1.2x P/BV entry point

[Jurgis]

 

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

 

Right. That's what I included in "In general though, the biggest risk is always human: leadership/management/operations."

[Charlie]

Buffett and Munger are the Masters in worst case thinking.

They have thought about all this risks.

The companies will widen their moats which are led by able fanatics.

I think a lot of people will be surprised how well it will turn out.

It´s a meritocracy.

 

As Munger said: "Don´t be so stupid to sell your Berkshire shares."  :)

[Guest longinvestor]

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

This is in my mind. Being a willing 20 year holder, would like to verify that leadership transitions at subs is being planned for. WEB has in his desk drawer a successor name from each subsidiary head. Would like to know a bit more, like how incentives are structured for alignment with BRK shareholders etc. Surely they've one. And likely that some of these would turn out to be idiots. This is speculative but they're putting in placethe Chairman-CEO duality in all important subs. TTT play here. Rose is one etc.

 

I submitted a question to the panelists at the meeting this year but it didn't get picked. Will try again next year.

[Jurgis]

BTW, for lolz Fido equity summary score for BRK is 1 (Very Bearish), which is I think close to the lowest it can get. There are 2 sell ratings and zero buy ratings.

 

;)

[scorpioncapital]

The only thing that will save Berkshire is the quality of their businesses over the long term after Buffett. I've seen too many succession horror stories to count on that. Perhaps it will be above average too, as are many things Berkshire does, but if it wasn't for Buffett's intelligence to allocate capital to high return enterprises and not just buy any old junk indiscriminately, I wouldn't think of putting much money into it with the investment leader at 85 years of age.

 

 

[rmitz]

The only thing that will save Berkshire is the quality of their businesses over the long term after Buffett. I've seen too many succession horror stories to count on that. Perhaps it will be above average too, as are many things Berkshire does, but if it wasn't for Buffett's intelligence to allocate capital to high return enterprises and not just buy any old junk indiscriminately, I wouldn't think of putting much money into it with the investment leader at 85 years of age.

 

I think the biggest red flag for me would be if they put Carly Fiorina in charge.

[rb]

I'm really confused about everyone speaking Buffett passing as this big existential risk for Berkshire. The company is not held together with spit and duck tape. Most of the subs were very successful companies before folding into BRK. Why would they stop being that. A lot of the subs went through leadership changes before. Add to this the 3 Ts, the fact that Todd and Ted are fantastic investors in their own right, and the fact that Buffett has been preparing a transition for years. Given these facts there is no existential risk here.

 

Now a more plausible argument would be that the future growth rate will be lower than in the past because Buffett is no longer in charge. Maybe. But I think most of us shareholders can live with excellent instead of out of this world.

 

Furthermore, if Buffett's death is such a massive risk, then how much should Berkshire without Buffett be worth today? Book? 0.8 Book?

[bargainman]

You should also look at the flip side risk which is what is resilient about Berkshire? To me the structure is very resilient. Buffett has talked about this in the past, but basically he left the companies run themselves and any leftover capital he is able to allocate either to other companies within Berkshire, the stock market, buying back shares, or private companies.

 

What this means is that as parts of business decline, whoever is allocating capital at the top will be able to take that cash flow and reallocate it to a business with greater potential. In addition whoever is on top is also to be highly focused on wide moat companies.

 

[Guest longinvestor]

I'm really confused about everyone speaking Buffett passing as this big existential risk for Berkshire. The company is not held together with spit and duck tape. Most of the subs were very successful companies before folding into BRK. Why would they stop being that. A lot of the subs went through leadership changes before. Add to this the 3 Ts, the fact that Todd and Ted are fantastic investors in their own right, and the fact that Buffett has been preparing a transition for years. Given these facts there is no existential risk here.

 

Now a more plausible argument would be that the future growth rate will be lower than in the past because Buffett is no longer in charge. Maybe. But I think most of us shareholders can live with excellent instead of out of this world.

