WEB's annual letter

[Mephistopheles]

Put it another way - say someone offered 10x or even 5x or 3x BV to Buffett in 65, I'm sure he would have gladly sold out...

[Jurgis]

People who think that BRK was worth 10x book value in 1965 should buy their favorite platform company at 2x today and hold forever.

 

2x for PSH anyone?  8)

 

 

No, seriously, I'm only partially sarcastic. If you believe in the jockey a lot, you could assign them a lot of value and buy their platform for 2x or 3x or whatever. Personally, I don't have confidence in any jockey to do that, although I think some of my purchases (FRMO, PRDGF, etc.) may look as if I do.

[merkhet]

I think the problem is that intrinsic value might be high in 1965 with hindsight, but the company at the outset still has to earn that intrinsic value over time.

[Jurgis]

Yes, also for mutual-fund-like companies (like PSH and perhaps old BRK), there is a question why would you pay more than 1x the value of market-traded-investments. People pretty much laughed at Ackman when he suggested that PSH should trade at 2x. Perhaps they did not like the jockey though. ;)

[merkhet]

Yes, also for mutual-fund-like companies (like PSH and perhaps old BRK), there is a question why would you pay more than 1x the value of market-traded-investments. People pretty much laughed at Ackman when he suggested that PSH should trade at 2x. Perhaps they did not like the jockey though. ;)

 

Value is a funny term though. Do you meant market value or intrinsic value? Because I could make a good argument for intrinsic value being higher than market value for a number of stocks. (Jeez, I hope I can -- otherwise, we're all in the wrong business...)

[Jurgis]

Yes, also for mutual-fund-like companies (like PSH and perhaps old BRK), there is a question why would you pay more than 1x the value of market-traded-investments. People pretty much laughed at Ackman when he suggested that PSH should trade at 2x. Perhaps they did not like the jockey though. ;)

 

Value is a funny term though. Do you meant market value or intrinsic value? Because I could make a good argument for intrinsic value being higher than market value for a number of stocks. (Jeez, I hope I can -- otherwise, we're all in the wrong business...)

 

I meant 2x book.

 

I know that there's a good argument for paying for the jockey and buying a mutual-fund-alike (sans redemptions) for 2x book.

And yet, would you?

[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.

 

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.

 

I agree when we talk about 5 times or 10 times. This is dangerous stuff because one is paying for quite a few years "up front" so to speak.  And as you point out jockeys are mortal, and even the best assets are not invulnerable.  But within the usual range? 1.1, 1.3, 1.8 times BV?  I think this is a painfully false precision when one has studied and developed conviction in the three elements.  The variation between the top of the range and the bottom is not an accurate reflection of risk of death, fraud etc. For the long term investor the margin of safety is nearly the same at 1 times book as 2 times book.

 

Buffett has encouraged this nitpicking.  And of course he has his reasons. As you point out many platforms, people and assets have over the years undeservingly been ascribed high multiples. But on the flip side the mathematics of compound interest are not properly appreciated. Neither broadly in society nor even among the value investing community. It's always mentioned sort of as an aside. Of course everyone can do the arithmetic. But it has a brutal power and we should, like Einstein, honor it as the eighth wonder of the world.

 

Instead we protect ourselves with various liquidation-type valuations as if our investment outcomes were going to be measured after a year or two and plus or minus 20% was the defining factor.  But for all the young people starting out the real risk towering over all others is not participating. 

[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.

 

I agree when we talk about 5 times or 10 times. This is dangerous stuff because one is paying for quite a few years "up front" so to speak.  And as you point out jockeys are mortal, and even the best assets are not invulnerable.  But within the usual range? 1.1, 1.3, 1.8 times BV?  I think this is a painfully false precision when one has studied and developed conviction in the three elements.  The variation between the top of the range and the bottom is not an accurate reflection of risk of death, fraud etc. For the long term investor the margin of safety is nearly the same at 1 times book as 2 times book.

