then you must be short the S&p500 which has enjoyed an increasing ROE since the 1970s and has 2x the ROE of Berkshire? Because capitalism works.

BTW, not to nitpick, but I think if you were going for some sort of 'creative destruction'/capitalism analogy when you referred to the S&P, I do not think the analogy there is clear-cut. The velocity of the capital markets has increased such that some start-up somewhere that is being founded now can go public in 2018 and enter the S&P500 in 2020 and kick out a marginally weaker company out of the index. So it's no longer clear to me whether S&P500 is the 'incumbent' or the 'disruptor'. I just think of it as a plain market-weighted index of the biggest companies. You could say they are the 'best' companies and I guess in a sense, you would be right, but the connection there is a bit more uncertain so I'm not making that statement.

 

So I think 'capitalism' works better when we talk about individual companies (like BRK or something else), not about indices where the roster of constituents gets refreshed every once in a while.

[Guest Grey512]

You think the mean reverting ROE is 5%? Crazy, no one would deploy capital at those levels (in an inflationary environment).

Granted, maybe I went a little overboard with that 5% figure.. I just wanted to have a decent range with a low left-bound to provide for some sort of downside scenario. No business is immune from a possibility that it may enter a period of value-destroying returns (either through a tough environment, poor choices by management, or a confluence of both). Not even BRK, in my humble estimation.

 

Also - maybe I'm misanthropic, maybe I'm crazy and am making crazy assumptions in an attempt to build a massive margin of safety; maybe I drunk too much QE cool-aid and believe BRK's cost of equity is tiny. Or maybe, just maybe, BRK's cost of equity is actually not so tiny (8%) and BRK therefore is making 2% value spread today (with OCI) and will probably be making a 0% value spread in the next few years.

[thepupil]

So I think 'capitalism' works better when we talk about individual companies (like BRK or something else), not about indices where the roster of constituents gets refreshed every once in a while.

 

 

- in general, i also hate when people tell me why non-GAAP isn't appropriate, but with respect to the minor tax adjustments, I know you understand why it's not crazy to make those.

 

- Berkshire's mix of businesses don't get refreshed? I think Berkshire probably has a higher turnover of company's as a % of earnings than SPY the past few years. Berkshire isn't an individual company. It's a portfolio and becomes more diversified (for better or worse) every year

 

- I agree with your negative assessment of the S&P 500, which is another reason why i'm excited about berkshire. I think without a re-rating of book, berkshire will outperform the S&P over 3, 5, and 10 years on earnings growth alone, EVEN at a low rate of reinvestment.

 

- i also agree with you that OCI will be lower. 1% from OCI implies about 3% capital appreciation of the stock portfolio (a reasonable long term expectation), but as you point out probably not a reasonable short term 1

 

- My $24B figure was pre-tax earnings spitball going forward and not an indicator of cash flow, or free cash flow or anything; it also takes into account PCP and Duracell coming on line. That being said, if $20B is the number you calculate (which is GAAP earnings last year), then Berkshire is at a 6.25% earnings yield pre-PCP capital deployment, pre dividend increases at most major holdings. A greater than S&P earnings yield, with better growth, better management, no stock option leakage, excess capital (albeit much of that was just used, but they will very soon have excess capital gain with some sad maturations of above market preferreds), etc.

 

- I think if you used GAAP net income as the way to assess Berkshire over its recent (and certainly its ancient) history, then you'd never have bought it.

 

- you understand this better than your original post indicated, which I had a hunch was the case

 

 

[Jurgis]

- I think if you used GAAP net income as the way to assess Berkshire over its recent (and certainly its ancient) history, then you'd never have bought it.

 

Which is possibly why BRK is so cheap.

 

BTW, BRK ROE was always low. Nobody ever bought BRK for its plain ROE.

[Jurgis]

Or am I long BRK because I believe BRK is the best investment opportunity offered by Mr Market at these times (even with a long-term, tax-efficient perspective)? I could not frankly say to  myself that it was the latter. So I sold a big chunk of BRK and deployed the proceeds elsewhere.

 

Pray do tell what is in your opinion "best investment opportunity offered by Mr Market at these times" then.

[Guest Grey512]

1. Cash

2. AAPL

3. LYB

4. PCLN

5. GOOGL

6. INTC

7. FOXA

+ a few small/illiquid names that I will mention once I've satisfied myself with building a sufficient position.

 

Not a lot. It's dry as hell out there (at least, that's how I find it), so I am rather inactive.

 

I hope I'm not exposing myself to a commitment-consistency psychological trap by listing these here, but it's an anonymous forum and I got a lot out of reading COBF posts (including yours!) so it's probably fair that I try to be as open as I can.

[Jurgis]

1. Cash

2. AAPL

3. LYB

4. PCLN

5. GOOGL

6. INTC

7. FOXA

+ a few small/illiquid names that I will mention once I've satisfied myself with building a sufficient position.

