WEB's annual letter

[John Hjorth]

sleepydragon,

 

Numbers explanation of the 6.4%:

 

Berkshire Hathaway shareholder's equity per outstanding Class A equivalent common share end 2014 [uSD 146,186] X 1.064 ~

Berkshire Hathaway shareholder's equity per outstanding Class A equivalent common share end 2015 [uSD 155,501]

 

[Figures: Annual Report p. 34]

 

But what is the Total book value. Is it: 15.5 billion / 6.4% = 240billion?

Is so, the mktcap is 330 billion. It seems a much bigger gap than the per share numbers?

 

Your calculations makes no sense. Total book value is equal to total shareholders equity ex. non controlling interests [M USD 255,550][Annual Report p. 37]

 

The missing piece of his calculation is that 15.5B/6.4% = 240B, but that is the starting point for last year, so you re-add 15.5B, which matches your number.

 

thanks!

 

sleepydragon,

 

I apologize for the not very constructive reply from me above. rmitz got it right on behalf of me though. Thanks.

[Guest longinvestor]

A point of departure in this year's AR, relating to the Intrinsic Business Value.

 

- Insurance underwriting income has been added to the operating earnings per share. Rationale provided is the relatively smaller mega cat exposure today versus earlier.

 

- Cash + investments per share now versus just investments per share before

 

The impact of these changes on the 1970-present?

 

Earnings CAGR over 44 years is now 23.6% versus 20.6% as previously measured. Arguably, ignoring underwriting income did not reflect what Berkshire was all about. Going forward, it is likely that the earnings metric will get (a whole lot) lumpier from year to year. Good luck to those using spreadsheet models using linear assumptions.

 

And arguably, if the cash hoard balloons, the investment+cash number will be somewhat tempered from market price variation of the portfolio.

 

 

 

 

Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased 8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses – including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor the dividends and interest from the investments we hold because including them would produce a double-counting of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax.

I used the italics in the paragraph above because we are for the first time including insurance underwriting income in business earnings. We did not do that when we initially introduced Berkshire’s two quantitative pillars of valuation because our insurance results were then heavily influenced by catastrophe coverages. If the wind didn’t blow and the earth didn’t shake, we made large profits. But a mega-catastrophe would produce red ink. In order to be conservative then in stating our business earnings, we consistently assumed that underwriting would break even over time and ignored any of its gains or losses in our annual calculation of the second factor of value.

Today, our insurance results are likely to be more stable than was the case a decade or two ago because we have deemphasized catastrophe coverages and greatly expanded our bread-and-butter lines of business. Last year, our underwriting income contributed $1,118 per share to the $12,304 per share of earnings referenced in the second paragraph of this section. Over the past decade, annual underwriting income has averaged $1,434 per share, and we anticipate being profitable in most years. You should recognize, however, that underwriting in any given year could well be unprofitable, perhaps substantially so.

Since 1970, our per-share investments have increased at a rate of 18.9% compounded annually, and our earnings (including the underwriting results in both the initial and terminal year) have grown at a 23.7% clip. It is no coincidence that the price of Berkshire stock over the ensuing 45 years has increased at a rate very similar to that of our two measures of value. Charlie and I like to see gains in both sectors, but our main goal is to build operating earnings.

 

[JBird]

From the Intrinsic Value Section,

 

Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased

8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses –

including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor

the dividends and interest from the investments we hold because including them would produce a double-counting

of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization

and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax.

 

IV?

$160K + 10x $12.3k = $283 k/A share

          + 12x $12.3k = $308 k/A share

 

If we really go crazy,

          +15x $12.3k = $345 k/A share    (that would make WEB's 1.2x BV buy back a 50 cent -dollar purchase)

 

Tilson's August 2015 estimate was $275K and a projection of $305K in a year from then. We're there now, ha!

 

It's important to note at the bottom of page 4 of the letter that all earnings are stated on a pre-tax basis. If I remember correctly from the AGM a couple years ago, he thought the operating businesses in aggregate were worth 8 or 9 times pre-tax earnings.

 

So the calculation would go more like 160k + 99k.

$170 or so per B share.

[John Hjorth]

From the Intrinsic Value Section,

 

Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased

8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses –

including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor

the dividends and interest from the investments we hold because including them would produce a double-counting

of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization

and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax.

 

IV?

$160K + 10x $12.3k = $283 k/A share

          + 12x $12.3k = $308 k/A share

 

If we really go crazy,

          +15x $12.3k = $345 k/A share    (that would make WEB's 1.2x BV buy back a 50 cent -dollar purchase)

 

Tilson's August 2015 estimate was $275K and a projection of $305K in a year from then. We're there now, ha!