 

Buffett has encouraged this nitpicking.  And of course he has his reasons. As you point out many platforms, people and assets have over the years undeservingly been ascribed high multiples. But on the flip side the mathematics of compound interest are not properly appreciated. Neither broadly in society nor even among the value investing community. It's always mentioned sort of as an aside. Of course everyone can do the arithmetic. But it has a brutal power and we should, like Einstein, honor it as the eighth wonder of the world.

 

Instead we protect ourselves with various liquidation-type valuations as if our investment outcomes were going to be measured after a year or two and plus or minus 20% was the defining factor.  But for all the young people starting out the real risk towering over all others is not participating.

 

I think you're getting at the "art" of the whole thing, which is, at what point am I not nitpicking, but overpaying? 1.5x book? 2x book? 3x book? At some point, we have to bring everything into the realm of numbers. And it will differ from business to business and even at different parts of the lifetime of the same business.

 

2x Book value for Berkshire versus 1x will make an enormous difference to your return 15 years from now, because the company's size dictates that it doesn't compound as fast any more. (Let's say BV is $450 per B share in 15 years. If it trades at book value then, buying at book value today gives you a 10% per annum return. Buying at twice book value gives you a 5% per annum return. Big difference!) But this was less true 30 years ago.

 

Where we wholeheartedly agree is that, if you've got the right opportunity, trying to time the multiple down to the last tenth of a point is a mistake. For sure.

 

[thefatbaboon]

Coc,

 

I think pretty much everyone agrees that tenths are irrelevant and that a top opportunity such as a young Buffett must be seized. But I think I'm trying to say something more than that. let's take your example but imagine an investing lifetime instead of 15 years.

Say book per b is 105 today. Say it grows at 10% for 49 years. That's 7 doubles. So book goes to 13,120. In the "steal" scenario we pay book and make 10%. In the "grossly overpay" scenario we pay 2 times book and make about 9%.

i would therefore argue that 1x or 2x book should be rendered irrelevant over an investors lifetime.

It is this kind of long term compounding effect that I was trying to get at in my previous comment.

[coc]

Coc,

 

I think pretty much everyone agrees that tenths are irrelevant and that a top opportunity such as a young Buffett must be seized. But I think I'm trying to say something more than that. let's take your example but imagine an investing lifetime instead of 15 years.

Say book per b is 105 today. Say it grows at 10% for 49 years. That's 7 doubles. So book goes to 13,120. In the "steal" scenario we pay book and make 10%. In the "grossly overpay" scenario we pay 2 times book and make about 9%.

i would therefore argue that 1x or 2x book should be rendered irrelevant over an investors lifetime.

It is this kind of long term compounding effect that I was trying to get at in my previous comment.

 

I know what you're trying to get at, but I've done a poor job so far making two important points:

 

(1) The law of large numbers has forged an anchor for a business like Berkshire (and many others). In your scenario, Berkshire would be worth $36 trillion in 2065. That's a multiple of the size of the current US economy. Do you consider that likely? If not, I think we need to be a lot more sensitive to price paid because Berkshire simply can't compound quickly anymore. The numbers are too big. Thus, I don't think it's fair to negate the price-sensitive argument by simply pushing out the timeframe.

 

(2) By assuming the future is inevitably bright, and I think too bright, you are still are not considering the concept of margin of safety. The point about price sensitivity is that the future is filled with a lot of sharks. Going from $350 billion to $36 trillion in one adult lifetime is something I'd be careful to assume.

 

[writser]

Coc,

 

I think pretty much everyone agrees that tenths are irrelevant and that a top opportunity such as a young Buffett must be seized. But I think I'm trying to say something more than that. let's take your example but imagine an investing lifetime instead of 15 years.

Say book per b is 105 today. Say it grows at 10% for 49 years. That's 7 doubles. So book goes to 13,120. In the "steal" scenario we pay book and make 10%. In the "grossly overpay" scenario we pay 2 times book and make about 9%.

i would therefore argue that 1x or 2x book should be rendered irrelevant over an investors lifetime.

It is this kind of long term compounding effect that I was trying to get at in my previous comment.

