1.2x P/BV entry point

[netnet]

Have members ruled out that BV might decline? I mean BRK is so leveraged and heavily into cyclical, industrial stocks which are getting pounded this year. Eg, NSC is down -30% YTD, and if we assume a similar valuation decline for BNSF, and multiply by 2x for leverage, the "true" BV might be lower than anticipated?

 

How does the MV decline of a wholly owned sub impact BV? Also - highly doubt BNSF equity is financed with 1:1 debt/equity.

 

Jay, see my posts. I think he means "mark to market book value" when he says "true book". MTM book for BNSF has certainly decreased with UNP, NSC, CSX and KSU all down significantly. XLI is also off 12% this year if we use that as a proxy for Marmon, Iscar, and the like. So it's fair to say that MTM book value of wholly owned subs has decreased, in addition to the decline in MTM value of the stock portfolio. BUT the MTM book value of those 2 subs was and is still WELL above GAAP book value.

 

And KHC added a good bit after Q2 to help offset this, as will $23B or so of pre-tax investment income + operating earnings,  plus whatever underwriting profit shakes out to be.

 

and yes, BNSF equity is not levered at all. The company itself is levered, but the equity stake is definitely not!

 

Not to pick at nits, but ...For a company, in this case the BNSF sub, that does not own tradable assets as a meaningful part of its book, i.e. it's not a finance company or does not own substantial financial assets, saying marked to market book value really has no meaning.  The point of book value is a more stable estimate of value.

 

Now you could adjust book value with estimates of replacement costs, but that is not what is being discussed. No one is suggesting that the value of the railcars, tracks, etc has gone down.  Instead of book, you are comparing BNSF to its publicly traded peers, which of course is fine, BUT it is NOT book value, by any stretch.

 

(Jeez, I sound like a seriously anal accounting prof at a community college, with apologies to any such accounting profs out there.)

[thepupil]

I agree with you that some seriously imprecise language is being thrown around by yours truly.

 

Perhaps I should have used NAV instead of "adjusted book". I think of BNSF and BE as public companies inside Berkshire (they file K's and Q's and have some decent comparables) and like to compare what those are trading for in the market to what I think I'm paying for them by buying Berkshire, but obviously I realize that UNP going down in stock price isn't going to effect the GAAP book value of BNSF; it may however reflect a decrease in intrinsic value or NAV.

[no_free_lunch]

Decent article by morningstar on Berkshire valuation.  I am just putting in the end numbers but quite a bit of details if anyone is interested.

 

Our new fair value estimate is equivalent to 1.8 times Berkshire's reported book value per Class A (Class B) share of $149,735 ($100) at the end of the second quarter. With book value expected to expand in the back half of the year, augmented by a noncash gain on Berkshire's stake in Heinz (which merged with Kraft at the start of July), our new fair value estimate is equivalent to 1.7 and 1.5 times our projected book value for the firm at the end of 2015 and 2016, respectively.

 

http://news.morningstar.com/articlenet/article.aspx?id=715603

[thepupil]

So there are 2.464B B share equivalents which implies the following morningstar valuations

 

Insurance  $135B

KHC          $24B

PCP          $34B

BNSF        $96B <--this seems a little high to me, unless you think BNSF is immune to the troubles of the other railroads*

BE            $37B <--this seems a little low to me

M,S,R        $96B

Finance    $15B

              $436B , 1.8X

 

My roughly calculated base case a few pages back was about 1.9X which I think came from me being a touch too generous on the insurance.

 

*UNP can be bought for 76% of Morningstar's valuation of BNSF...it has earned more in each of the last 3 years...if you believe m*'s BNSF valuation, then UNP is certainly a buy. Perhaps, I'm missing something about the differences between the two...