 

Not a lot. It's dry as hell out there (at least, that's how I find it), so I am rather inactive.

 

I hope I'm not exposing myself to a commitment-consistency psychological trap by listing these here, but it's an anonymous forum and I got a lot out of reading COBF posts (including yours!) so it's probably fair that I try to be as open as I can.

 

Thanks for posting.

 

Edit: I agree that there are very few clear opportunities available.

 

I disagree with a lot of above, but this is not the thread to discuss it. Good luck. :)

[rb]

Jurgis,

 

I think you touched on something here. In these threads the longevity of the companies gets ignored. People just project cash flows out to kingdom come. In real life that's not true. One of the big positive points of Berkshire is its resilience. It has businesses for which its clear that they'll be around for many years. It also has regenerative capabilities - Blue Chip Stamps is no longer with us (well... almost) but its cash flow gave birth to other divisions.

 

Grey's #1 stock is Apple - which no one know whether it'll be around 20 years from now. DCFs look different if you stick a 0 at year 20. This resilience on the part of Berkshire must have some value and I would imagine a not so little one.

[original mungerville]

1. Cash

2. AAPL

3. LYB

4. PCLN

5. GOOGL

6. INTC

7. FOXA

+ a few small/illiquid names that I will mention once I've satisfied myself with building a sufficient position.

 

Not a lot. It's dry as hell out there (at least, that's how I find it), so I am rather inactive.

 

I hope I'm not exposing myself to a commitment-consistency psychological trap by listing these here, but it's an anonymous forum and I got a lot out of reading COBF posts (including yours!) so it's probably fair that I try to be as open as I can.

 

Just a heads up (I am not an expert - actually know nothing). But in terms of Intel (and Apple as well I believe), Bill Fleckenstein (and a guy named Fred Hickey) are short. Bill is looking for a big disappointment this coming October for Intel. You should try and understand his thesis. In any case, what I would do (and given you are negative on the market generally) is just buy some put protection pre-earnings release (ie October) for INTL a short period afterward. He is long the October puts and targeting the earnings release which he seems quite certain will disappoint. Anyway, I would suggest you try and understand their thesis - I believe these guys know what they are doing. I certainly don't with respect to INTL or Apple.

 

Anyway, take that for what it is worth.

[Guest Grey512]

rb - fair point. I do try to think about what will happen on a 20/30 year basis, but I'm just not that smart/wise. So the time period that I am more focused on is more like the next 7 years. If you asked me to pick only 5 securities under the condition that I invest all of my net worth and cannot take that money out for the next 20 years and just sit and wait, then I would pick something different (i.e. low tech).. Perhaps JNJ, NESN, but possibly also LYB. You get the idea.

 

By the way, is BRK absolutely future-proof? Do I just have to accept that?

Will BRK's (re)insurance moat still be as big in 20 years and earning the same returns as it is earning now? I actually don't know that. Most people I ask "know" that. They say BRK will be bigger and more awesome in 20 years. I don't know.. particularly with regards to (re)insurance. There's competition. There's regulation. And finally - advances in computing, big data, and artificial intelligence. Underwriting and pricing risk will become significantly less human-intensive activities, whilst at the same time, any and all information pertaining to pricing risk will become more transparent and travel at a higher velocity. Think about what happened to the long-only risk premium with SEC's introduction of the 13F requirement in the past few decades. At least - this is how I think about things when I look out the next 20 years.

 

BNSF is probably the most durable part of BRK, in my opinion, and even that is not absolutely riskless e.g. hyperloop.

 

 

original mungerville - thanks. I have not come across their short theses, so will check those out.

[scorpioncapital]

What are the odds that insurance will be around in 20 years vs the income model of a fast changing technology or biotech firm? Can you imagine if it's hard to predict where insurance will be in 20 years how hard it must be to predict where technology will be? It's hard enough with old businesses not to mention new ones. I saw a list of the top 20 industries since 1932. Computers aren't even on that list, not to mention things like online travel, etc..

 

 

 

 

[Guest Grey512]

Agreed. But again, my horizon is more like 7 years. And generally, I am willing to make an investment into any company - at the right price. Borrowing from Carlo Cannell - I am looking for the biggest mismatch between value and quality. I just figured that the mismatch in the investments that I picked was greater than that for BRK.B - on a 7 year basis. I'm not a long-only, buy & hold forever investor. I go short, I sometimes invest in spin-offs or levered / distressed situations, etc. The re-insurance tech disruption risk thought experiment that I engaged in (see post above) was just me pondering things out loud and also checking to see if the people who say that BRK.B is future-proof have at a minimum considered what I described and if they have, that they are comfortable with it. It's just that too often I see people accepting some 'truths' at face value with little-to-no discussion, and one of these (almost) universally accepted truths is that 'BRK.B is going to grow bigger forever'.