 

Agreed, but you make an implicit assumption that you can identify which company will grow 10% p.a. for half a decade. However, suppose you identified Valeant as the next great compounder and  bought it at 10x book (extreme example). If it turns out it is actually a fad you will lose a lot of money. Money that you can't compound anymore during the next 49 years. Compounding works both ways - hence the often heard Buffett quote about rule #1 and rule #2.

 

Buying at a cheap multiple is not as much about trying to squeeze out an additional 1% p.a. if you are correct - it is insurance for when things don't go as planned. If you lose 60% your first year and compound at 10% for the next 49 years you are worse off than when you compound for 8% p.a. without the initial loss.

[thefatbaboon]

 

I don't know if Berkshire grows to that level or not. It sounds outlandish but then again us gdp in 1965 was 744bn. So a single company having a 700bn mkt cap would have sounded pretty wild to the hippies back then. Either way the point is not that important. What I'm trying to get across is that over long periods of time it is about rates of growth much more than it is about ratio to book value (within reason).  So use 7% if you prefer. That's 5 doubles over 50 years. Book goes to 3360. And if bought and sold at book that's 7%. And if bought at 2 book and sold at book that's 5.6%. I'd say that's not so terribly important. Further I'd point out that we've been looking at a abnormally wide range. If one just dealt with the range of the last few years there's a spread from 1.1 to 1.6.  Buying at either of these extremes would be irrelevant with 7% growth over 50 years.

 

And margin of safety...surely the maths clearly suggests that the main risk is to have missed the ride?  this decimal to book value stuff is just a silly kind of market timing wearing a different set of clothes. If someone likes Berkshires prospects and has a long term horizon they should just buy and pay no attention to where it is between 1.1 and 1.6 

I don't advocate buying anything at 10 times! Just looking at the range that Berkshire had always traded in between 1 and 2. Which people always make a big deal about (myself too at various points in my life!)

 

The risks to predicting growth into the future is of course real.  As a result I sometimes find it difficult to argue against getting 120% long the s&p as being the optimum investment strategy. Risk adjusted perhaps better than BRK or looking for new brks.

[coc]

 

I don't know if Berkshire grows to that level or not. It sounds outlandish but then again us gdp in 1965 was 744bn. So a single company having a 700bn mkt cap would have sounded pretty wild to the hippies back then. Either way the point is not that important. What I'm trying to get across is that over long periods of time it is about rates of growth much more than it is about ratio to book value (within reason).  So use 7% if you prefer. That's 5 doubles over 50 years. Book goes to 3360. And if bought and sold at book that's 7%. And if bought at 2 book and sold at book that's 5.6%. I'd say that's not so terribly important. Further I'd point out that we've been looking at a abnormally wide range. If one just dealt with the range of the last few years there's a spread from 1.1 to 1.6.  Buying at either of these extremes would be irrelevant with 7% growth over 50 years.

 

And margin of safety...surely the maths clearly suggests that the main risk is to have missed the ride?  this decimal to book value stuff is just a silly kind of market timing wearing a different set of clothes. If someone likes Berkshires prospects and has a long term horizon they should just buy and pay no attention to where it is between 1.1 and 1.6 

I don't advocate buying anything at 10 times! Just looking at the range that Berkshire had always traded in between 1 and 2. Which people always make a big deal about (myself too at various points in my life!)

 

The risks to predicting growth into the future is of course real.  As a result I sometimes find it difficult to argue against getting 120% long the s&p as being the optimum investment strategy. Risk adjusted perhaps better than BRK or looking for new brks.

 

I won't belabor my points, but two responses. (Although I agree with some of your general points.)

 

(1) The fact that the math suggest the biggest risk is missing it is because you're cherry-picking a successful company in hindsight. If you applied the "twice book value is just as good as once book value" mentality in general, on a go-forward basis, I think you'd find you wished you had more margin of safety in lots of situations that didn't work out as well as Berkshire. 

 

(2) The difference between 5.6% and 7% per annum over 50 years on a $50,000 investment is having $1.5 million versus $760,000. I would argue ending up with twice as much money is worth figuring out how to achieve.

 

Anyways, good discussion, thanks for your points.