 

It's important to note at the bottom of page 4 of the letter that all earnings are stated on a pre-tax basis. If I remember correctly from the AGM a couple years ago, he thought the operating businesses in aggregate were worth 8 or 9 times pre-tax earnings.

 

So the calculation would go more like 160k + 99k.

$170 or so per B share.

 

I - for one - understand your academics.  Are you a buyer at these levels, or are you not?

[serendibz]

On p21:

"By 2014, Class I railroads carried 1.85 trillion ton-miles, an increase of 182%"

 

On p22 (BNSF's share):

"Last year the comparable figures were 702 million ton-miles (plus 71%) and 47,000 employees

(plus only 4%)"

 

Is there a typo somewhere because BNSF's market share seem to be way too low.

[matjone]

The best piece of news for me was that there's a book coming out about the Buffett partnerships.  This to me seems to be the biggest hole for those who would like to understand Buffett the investor.  There has been a decent amount of coverage about his early days investing his own money and much in-depth coverage of Berkshire but the partnership is a bit of a mystery.

[gfp]

On p21:

"By 2014, Class I railroads carried 1.85 trillion ton-miles, an increase of 182%"

 

On p22 (BNSF's share):

"Last year the comparable figures were 702 million ton-miles (plus 71%) and 47,000 employees

(plus only 4%)"

 

Is there a typo somewhere because BNSF's market share seem to be way too low.

 

BNSF's market share is much much higher in ton miles than it is in revenues, if that is what you are getting at -

 

"In that respect, we are a strong number one among the seven large American railroads (two of which are Canadian-based), carrying 45% more ton-miles of freight than our closest competitor."

[serendibz]

On p21:

"By 2014, Class I railroads carried 1.85 trillion ton-miles, an increase of 182%"

 

On p22 (BNSF's share):

"Last year the comparable figures were 702 million ton-miles (plus 71%) and 47,000 employees

(plus only 4%)"

 

Is there a typo somewhere because BNSF's market share seem to be way too low.

 

Both quoted figures refer to ton-miles. And according to those figures BNSF has a market share of 702m / 1.85t = <0.1%. But it is the number 1 railroad in terms of market share. What am I missing?

 

BNSF's market share is much much higher in ton miles than it is in revenues, if that is what you are getting at -

 

"In that respect, we are a strong number one among the seven large American railroads (two of which are Canadian-based), carrying 45% more ton-miles of freight than our closest competitor."

[gfp]

I see what you are referring to now - it is a typo - BNSF transported over 700 Billion ton miles, not million.  A rare typo in a Berkshire report. 

[Guest longinvestor]

"Gift to my successor" appears for the first time ever,

 

The table on page 55 gives you the current status of our intangible assets as calculated by GAAP. We now

have $6.8 billion left of amortizable intangibles, of which $4.1 billion will be expensed over the next five years.

Eventually, of course, every dollar of these “assets” will be charged off. When that happens, reported earnings

increase even if true earnings are flat. (My gift to my successor.)

 

What other gifts in store?

 

- The 1.2xBV if left unchanged until after the succession. Would create headroom (IV:BV gap) to execute the promised buyback. The longer it takes for the transition, the more the headroom.

- TTT taking on Chair person roles at subs where this does not exist today. How about Combs for Chairman role at PCP?

- BHE and BNSF retain 100% of earnings for a long time. Don't burden Omaha unless needed.

- Others?

 

This is a transition in slow motion, but for sure is.

[Guest longinvestor]

From the Intrinsic Value Section,

 

Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased

8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses –

including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor

the dividends and interest from the investments we hold because including them would produce a double-counting

of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization

and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax.

 

IV?

$160K + 10x $12.3k = $283 k/A share

          + 12x $12.3k = $308 k/A share

 

If we really go crazy,

          +15x $12.3k = $345 k/A share    (that would make WEB's 1.2x BV buy back a 50 cent -dollar purchase)

 

Tilson's August 2015 estimate was $275K and a projection of $305K in a year from then. We're there now, ha!

 

It's important to note at the bottom of page 4 of the letter that all earnings are stated on a pre-tax basis. If I remember correctly from the AGM a couple years ago, he thought the operating businesses in aggregate were worth 8 or 9 times pre-tax earnings.

So the calculation would go more like 160k + 99k.

$170 or so per B share.