 

UNP pretax:  $6.3B, $7.0B, $8.3B, 1H: $3.8B

BNSF pretax: $5.3B, $5.9B, $6.1B, 1H: $3.2B

[100 Shares]

It's important to note that although the current market value of UNP is 73B, Morningstar values UNP at 99B if you have access to their premium accounts. Given the earnings differences, I would agree with you that BNSF should be less than UNP, not about equal as Morningstar says.

[thepupil]

Nice, so using an alternative method of saying BNSF is worth 80% of UNP (since it currently has 80% of its earnings, so not baking in any kind of better than UNP growth/margin improvement), Morningstar would be at about $80B (rather than $96). Using 80% of UNP market value, it's $60B.

 

Either way,  the 14% of Berkshire's GAAP book value represented by BNSF, is worth 1.7X book using [uNP* 0.8], 2.3X book using [Morningstar UNP PT *  0.8] and a wopping 2.8X using (Morningstar PT).

 

With Berkshire at 1.3X book, how can you not like those numbers?

 

Anyways, I'm getting quite repetitive....

 

 

[no_free_lunch]

 

Anyways, I'm getting quite repetitive....

 

 

No you're not.  Greatly appreciate your analysis.

[scorpioncapital]

I thought I heard Buffett on a video not too long ago say BNSF was the top dog railroad. Best operating metrics in all areas. Not sure if this is true or not but if it is, would it command a higher premium than the other railroads?

[ourkid8]

Maybe US rails but CN Rail is the top dog railroad in N.A.

 

I thought I heard Buffett on a video not too long ago say BNSF was the top dog railroad. Best operating metrics in all areas. Not sure if this is true or not but if it is, would it command a higher premium than the other railroads?

[Williams406]

I'm not sure about the Buffett BNSF top dog quote,  but here's a link to a June 2015 article profiling UP and some of the operational improvements in recent years.

 

http://fortune.com/2015/06/04/union-pacific-railroad/

[Guest longinvestor]

 

OK, here's a prior post of mine, coming at it from another angle. Stock price over the fifty years has roughly  followed both earnings growth and bv growth; both ~20%

 

From the 10-K

 

Per-share pre-tax earnings (non-insurance, non-investment)growth rates

1970-1980:20.8%

1980-1990:18.4%

1990-2000: 24.5%

2000-2010: 20.5%

 

2011: 18%

2012: 15.7%

2013: 20.6%

2014: 19%

There is little evidence that earnings growth has materially changed in the past four years from the previous four decades.  Buffett has been singing for many years that their focus going forward is on per share earnings, not on BV growth.

 

I don't see any number below 15%, not in 1-,3-,5- years, or over 5 decades; do you? I put the table of stock prices to show that the 10-20 period is different (world messed up, not BRK, they just went into a shell letting the cash pile up) than the most recent 3-5- and the older 20-30-40 year periods, when the capital was freely deployed. Stock price will follow. I think it is urban myth to project the 10-15 year history into the future. That one makes ZERO sense to me as the opposite does to you.

 

No, I don't agree with you. On the other side, not trying to convince you or anyone else about the future prospects of BRK.

 

I agree that intrinsic value growth (approximated by book value growth over time) can be measureed as the combination of the growth of investments per share and earnings per share. As such, it would be helpful for you to stare at not only the numbers above re earnings growth but also investments per share growth and book value growth. This would help our conversation and make clear to you that BRK will not grow intrinsic business value at 15% compounded going forward. Buffett said "focus" on earnings per share growth, not "only look at that" and ignore the other parts of the business which drive intrinsic business value - this is where you are erring.

 

Let's not get hung up on 15% though. If you are saying the next 10-15 years may look better than the last 10-15 years for BRK (especially relative to the S&P) as the driver of intrinsic value is shifting more and more from growth in investments per share to pre-tax earnings growth - and not everyone has figured that out yet - then I completely agree with you. And this is counter-intuitive to a degree because you would not expect this result after the business has become larger.

 

12% on the high end may be doable because of this point I think you are making. Just forget about 15%.