[thefatbaboon]

 

I don't know if Berkshire grows to that level or not. It sounds outlandish but then again us gdp in 1965 was 744bn. So a single company having a 700bn mkt cap would have sounded pretty wild to the hippies back then. Either way the point is not that important. What I'm trying to get across is that over long periods of time it is about rates of growth much more than it is about ratio to book value (within reason).  So use 7% if you prefer. That's 5 doubles over 50 years. Book goes to 3360. And if bought and sold at book that's 7%. And if bought at 2 book and sold at book that's 5.6%. I'd say that's not so terribly important. Further I'd point out that we've been looking at a abnormally wide range. If one just dealt with the range of the last few years there's a spread from 1.1 to 1.6.  Buying at either of these extremes would be irrelevant with 7% growth over 50 years.

 

And margin of safety...surely the maths clearly suggests that the main risk is to have missed the ride?  this decimal to book value stuff is just a silly kind of market timing wearing a different set of clothes. If someone likes Berkshires prospects and has a long term horizon they should just buy and pay no attention to where it is between 1.1 and 1.6 

I don't advocate buying anything at 10 times! Just looking at the range that Berkshire had always traded in between 1 and 2. Which people always make a big deal about (myself too at various points in my life!)

 

The risks to predicting growth into the future is of course real.  As a result I sometimes find it difficult to argue against getting 120% long the s&p as being the optimum investment strategy. Risk adjusted perhaps better than BRK or looking for new brks.

 

I won't belabor my points, but two responses. (Although I agree with some of your general points.)

 

(1) The fact that the math suggest the biggest risk is missing it is because you're cherry-picking a successful company in hindsight. If you applied the "twice book value is just as good as once book value" mentality in general, on a go-forward basis, I think you'd find you wished you had more margin of safety in lots of situations that didn't work out as well as Berkshire. 

 

(2) The difference between 5.6% and 7% per annum over 50 years on a $50,000 investment is having $1.5 million versus $760,000. I would argue ending up with twice as much money is worth figuring out how to achieve.

 

Anyways, good discussion, thanks for your points.

 

1. I thought I'd just done it prospectively on brk using 7%  and the full range of the last few years from 1.1 to 1.6.  Dont think that is cherry picking in hindsight.

 

2. Of course it's nice to have made twice as much money! And I spend a lot of time figuring on how to add (or not lose) small increments. But the main thing is to have not missed the ride from 50,000 to 760,000. Missing that boat because one waited for 1.2 which never came. Or perhaps it took 10 years and a lost double to arrive. Defending against this risk is more important than the defence afforded by an extra 20% discount to BV for the lifelong investor.

 

Thank you too for the interesting ideas.

 

 

 

[thepupil]

 

But the main thing is to have not missed the ride from 50,000 to 760,000. Missing that boat because one waited for 1.2 which never came. Or perhaps it took 10 years and a lost double to arrive. Defending against this risk is more important than the defence afforded by an extra 20% discount to BV for the lifelong investor.

 

Thank you too for the interesting ideas.

 

agreed, but for most it probably isn't a question of "berkshire or cash" but rather a relative value assessment against other companies' stocks and bonds, right?

 

I mean is someone really out there saying "well i would invest 20% in berkshire, but since it's at 1.3X and not 1.2X, I'm going to sit on cash for the next 40 years". I doubt it.

 

the relative value proposition of berkshire, all else equal, is very different at 1.8X versus 1.3X (or 1X versus 2X).

 

I would think most people debating about what price to buy it at are not engaging in market timing, but are instead trying to assess relative risk / reward.

[Dynamic]

I've long been under the impression that great investors like Buffett are able to buy close to the bottom of the market not so much by TIMING but by more by PRICING.

 

I have a feeling an old article on fool.co.uk by TMFMayn might have clarified this.

 

The essence is that if you have a bunch of companies whose qualities you like (management, moat, consistent earnings, fair treatment of shareholders etc) then you can regularly reappraise their intrinsic value (by which I mean their conservatively appraised IV based on cautious assumptions) or some proxy measure appropriate to each company.