 

Furthermore, if Buffett's death is such a massive risk, then how much should Berkshire without Buffett be worth today? Book? 0.8 Book?

Agree, will happily take excellent, or even modestly better than the index over 20-30 years.

 

In some ways, it is not just about the transition. The operating side of BRK is a $200 B and briskly growing business. The question is the hands-off, near abdicated model is such a unique culture, there is little else to compare with. Owner-operator generational transitions seldom work out, it is my curiosity(idle speculation) to think of currently-absent risks. What I'd love to hear is that the subs chiefs have close to 100% of their net worth in BRK shares, following WEB's lead. And the incumbents at the subs..ok,ok, maybe not 100%, just significant holdings. They used to own all of it pre-BRK after all! Nothing beats aligned, strong ownership interest.

[rb]

Agree, will happily take excellent, or even modestly better than the index over 20-30 years.

 

In some ways, it is not just about the transition. The operating side of BRK is a $200 B and briskly growing business. The question is the hands-off, near abdicated model is such a unique culture, there is little else to compare with. Owner-operator generational transitions seldom work out, it is my curiosity(idle speculation) to think of currently-absent risks. What I'd love to hear is that the subs chiefs have close to 100% of their net worth in BRK shares, following WEB's lead. And the incumbents at the subs..ok,ok, maybe not 100%, just significant holdings. They used to own all of it pre-BRK after all! Nothing beats aligned, strong ownership interest.

Good choice. Even modestly over the index will make you a lot of money. If you can do it with companies like Berkshire it's even better cause you get to sleep really well.

 

I think that the op side of Berkshire is worth significantly more than 200B but that doesn't really matter. We all have our opinions.

 

But I think that your standard of the op sub managers to have most of their wealth in BRK stock may be a bit unfair. Honestly if we were to apply that standard in general we wouldn't invest in many names. People may worry about diversification or other reasons. After all they sold the companies to BRK for a reason. With all that said I think that a lot of the operators do have a significant amount of wealth in BRK stock.

 

But even the above is not really relevant. Despite the folklore, a lot of the op earnings won't come from companies acquired from former owner operators. The railway, energy, PCP, Lubrizol, and part of insurance were all former big public companies. They provide a huge chunk of the earnings and are not owner operator businesses. In addition they are quite old and managed several successions just fine on their own.

 

Even in the smaller businesses segment that you could refer to as the owner operator. A lot of this businesses went through at least one succession until now. Given all of this I don't think it's as scary as you imagine it. In addition, if Berkshire continues it's policy of supplying its subs with capital, paying managers well, and staying out of their way I don't envision it would be very hard to attract talent. That's pretty much how you describe heaven for an executive.

[Charlie]

From Barrons´s interview of the manager of Fidelity Contrafund:

 

Why is Berkshire your single largest holding?

 

I try to keep investing relatively simple. Who wouldn’t want to partner with Warren Buffett? Who wouldn’t want to partner with one of the greatest investors and arguably the greatest business mind of an entire generation? I initially came to Berkshire during the Internet bubble, or a little before then, when, with the help of Fidelity’s insurance analyst, I realized that the insurance market was starting to tighten up. Various insurance executives identified Berkshire and AIG [ American International Group ] as two of the great insurance companies in the world. I’ve never sold a share of Berkshire.

 

The stock has been an underperformer this year and trades at around 1.3 times book value. Buffett is 85. Does Berkshire still look so compelling?

 

Earnings will continue to climb. Buffett’s insurance operation is the best in the world. He is generating a combined ratio [incurred losses and expenses as a percentage of earned premium] in the low 90% area. And he’s buying companies and generating low double-digit returns. Berkshire is worth more than 1.3 or 1.4 times book value. Buffett has assembled an outstanding collection of companies.

[Guest longinvestor]

Agree, will ha.

Good choice. Eve...

 

 

But I think that your standard of the op sub managers to have most of their wealth in BRK stock may be a bit unfair. Honestly if we were to apply that standard in general we wouldn't invest in many names. People may worry about diversification or other reasons. After all they sold the companies to BRK for a reason. With all that said I think that a lot of the operators do have a significant amount of wealth in BRK stock.