 

What they actually said was what they'd pay for business similar to the subs. That'd be a fair price they'd pay, not the IV. One may have noticed their addiction to buying cheap. There's nothing wrong for us to do the same when buying BRK, while it is still available. Buying at today's price means we are getting the earnings stream at ~ 3x. Or that we're getting it at 16-17x earnings and the entire investment portfolio for free.   

[nodnub]

I'm not surprised, but disappointed how "moral authority" like buffett can support openly criminals like clinton(s). 

 

https://www.youtube.com/watch?v=nElTTTBw3s4

 

infowars?  Lol.

Leave this pseudo-political stuff on yahoo boards

[redskin]

"Gift to my successor" appears for the first time ever,

 

The table on page 55 gives you the current status of our intangible assets as calculated by GAAP. We now

have $6.8 billion left of amortizable intangibles, of which $4.1 billion will be expensed over the next five years.

Eventually, of course, every dollar of these “assets” will be charged off. When that happens, reported earnings

increase even if true earnings are flat. (My gift to my successor.)

 

What other gifts in store?

 

- The 1.2xBV if left unchanged until after the succession. Would create headroom (IV:BV gap) to execute the promised buyback. The longer it takes for the transition, the more the headroom.

- TTT taking on Chair person roles at subs where this does not exist today. How about Combs for Chairman role at PCP?

- BHE and BNSF retain 100% of earnings for a long time. Don't burden Omaha unless needed.

- Others?

 

This is a transition in slow motion, but for sure is.

 

BNSF has been paying out most of their earnings to Omaha.  They have paid $20 billion in dividends since Berkshire purchased.

[thefatbaboon]

I find it strange that Buffett always opens his letter with an obvious error. "During the first half of those years Berkshires net worth was roughly equal to the number that really counts: the intrinsic value of the business. "

 

Given that Berkshire returned 20.8% for 50 years, more than double the market, clearly the intrinsic value all those years ago was WELL above book value. Probably significantly more so than it is today.

[Dynamic]

I agree with you about IV in retrospect clearly being enormously higher than BV in the early years.

 

What I guess he means is that his and Charlie's estimates of IV at the time using the figures available to them at the time would have been closer to BV.

 

It might be interesting to take an old annual report and run some numbers. One certainly wouldn't value it on the assumption of such enormous returns on the stock portfolio as a sensible value investor at the time.

[Guest longinvestor]

No, there's no error in that statement. The proportion of mark-to-market was high then, now it's the wholly owned(and never-revised-up) which dominates the IV. I read from WEB's note that it's the second half that the market is off on net worth estimation. The rest of the letter has this repeatedly mentioned.

 

Quick mental math on the 50 year table. Average annual increase of stock price for the first 25 years: 40%; second 25 years: 14%

[thefatbaboon]

Longinvestor, try not to be dimwitted. it must be one of the most erroneous comments in all of investing history that the the Intrinsic value of Berkshire 50 years ago was close to its book.

 

I could have bought Berkshire at TEN times book value in 1965 and still have beaten the market return by TEN fold.

[Guest longinvestor]

Longinvestor, try not to be dimwitted. it must be one of the most erroneous comments in all of investing history that the the Intrinsic value of Berkshire 50 years ago was close to its book.

 

I could have bought Berkshire at TEN times book value in 1965 and still have beaten the market return by TEN fold.

 

When making a statement, try not to use adjectives to describe those that oppose your pov. All I was pointing out is the rest of what he wrote, for context it is reproduced below.

 

It is not Buffett's style to predict whether BRK would beat the market return by 10x over the next 50 years. He states what is and has been and suggests to his shareholders when BRK is undervalued (or overvalued). There is no error at all in his statement, it is always about that point in time. Also, who knows, one can believe that by buying BRK at 1.2x BV today and still beat the market return by 10x over the next 50. We'll only know in 2065 if that was correct or not. 

 

From the 2014 letter:

With that in mind, we have added a new set of data – the historical record of Berkshire’s stock price – to the performance table on the facing page. Market prices, let me stress, have their limitations in the short term. Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. Charlie Munger, Berkshire Vice Chairman and my partner, and I believe that has been true at Berkshire: In our view, the increase in Berkshire’s per-share intrinsic value over the past 50 years is roughly equal to the 1,826,163% gain in market price of the company’s shares

 

and from the 2015 letter:

During the first half of those years, Berkshire’s net worth was roughly equal to the number that really counts: the intrinsic value of the business. The similarity of the two figures existed then because most of our resources were deployed in marketable securities that were regularly revalued to their quoted prices (less the tax that would be incurred if they were to be sold). In Wall Street parlance, our balance sheet was then in very large part “marked to market.”