 

Then, you calculate how much of a discount to IV you require to buy the shares in a truly meaningful amount, which might vary given the qualities of the company and their prospects for reinvesting earnings (e.g. incremental ROE) to compound earnings over decades to come.

 

That might be a certain multiple of book value, a certain ratio for an insurer or financial company, or a certain earnings yield (inverse of P/E), Free Cash Flow yield or Dividend Yield (possibly averaged over a few years if earnings are lumpy) gives you your entry price.

 

There's a certain minimum hurdle such as initial earnings yield or 'coupon' even where Munger would say it's worth paying up for quality, and for good but not superb companies, a bigger discount would be necessary to achieve high returns.

 

For high quality companies like Coca Cola or American Express that might mean he needs to wait for a temporary mishap like New Coke or the Salad Oil Scandal, for others it might be in times of market or sector turmoil (e.g. the 70s oil crisis, 80's Black Friday, Sep 11 2001).

 

It doesn't mean the price won't fall further. I suspect it can involve a little bit of assessment and feeling for how low the shares typically trade to set the pricing rules for your brokers to build a position. For me, I can buy my entire portfolio in a single day through a discount broker without moving the market. For Berkshire, it has long required weeks or months of buying a good fraction of daily volume unless off market deals or preference shares/convertible warrants can be arranged.

 

It does occasionally mean that the price he chooses will not quite be reached and he might miss buying a Walmart, which thinkll call an error of omission.

 

Once you've narrowed your list to quality companies within your circle of competence, the bigger the discount you insist upon (given the qualities of the company), the bigger your return. Insisting on a discount at all also helps you to preserve capital and often get out of mistakes (companies whose problems weren't temporary after all) with most of your capital intact or even a modest profit.

 

Given that the future is murky and we can't invest with perfect foresight for how value will grow, I think a discount that adds  twenty percent to fifty percent to first year returns, is very valuable, especially if repeated every few years over a long investing career.

 

I feel personally that by aiming for PRICING the market rather than TIMING the market, I have significantly improved my returns on my most significant positions and preserved my capital for times when I needed it.

 

For example I bought Halma plc in the UK for about 136 GBX (about 8.4% earnings yield and about 3-4% dividend yield) in October 2011 and sold at about 808 GBX (about 3.6% earnings yield) in Feb 2016 to but BRK at about 124 USD (1.234x historic BV, estimated 1.2*BV for 4Q15), being a very passive investor over those years. (The switch decision was made easier by having it in a tax exempt account)

 

The earnings increase on HLMA was about 2.5-fold over 14.35 years or so (6.7% annualized). My total capital gain was almost 6-fold. And growing dividends added about 83% of my original purchase price.

 

Having realised 6.75x the purchase price in total cash returns, that annualizes to about 14.2% which is a worthwhile difference to me, over about the 8.5% total return from earnings growth plus dividends if I'd sold at a similar multiple to where if bought, especially in an environment of low inflation and modest growth.

 

Also if I needed the money, even at a low multiple like where I bought I'd have made a 8.5% annualized return and made about 3.25x my initial investment

 

The difference in multiple between buying and selling added about 5.7% to my annualized returns over 14.35 years.

 

In finding good companies like Halma in 2001 rather than incredible companies like Berkshire in 1965, I'm very glad to have bought at a price that gave me margin of safety and doubled my ultimate return.

 

No doubt I could have sold Halma earlier and bagged a much greater annualized return by investing in something else at a bigger discount to really aim for way above market returns, but I'm still happy that the bigger the discount, the greater the return (unless you require such a big discount that you never buy).

 

So aside from the semantics of how we define IV, buying at a discount to a conservative estimate of IV without rosy assumptions about the future makes sense.

[Guest longinvestor]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

[coc]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

Can you explain how Berkshire would be valued at $480-$680 billon? Thanks.

[Guest longinvestor]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

Can you explain how Berkshire would be valued at $480-$680 billon? Thanks.