 

No, I won't. In fact I'm willing to wager. Are you?

 

Went through something like this with another poster

 

what you'd pay..disproportionate bet in B shares

13%=10

14%=20

15%=40

16%=80

17%=160

18%=320

19%=640

.....

 

what i'd pay

 

14%=10 (you'd  be paying me 10 shares)

13%=20 (i'd be paying you 10 shares)

12%=40

11%=80

10%=160

9%=320

8%=640

.....

 

 

For the period 2010-19, taken as the average Stock price growth. That's a reasonably long time to treat SP and IV as having converged. We could do longer, like 2010-2025,, but that's too long to keep up with it.

[vinod1]

longinvestor,

 

If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.

 

Vinod

[Guest longinvestor]

longinvestor,

 

If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.

 

Vinod

 

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV  but BV never gets revised upwards.  The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.

 

My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.

 

"Berkshire has not gotten that worse".  That is my bet, and it is in stock price growth.

 

[Munger_Disciple]

they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV  but BV never gets revised upwards

 

Retained earnings increase book value.

[scorpioncapital]

Why a stock price column and not an ROE or free cash flow growth % column? BV is based on internal criteria, stock price perhaps a delayed proxy in the best of times.

 

 

[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?

 

 

[original mungerville]

I actually partially agree with longinvestor. I think intrinsic value has a shot (not a certainty) at growing faster than the 10% of the past 15 years. Like maybe 12% - possibly for the same reasons as longinvestor, but I can't see 15% over an extended period (ie say 2015 - 2025)

[Palantir]

Have members ruled out that BV might decline? I mean BRK is so leveraged and heavily into cyclical, industrial stocks which are getting pounded this year. Eg, NSC is down -30% YTD, and if we assume a similar valuation decline for BNSF, and multiply by 2x for leverage, the "true" BV might be lower than anticipated?

 

 

BNSF has a book value to Berkshire of $34B. Using a simplistic analysis of the decrease in market value of BNSF (simply saying the "right" multiple has gone from 20X to 14X), then BNSF went from being worth $90B to $56B, from 2.3X GAAP book to 1.6X GAAP Book.

 

It would be incorrect to say NSC is down 30%, Berkshire has 44% equity/ assets, ergo Berkshire's interest in BNSF is worth 60% less.

 

BNSF is simply "worth" a less giant premium to book than before. That premium moves up in down in an unlevered fashion because Berkshire's equity stakes in BNSF and BE are not themselves levered like that.

 

Interesting, thanks.

[Charlie]

Intrinsic value has especially the chance of growing nicely after a good stock market decline and after Buffett fired his elephant gun.

 

 

[Charlie]

from the Motley Fool board:

 

http://stonewellfunds.com/ForwardReturnPredictor.jpg

[vinod1]

longinvestor,

 

If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.

 

Vinod

 

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV  but BV never gets revised upwards.  The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.

 

My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.

 

"Berkshire has not gotten that worse".  That is my bet, and it is in stock price growth.

 

I disagree with your interpretation of Buffett's comments in the annual report.

 

The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings.

 

He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value.

 

He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report.

 

So all he is saying is we need to use a multiple of book value now and not just 1x book value.

 

I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points.

 

Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV.

 

As I said before, I root for you to be right for my portfolio sake.

 

Vinod

[shalab]

Good discussion overall  thanks guys for all the different opinions.

 

I think the IV is deviating from book more than 1% a year.

 

If we look at BNSF alone, the price on books is 34B. It is worth double that now in five years - even if we say it is worth $30B more, it has contributed to roughly 10% increase in market value at today's market cap. So 1.9% increase in IV just from BNSF. This is excluding the retained earnings that is paid out as dividend to the parent.

 

This doesnt even include other businesses which have increased in value since.

 

 

longinvestor,

 

If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.

 

Vinod

 

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV  but BV never gets revised upwards.  The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.