By the early 1990s, however, our focus had changed to the outright ownership of businesses, a shift that diminished the relevance of balance-sheet figures. That disconnect occurred because the accounting rules that apply to controlled companies are materially different from those used in valuing marketable securities. The carrying value of the “losers” we own is written down, but “winners” are never revalued upwards.

We’ve had experience with both outcomes: I’ve made some dumb purchases, and the amount I paid for the economic goodwill of those companies was later written off, a move that reduced Berkshire’s book value. We’ve also had some winners – a few of them very big – but have not written those up by a penny.

Over time, this asymmetrical accounting treatment (with which we agree) necessarily widens the gap between intrinsic value and book value. Today, the large – and growing – unrecorded gains at our “winners” make it clear that Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value. At that level, purchases would instantly and meaningfully increase per-share intrinsic value for Berkshire’s continuing shareholders.

The unrecorded increase in the value of our owned businesses explains why Berkshire’s aggregate marketvalue gain – tabulated on the facing page – materially exceeds our book-value gain. The two indicators vary erratically over short periods. Last year, for example, book-value performance was superior. Over time, however, market-value gains should continue their historical tendency to exceed gains in book value.

 

 

 

[thefatbaboon]

I feel I'm arguing with someone about whether 2+2 = 4. To my mind it isn't a point of view.

 

How can you straight faced say that Berkshire IV in 1965 was close to book? What do you understand by intrinsic value?

[coc]

I believe Buffett sees the concept of intrinsic value as what's "there now" -- in other words, almost all of Berkshire's value in 1965 was "on the come." Buffett built that value through an interesting program of capital allocation, but it wasn't there in 1965. And if it isn't "there," I don't think Buffett includes it in his calculation of intrinsic value. If he had sold BRK in 1965, the whole company, it would probably have fetched book value +/- some small amount.

 

With that said, he has mentioned in past letters that there are three buckets of value at Berkshire.

 

(1) Investments

(2) Operating earnings

(3) Value of reallocated earnings

 

He calls (3) a "qualitative" variable. I believe what he means is -- how much do you want to overpay versus today's intrinsic value to get the benefit of his capital allocation?

 

Charlie also used to state the intrinsic value of Wesco (using the words "intrinsic value") as its liquidating value plus a portion of the value of its deferred taxes on unrealized stock gains (because they're paid back at some indefinite future time). He didn't add a premium for his skills that would add value "on the come." If Wesco stock was above this value, he made sure to point out that the stock was above intrinsic value.

 

So I don't think it's incompatible to say BRK was trading about its value in 1965, and yet you'd reasonably have chosen to overpay, or even fairly pay, to get the possibility of Warren doing interesting things. Saying BRK was worth 10x book in 1965 is really not how Buffett or Munger would see it. If they had sold BRK to someone else, it wouldn't have sold for 10x book, and maybe not even book. The business wasn't worth that. The guys in charge added all that value. It wasn't at all clear in 1965 what would happen.

 

Similarly, I don't think it's fair or smart to take Wal-Mart's market cap today, discount it by 10% per annum back to 1968, and then say the business was worth $3 billion at a time when Walton had $12 million in sales and was earning $500,000 after-tax. That's crazy and would lead to a lot of mistakes. The concept of intrinsic value should be a tool to serve your craft, not a mathematical holy writ.

 

I use this same framework to look at most businesses, and I find it valuable to separate those two buckets (value today vs value on the come) so I am clear on what I'm buying.

 

Hope that helps some. 

[KCLarkin]

I know it's not popular right now, but Platform Value is real. I think it's fair to say that BRK's intrinsic value was 1.x book in 1965. And WEB has created enormous value since then.

[thefatbaboon]

I didn't mean to imply that I didn't understand why he uses a liquidation type IV. But I think it is a mistake. Obviously the mathematic approach reverse engineering shouldn't be viewed as a holy writ. But Three elements are far more important than ratios to book value. 1. Time. 2. right jockeys 3. right assets. Whether Berkshire was bought "cheap" at say 0.8 or "expensive" at say 2, pales into total insignificance in comparison. 

 

Most investors need to spend much more time pondering this.  I'm only trying to be helpful. And I find it strange because it would really help Buffett get his usual "buy and hold" message across. Historically anyone intending to own Berkshire for the long term should have paid absolutely zero attention to book value multiple.

 

Now coming back to today and to the three elements...I control time, the assets are above average, and I think the Buffett managers are also above average. I'd therefore argue that The intrinsic value to book value multiple in the usual range between 1 and 2 times is totally irrelevant. As in zero relevance.