 

But even the above is not really relevant. Despite the folklore, a lot of the op earnings won't come from companies acquired from former owner operators. The railway, energy, PCP, Lubrizol, and part of insurance were all former big public companies. They provide a huge chunk of the earnings and are not owner operator businesses. In addition they are quite old and managed several successions just fine on their own.

 

Even in the smaller businesses segment that you could refer to as the owner operator. A lot of this businesses went through at least one succession until now. Given all of this I don't think it's as scary as you imagine it. In addition, if Berkshire continues it's policy of supplying its subs with capital, paying managers well, and staying out of their way I don't envision it would be very hard to attract talent. That's pretty much how you describe heaven for an executive.

Great point, the heavy lifting in earnings is done by previously public companies. I personally prefer private businesses like Marmon, Van Tuyl, NFM et al over BNSF, PCP etc. Coming into the family. Public companies have a bit more baggage and diluted ownership interest. This brings us to the developing partnership with 3G into the picture. My experience working in/with large public corporations has me fully convinced of 3G's austerity measures as they buy public businesses. There is simply too much BS just because of the public ownership. The marriage with BRK is somewhat of a conundrum and played large at this years annual meeting. We'll hear more on this.

 

 

[scorpioncapital]

Can anyone explain this phenomenon? I have seen conglomerates that own 50% or more, sometimes 80% of a publicly traded operating company. Sometimes it's a consumer products company, sometimes an insurance sub...Yet they still trade at a conglomerate discount of perhaps 15-25%. Would buying out those publicly traded subs increase the value because outsiders have to buy the conglomerate to participate in that business? Or would it cause even more discounting due to the fact that the subs performance may be masked and can't be split out? In other words, why is Berkshire such a unique example for a premium to book - is it simply superior management running superior businesses (although many are old school average margin businesses) or great salesmanship and popularity?

 

[original mungerville]

Agree, will ha.

Good choice. Eve...

 

 

But I think that your standard of the op sub managers to have most of their wealth in BRK stock may be a bit unfair. Honestly if we were to apply that standard in general we wouldn't invest in many names. People may worry about diversification or other reasons. After all they sold the companies to BRK for a reason. With all that said I think that a lot of the operators do have a significant amount of wealth in BRK stock.

 

But even the above is not really relevant. Despite the folklore, a lot of the op earnings won't come from companies acquired from former owner operators. The railway, energy, PCP, Lubrizol, and part of insurance were all former big public companies. They provide a huge chunk of the earnings and are not owner operator businesses. In addition they are quite old and managed several successions just fine on their own.

 

Even in the smaller businesses segment that you could refer to as the owner operator. A lot of this businesses went through at least one succession until now. Given all of this I don't think it's as scary as you imagine it. In addition, if Berkshire continues it's policy of supplying its subs with capital, paying managers well, and staying out of their way I don't envision it would be very hard to attract talent. That's pretty much how you describe heaven for an executive.

Great point, the heavy lifting in earnings is done by previously public companies. I personally prefer private businesses like Marmon, Van Tuyl, NFM et al over BNSF, PCP etc. Coming into the family. Public companies have a bit more baggage and diluted ownership interest. This brings us to the developing partnership with 3G into the picture. My experience working in/with large public corporations has me fully convinced of 3G's austerity measures as they buy public businesses. There is simply too much BS just because of the public ownership. The marriage with BRK is somewhat of a conundrum and played large at this years annual meeting. We'll hear more on this.