 

My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.

 

"Berkshire has not gotten that worse".  That is my bet, and it is in stock price growth.

 

I disagree with your interpretation of Buffett's comments in the annual report.

 

The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings.

 

He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value.

 

He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report.

 

So all he is saying is we need to use a multiple of book value now and not just 1x book value.

 

I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points.

 

Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV.

 

As I said before, I root for you to be right for my portfolio sake.

 

Vinod

[KinAlberta]

In these discussions I think it would help if people explained what they see as IV and "worth". If holdings are market priced at some level above or below their own IV, then to some extent that market price is realizable value to BRK, if the holdings that can be sold at that market value. Otherwise that holding's earnings based value (and possibly a PC of estimated balance sheet value) should be used to value those permanent holdings and added to the IVs of other such permanent holdings.

[vinod1]

Good discussion overall  thanks guys for all the different opinions.

 

I think the IV is deviating from book more than 1% a year.

 

If we look at BNSF alone, the price on books is 34B. It is worth double that now in five years - even if we say it is worth $30B more, it has contributed to roughly 10% increase in market value at today's market cap. So 1.9% increase in IV just from BNSF. This is excluding the retained earnings that is paid out as dividend to the parent.

 

This doesnt even include other businesses which have increased in value since.

 

 

longinvestor,

 

If you start with year end 2014 and use book value for measuring performance to say either year end 2019 or 2024, I am on.

 

Vinod

 

After 22 pages of discussing the fact that BV is / has become a poor proxy of BRK's IV, why would I do that? Because of the nature of BRK today...they keep adding value to the coffers regularly which in turn contributes to earnings which is increasingly retained and adds to IV  but BV never gets revised upwards.  The whole reason why BRK is misunderstood today. Why WEB has started measuring stock price in the table for the very first time. It is clearly explained on the very first page of the Annual report.

 

My bet is self-explanatory. It is based on stock price which over time converges with IV. I want to go back to the year 2010 for a very specific reason. There is a whole new BRK developing since then, the world is late to catch on.

 

"Berkshire has not gotten that worse".  That is my bet, and it is in stock price growth.

 

I disagree with your interpretation of Buffett's comments in the annual report.

 

The context for that discussion is Berkshire's failure to meet his 5 year test. That Berkshire as measured by book value would beat S&P 500 total return over a 5 year period as defense for retaining all the earnings.

 

He was saying book value as in "IV being roughly equal to book value" was a good measure early on but that now IV is much higher than book value.

 

He never said that IV is unrelated to book value. In fact, he lays out when he thinks Berkshire is attractive and when it is overvalued entirely as a multiple of book value later on in the annual report.

 

So all he is saying is we need to use a multiple of book value now and not just 1x book value.

 

I do not disagree that IV and MV would converge over the long term. But Berkshire is undervalued now and over 5 or 10 year period changes in valuation would add or detract to returns just due to end points.

 

Growth in IV I believe would be much closer to growth in IV. I do believe that IV is growing at a slightly faster rate than BV but that difference is less than 1% annually. So book value growth remains a convienent and reasonable method to estimate growth in IV.

 

As I said before, I root for you to be right for my portfolio sake.

 

Vinod

 

BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example.

 

Vinod

[shalab]

Yes - I think energy is generally tied to book value somewhere in the 1.6 - 1.9 times book. Insurance is another that is typically tied to a multiple of book - Gieco is probably an exception here.

 

There are several others that aren't tied as much - examples:

 

Lubrizol

Van Tuyl

Iskar

Marmon(?)

Fruit of the Loom

Brooks shoes

Sees candies

Retail(?)

PCP when it gets done

 

So I think the assertion of IV deviating to the higher side of book over time is correct.

 

BNSF was of the best investments that Buffett made in recent years and it was an opportunity that came about from the 2008 bear market. I do not think you can extrapolate such results onto all other investments. Energy is a good example.

Vinod