 

[Jurgis]

I agree with Grey512 that looking at 20 year horizon, BRK has risks as does his other picks. I would not be comfortable to buy anything for 20 years, except perhaps market weighted index.

 

Regarding Grey512's picks, I think this is not the place to discuss them. I asked him the question because I was interested in the context/comparison of what he considered more attractive than BRK.

 

Thanks

[original mungerville]

Ya we are not discussing, I just gave him a heads up*. Done.

 

*Fleckenstein and Hickey are not lightweights - when they are short its some pretty serious thinking / experience that goes into it.

 

[valueinvesting101]

@Grey, what sort of advances in computing, big data, and artificial intelligence can be disruptive to reinsurance or insurance? Great things were talked about AI in 1960-70 but we see only piecemeal improvements in AI so far. Mostly likely we will better outcome in next 20-40 years. But how will that flow in to pricing insurance?

 

I guess current available technical resources can allow greater insights into underlying risk but it is not effectively used in presence of greed and fear. I doubt that will change drastically going forward in 20-30 years. More likely there will be global growth in insurance due to emerging markets and globalization with improved penetration rates. Banking has been around millenniums and also using latest technical advances but fundamentals of the business have remained same and more likely to remain the same in next 20-30 years.

 

Looking back, I think Berkshire made money by pricing risk conservatively and patiently rather than superior knowledge or data analysis. This trait is not just evident in insurance but also applicable in Berkshire's purchase of whole businesses or public securities. This trait is less likely to be copied by other companies. 

 

 

[Jurgis]

20 year risks to BRK?

 

- Clearly Buffett dying. Some people think it's not a big deal for BRK. I think it is. This been discussed to death (pun intended  :P ).

- I won't mention operational/leadership/management risks per business. See bullet above.

- Reinsurance. What 20 year risks? Buffett says that already right now reinsurance is crap. It's not for nothing Ajit Jain spends more time on specialty insurance rather than on re. Might be better or worse in the future. I think it's cyclical. I think that modeling will improve in the future, but greed/fear cycles might not disappear while humans are in the loop.

- BNSF. This one has fewer risks. Longer term (> 20 years?): hyperloop, self driving trucks, 3D printed objects (no need to transport stuff?)

- Geico. Self driving cars - probably will change the face of auto insurance totally.

- Berkshire Energy. I think this one has fewer risks too. People mention off-grid-solar, but that's possibly far. Yet, 20 years... hmm.

 

What businesses did I miss?

 

In general though, the biggest risk is always human: leadership/management/operations.

 

Anyway, as I said above "I would not be comfortable to buy anything for 20 years, except perhaps market weighted index."

Others might think differently. We can't test these beliefs though, since nobody is forced to hold their purchases 20 years with key thrown away. ;)

 

 

 

[Guest Grey512]

valueinvesting101 - you are right; I guess I discounted the upsides from growing affluence and financial sophistication in the developing countries, where people who did not want or need to take out insurance will do so. With regards to technology, computing power and greater info transparency disrupting insurance - I think though it is a matter of when, not if. Maybe not 20 years, maybe 30, but I think it will happen. Very tough to handicap how that will affect BRK though.

 

Fascinating to talk about the future, as always, but because of all these unknowns (and my own limited intellectual horsepower), I stick to a shorter time horizon, even though that's irrational from a tax & transaction costs point of view.

[vinod1]

20 year risks to BRK?

 

- Clearly Buffett dying. Some people think it's not a big deal for BRK. I think it is. This been discussed to death (pun intended  :P ).

- I won't mention operational/leadership/management risks per business. See bullet above.

- Reinsurance. What 20 year risks? Buffett says that already right now reinsurance is crap. It's not for nothing Ajit Jain spends more time on specialty insurance rather than on re. Might be better or worse in the future. I think it's cyclical. I think that modeling will improve in the future, but greed/fear cycles might not disappear while humans are in the loop.

- BNSF. This one has fewer risks. Longer term (> 20 years?): hyperloop, self driving trucks, 3D printed objects (no need to transport stuff?)

- Geico. Self driving cars - probably will change the face of auto insurance totally.

- Berkshire Energy. I think this one has fewer risks too. People mention off-grid-solar, but that's possibly far. Yet, 20 years... hmm.

 

What businesses did I miss?

 

In general though, the biggest risk is always human: leadership/management/operations.

 

Anyway, as I said above "I would not be comfortable to buy anything for 20 years, except perhaps market weighted index."

Others might think differently. We can't test these beliefs though, since nobody is forced to hold their purchases 20 years with key thrown away. ;)

 

To me long term the more likely risk is management succession at subs. All these companies that have sold themselves to Berkshire, have owners who have personal loyalty to Buffett. They are willing to work for probably lower salaries than they could get outside just because they love doing what they are doing and basking in Buffett's praises. As these owners die off or retire, the next generation might have less personal attachment to Buffett's successor. That is when problems could start coming up with "Management bordering on negligence".

 

Vinod