 

Not much of a conundrum to me. Buffett figures with BRK so big, he has to buy big. And with 3G waiting in the wing to go in with him (or vice versa him waiting in the wing for them to decide on something) on the acquisition of a poorly managed large company, it provides him with one more avenue to deploy capital in a somewhat entrepreneurial way (ie after 3G gets through with the company, its much more focused, less bureaucratic, leaner, etc). So he can basically target large bureaucratic companies now in certain industries. Its pretty sweet. The unspoken deal is probably "hey, I provide certain intangibles and I'll provide you capital when the market tanks" but "you bring me in on deals when the market is good (even though others could finance you at that point)". I don't know. At this point, the relationship seems to be quite an advantage for BRK.

 

 

[vinod1]

Can anyone explain this phenomenon? I have seen conglomerates that own 50% or more, sometimes 80% of a publicly traded operating company. Sometimes it's a consumer products company, sometimes an insurance sub...Yet they still trade at a conglomerate discount of perhaps 15-25%. Would buying out those publicly traded subs increase the value because outsiders have to buy the conglomerate to participate in that business? Or would it cause even more discounting due to the fact that the subs performance may be masked and can't be split out? In other words, why is Berkshire such a unique example for a premium to book - is it simply superior management running superior businesses (although many are old school average margin businesses) or great salesmanship and popularity?

 

Premium or discount is related to the value add that is generated at the conglomerate level. How many conglomerates suck out all the cash flow from the subs and allocate them to the highest risk adjusted returns? Berkshire additionally gets low cost leverage from float - a value add due to its structure.

 

Compare it to other conglomerates. It is not great salesmanship or popularity that gets Berkshire its premium to book value.

 

Vinod

[netnet]

Can anyone explain this phenomenon? I have seen conglomerates that own 50% or more, sometimes 80% of a publicly traded operating company. Sometimes it's a consumer products company, sometimes an insurance sub...Yet they still trade at a conglomerate discount of perhaps 15-25%. Would buying out those publicly traded subs increase the value because outsiders have to buy the conglomerate to participate in that business? Or would it cause even more discounting due to the fact that the subs performance may be masked and can't be split out? In other words, why is Berkshire such a unique example for a premium to book - is it simply superior management running superior businesses (although many are old school average margin businesses) or great salesmanship and popularity?

 

Premium or discount is related to the value add that is generated at the conglomerate level. How many conglomerates suck out all the cash flow from the subs and allocate them to the highest risk adjusted returns? Berkshire additionally gets low cost leverage from float - a value add due to its structure.

 

Compare it to other conglomerates. It is not great salesmanship or popularity that gets Berkshire its premium to book value.

 

Vinod

 

+1 to Vinod's comments

 

Additionally, you need to look at both the value you are using with BRK and  the comparison class that you are using.  Some conglomerates trade at a premium and some at a discount.  If I remember the literature, about 2/3 trade at a discount 1/3 at a premium.  So BRK is not unique one way or the other.  Furthermore, you are valuing BRK on book, that is not really the best metric at all, obviously that is the easiest to use and calculate, but really the number (although variable estimate) would be IV.  The metric should be how does a conglomerate trade in relation to its IV.

(Also the discount to publicly owned shares is not limited to conglomerates, numerous examples from Palm to Yahoo.)

[marazul]

I think BRK at the moment is one of the best risk-reward situations in the market. You have BRK trading at less than 5% above buyback territory. At the same time, the person that knows the company best (WEB) thinks it is incredibly cheap at this valuation. On the other hand, you have a market that is trading at a fair to slightly rich valuation. For the next 5 years, I think this is a solid way to beat the index. I wouldn´t be surprised if BV grows at ~8% for the next 5 years, while IV grows at a slightly higher rate. In addition to that, BRK should trade near 1.5x book not ~1.25x (using expected 3Q15 BV). If I am correct, BV grows at 8% for the next 5 years and BRK rerates to 1.5x BV then investors should earn 12% compounded in this period. Not bad for a safe investment with little downside risk IMO.

[John Hjorth]

... Berkshire additionally gets low cost leverage from float - a value add due to its structure. ..

Add to that deferred taxes as per 1H2015 approx. USD 62.7 B. [Nature of the deferred taxes is different from the nature of insurance float, but also basicly low/zero cost leverage].