 

Using two of the three pillars of IV

 

Portfolio=$160k;

+Earnings=$12k x 10 = $280K per A share (30% above today)

 

+Earnings=$12k x 12 = $304k per A share (50% above today)

 

Actually the multiple deserves to be much higher for a business that has grown earnings at a 23.4% clip for 50 years and this decade looks on pace for 15%+. In my mind, for the earnings multiple, comparables are premier conglomerates, DHR, ITW; They are selling at 18x. Berkshire is better in important ways than these two. (I am intimately familiar with DHR, worked there for a meaningful length of time) .

 

Some more IV to chew on (few want to go there); a factor of >1.0 for the third/qualitative pillar of IV needs to be included based on the historically disproportionate retention of earnings over the past 7 years, but we will let time tell if that was deserved or not. 1 dollar is being turned into 1+ dollars as we speak. So as to not double count, I think a higher multiple of earnings will cover that. (higher than what I used above).  I suspect that it will all show through the continuing earnings growth. Willing to wait for that.

 

At 1.2x BV buyback, Berkshire will be picking up roughly a 50 cent dollar. Surely this is what Buffett meant when he said he would be "delighted" to do so. He started his investing career routinely doing so, he could very well do that as he ends it.

 

[coc]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

Can you explain how Berkshire would be valued at $480-$680 billon? Thanks.

 

Using two of the three pillars of IV

 

Portfolio=$160k;

+Earnings=$12k x 10 = $280K per A share (30% above today)

 

+Earnings=$12k x 12 = $304k per A share (50% above today)

 

Actually the multiple deserves to be much higher for a business that has grown earnings at a 23.4% clip for 50 years and this decade looks on pace for 15%+. In my mind, for the earnings multiple, comparables are premier conglomerates, DHR, ITW; They are selling at 18x. Berkshire is better in important ways than these two. (I am intimately familiar with DHR, worked there for a meaningful length of time) .

 

Some more IV to chew on (few want to go there); a factor of >1.0 for the third/qualitative pillar of IV needs to be included based on the historically disproportionate retention of earnings over the past 7 years, but we will let time tell if that was deserved or not. 1 dollar is being turned into 1+ dollars as we speak. So as to not double count, I think a higher multiple of earnings will cover that. (higher than what I used above).  I suspect that it will all show through the continuing earnings growth. Willing to wait for that.

 

Thanks for your explanation. A few follow-ups.

 

(1) I would be careful not to equate "Berkshire is trading at a 30-50% discount to intrinsic value" with "intrinsic value is 30-50% higher than today's price" -- they are not the same. The first statement implies, as I said, that Berkshire is worth $480-$680 billion. The second statement implies (and I think is what you meant) that Berkshire is worth $440 billion - $510 billion, a far more reasonable range. (In my opinion.) Your second statement implies a 22-33% discount to intrinsic value.

 

(2) I have seen this "two column" analysis before but one part of it does not make sense to me: Why is that $260 billion investment portfolio considered all belonging to shareholders? It is encumbered in two important ways: Deferred taxes on gains in the equity portfolio ($25 billion) and, more importantly, $88 billion belongs to policyholders in the form of float.

 

You would correctly argue that both of these will be paid at some indeterminate future time, and thus shouldn't be counted 100% against the investments - and I would agree. That means the $113 billion of liabilities are worth somewhere between $0 and $113 billion. I'm not sure what the final figure should be, but I know it should be something. If you disagree, I would ask you: Would you rather own $260 billion of cash and securities with no liabilities against them or with $113 billion of liabilities against them? Yet I never see this deducted in the two-column analysis. Deducting $40-60 billion would lower your intrinsic value by $25K-35K per share.

 

(3) Berkshire's operating earnings figure is pre-tax, I think the multiples you're citing for DHR and ITW are after-tax. They both also have much lower tax rates than Berkshire, which hurts the apples-to-applies comparison. (Pre-tax earnings at ITW and DHR are more valuable in that sense.)

 

Berkshire has some great businesses in there for sure, but remember that to generate that 15% per annum growth, he's had to invest a tremendous amount of capital -- it's not happening organically. To double that earnings stream again will require a massive investment.  So I would find it hard to swallow an argument that values those businesses at much more than 12x pre-tax earnings, which is roughly 19x after-tax earnings. Most of them are earn good returns, but aren't growing a whole lot anymore.