 

 

 

 

 

[coc]

I didn't mean to imply that I didn't understand why he uses a liquidation type IV. But I think it is a mistake. Obviously the mathematic approach reverse engineering shouldn't be viewed as a holy writ. But Three elements are far more important than ratios to book value. 1. Time. 2. right jockeys 3. right assets. Whether Berkshire was bought "cheap" at say 0.8 or "expensive" at say 2, pales into total insignificance in comparison. 

 

Most investors need to spend much more time pondering this.  I'm only trying to be helpful. And I find it strange because it would really help Buffett get his usual "buy and hold" message across. Historically anyone intending to own Berkshire for the long term should have paid absolutely zero attention to book value multiple.

 

Now coming back to today and to the three elements...I control time, the assets are above average, and I think the Buffett managers are also above average. I'd therefore argue that The intrinsic value to book value multiple in the usual range between 1 and 2 times is totally irrelevant. As in zero relevance.

 

The reason I think this is wrong is that you're looking at a historical process in hindsight. There is a huge, huge difference looking forward: History looks clear but it's a fog going forward. At any point, Buffett could have died, the insurance companies could have had a major fraud, the markets could have done something wacky that would have made it hard to redeploy capital, Buffett could have made a mistake, and on and on. If you had paid 4x book value, there were a number of things that could have wiped out a lot of your investment.

 

This is whole reason for the margin of safety principle, and why Buffett doesn't encourage people to think the way you're saying. In hindsight, yes, it was clearly the right decision to almost "pay any price" for Buffett up until about 1998. But in the moment, that would have been a mistake. Buffett only goes as far as to say "A dollar of retained earnings in the hands of Sam Walton was worth far more than in the hands of the then-managers of Sears Roebuck." So you're right, but only to an extent.

 

To give you a concrete counter-example, many investors in Fairfax Financial did exactly what you're talking about in the late 1990's -- they saw an extremely valuable and successful team compounding earnings like crazy and bid up the stock to 3-5x book value, far above any reasonable intrinsic value in the "point in time" sense. The argument went, I'm sure that it was worth it to "pay any price" for a team as good as Prem Watsa & Co., because even if they slowed down a bit, they were still pretty small and could continue compounding fast.

 

Then the company made a bunch of unforced errors. The stock went from 3-5x book to half of book value, and today sits at a modest premium. You would have had to withstand a major, emotion-testing reversal of business fortune (the price didn't just drop due to irrationality, although maybe it went too low at the bottom ticks) -- and even now, your return would be pretty mediocre for the period.

 

Which is all to say, while no reasonable person could disagree that you'd ascribe more value to the right jockeys and right assets than otherwise, the future is foggy and the best defense I can see is to use tools that leave me with some margin for error.

 

Thanks for the discussion - again hope to be helpful.

[KCLarkin]

I didn't mean to imply that I didn't understand why he uses a liquidation type IV. But I think it is a mistake. Obviously the mathematic approach reverse engineering shouldn't be viewed as a holy writ. But Three elements are far more important than ratios to book value. 1. Time. 2. right jockeys 3. right assets. Whether Berkshire was bought "cheap" at say 0.8 or "expensive" at say 2, pales into total insignificance in comparison. 

 

Most investors need to spend much more time pondering this.  I'm only trying to be helpful. And I find it strange because it would really help Buffett get his usual "buy and hold" message across. Historically anyone intending to own Berkshire for the long term should have paid absolutely zero attention to book value multiple.

 

Now coming back to today and to the three elements...I control time, the assets are above average, and I think the Buffett managers are also above average. I'd therefore argue that The intrinsic value to book value multiple in the usual range between 1 and 2 times is totally irrelevant. As in zero relevance.

 

To rephrase this, most investors overemphasize current earnings (or value) and underestimate how future earnings are allocated. $10B cash in the hands of Buffett are worth much more than $10B in the hands of Ballmer.

[Mephistopheles]

If you say IV in 1965 was well above 10x BV, then the inverse must be true too. For example, Lehman's IV in the 1870s was 0, as it was in all other years, and any non zero estimate of IV would be wrong.

 

I don't think it works like that. IV changes as the facts change, sometimes dramatically. It wouldn't be at all reasonable to assume, in 1965, that Berkshire would have such a magnificent success as it has. Yes, it would be in a range of possibilities, but that's a wide range.

 

And the reason for the growth since 65 was purely because of the CEO, not because of some intrinsic quality of the business. Buffett could have gotten hit by a bus in 66, and then paying 10x would have been silly.

 

Huge range of possibilities.