Insurance float as per 1H2015 USD 85.1 B.

Sum of deferred taxes and insurance float as per 1H2015 approx. USD 147.8 B,

relative to shareholders' equity as per 1H2015 USD 246.0 B,

[ie. sum of insurance float and deferred taxes relative to shareholders' equity approx. 60%].

[netnet]

... Berkshire additionally gets low cost leverage from float - a value add due to its structure. ..

Add to that deferred taxes as per 1H2015 approx. USD 62.7 B. [Nature of the deferred taxes is different from the nature of insurance float, but also basicly low/zero cost leverage].

Insurance float as per 1H2015 USD 85.1 B.

Sum of deferred taxes and insurance float as per 1H2015 approx. USD 147.8 B,

relative to shareholders' equity as per 1H2015 USD 246.0 B,

[ie. sum of insurance float and deferred taxes relative to shareholders' equity approx. 60%].

 

John and Vinod make an important point here that is often overlooked in the PB discussion: Low cost float is really a huge value. Specifically, Buffett has said that it is (can be) better than equity. (Low cost "permanent" or increasing float that BRK has.)

 

Now I would not add the entirety of it and the deferred taxes back to count as book, but certainly one should be able to add back a fraction to the book value.

 

Also remember that the buyback point means that Buffett himself thinks that 1.2 is undervalued, what might that mean?  Well it certainly means that at 1.2 it is significantly below IV, another words he is certain that he will make 12-15% per year at that valuation.

[scorpioncapital]

If float is free leverage and quality businesses can compound at 15%/yr, can we get 30% IRR in Berkshire at 2x float to equity? At 1x book, 30% per year; at 1.2x book, 24% per year; at current price, 20% per year. What is the disconnect between a theoretical return and reality? We know size is an argument but if each piece can do the required lifting...Perhaps if it's so hard at Berkshire with quality businesses to achieve this target, imagine how hard it must be at less than stellar companies.

 

 

[John Hjorth]

... What is the disconnect between a theoretical return and reality? We know size is an argument but if each piece can do the required lifting...

Personally I see the following reason for the disconnect - more reasons may exist:

 

The drag on CAGR from the laggards :

 

From owners manual, paragraph 11, especially from "We are also very reluctant..." and onwards:

 

"You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in aterrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior."

[thepupil]

If float is free leverage and quality businesses can compound at 15%/yr, can we get 30% IRR in Berkshire at 2x float to equity? At 1x book, 30% per year; at 1.2x book, 24% per year; at current price, 20% per year. What is the disconnect between a theoretical return and reality? We know size is an argument but if each piece can do the required lifting...Perhaps if it's so hard at Berkshire with quality businesses to achieve this target, imagine how hard it must be at less than stellar companies.

 

Scorpion, the disconnect between theory and reality is that your theory is totally bonkers. Berkshire is far less levered than that and the vast majority of companies they own are not going to compound at close to 15% (much less the cash and fixed income which returns close to 0%).

 

They have $80 odd billion of float and $240B of equity. If you write up BNSF and BE they have $300 or so of equity. Float is great and all but Berkshire is only like 25 or 30% levered wth it.

[John Hjorth]

An - at least to me - interesting article about Berskshire deferred taxes from SA:

 

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam

 

[i haven't tried to verify any info in the article.]

[Picasso]

Reminds me of this for some reason:

 

 

Deferred taxes are a secret ploy to grow float!  Not the obvious result of good capital allocation in a long lived asset!

[wknecht]

An - at least to me - interesting article about Berskshire deferred taxes from SA:

 

http://seekingalpha.com/article/2428045-how-buffett-is-changing-the-future-of-berkshires-float-from-insurance-to-uncle-sam

 

[i haven't tried to verify any info in the article.]

Insurance float results from a cash inflow whereas the PP&E DTL is only possible after a huge cash outflow (the capex). If the Capex earns a poor return then the associated float cannot somehow redeem that.  Berkshire's profitable insurance float is far superior.