 

(4) Regarding use of retained earnings, that could add a plus factor for sure, but I would argue that's partially captured already if you value Berkshire's businesses at a 12x multiple, moreso if you go higher. Looking at the metrics of the PCP deal for example, where Buffett had to pay 25x earnings or something in that neighborhood, tells me that BRK's operating earnings growth must slow pretty dramatically from 15%.

 

Thanks for the discussion, really helpful.

[Kiltacular]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

Can you explain how Berkshire would be valued at $480-$680 billon? Thanks.

 

Using two of the three pillars of IV

 

Portfolio=$160k;

+Earnings=$12k x 10 = $280K per A share (30% above today)

 

+Earnings=$12k x 12 = $304k per A share (50% above today)

 

Actually the multiple deserves to be much higher for a business that has grown earnings at a 23.4% clip for 50 years and this decade looks on pace for 15%+. In my mind, for the earnings multiple, comparables are premier conglomerates, DHR, ITW; They are selling at 18x. Berkshire is better in important ways than these two. (I am intimately familiar with DHR, worked there for a meaningful length of time) .

 

Some more IV to chew on (few want to go there); a factor of >1.0 for the third/qualitative pillar of IV needs to be included based on the historically disproportionate retention of earnings over the past 7 years, but we will let time tell if that was deserved or not. 1 dollar is being turned into 1+ dollars as we speak. So as to not double count, I think a higher multiple of earnings will cover that. (higher than what I used above).  I suspect that it will all show through the continuing earnings growth. Willing to wait for that.

 

Thanks for your explanation. A few follow-ups.

 

(1) I would be careful not to equate "Berkshire is trading at a 30-50% discount to intrinsic value" with "intrinsic value is 30-50% higher than today's price" -- they are not the same. The first statement implies, as I said, that Berkshire is worth $480-$680 billion. The second statement implies (and I think is what you meant) that Berkshire is worth $440 billion - $510 billion, a far more reasonable range. (In my opinion.) Your second statement implies a 22-33% discount to intrinsic value.

 

(2) I have seen this "two column" analysis before but one part of it does not make sense to me: Why is that $260 billion investment portfolio considered all belonging to shareholders? It is encumbered in two important ways: Deferred taxes on gains in the equity portfolio ($25 billion) and, more importantly, $88 billion belongs to policyholders in the form of float.

 

You would correctly argue that both of these will be paid at some indeterminate future time, and thus shouldn't be counted 100% against the investments - and I would agree. That means the $113 billion of liabilities are worth somewhere between $0 and $113 billion. I'm not sure what the final figure should be, but I know it should be something. If you disagree, I would ask you: Would you rather own $260 billion of cash and securities with no liabilities against them or with $113 billion of liabilities against them? Yet I never see this deducted in the two-column analysis. Deducting $40-60 billion would lower your intrinsic value by $25K-35K per share.

 

(3) Berkshire's operating earnings figure is pre-tax, I think the multiples you're citing for DHR and ITW are after-tax. They both also have much lower tax rates than Berkshire, which hurts the apples-to-applies comparison. (Pre-tax earnings at ITW and DHR are more valuable in that sense.)

 

Berkshire has some great businesses in there for sure, but remember that to generate that 15% per annum growth, he's had to invest a tremendous amount of capital -- it's not happening organically. To double that earnings stream again will require a massive investment.  So I would find it hard to swallow an argument that values those businesses at much more than 12x pre-tax earnings, which is roughly 19x after-tax earnings. Most of them are earn good returns, but aren't growing a whole lot anymore.

 

(4) Regarding use of retained earnings, that could add a plus factor for sure, but I would argue that's partially captured already if you value Berkshire's businesses at a 12x multiple, moreso if you go higher. Looking at the metrics of the PCP deal for example, where Buffett had to pay 25x earnings or something in that neighborhood, tells me that BRK's operating earnings growth must slow pretty dramatically from 15%.

 

Thanks for the discussion, really helpful.

 

This is a good discussion. 

 

On (1) -- Buffett has laid out the numbers as clearly as ever in this year's report.  It's probably worthwhile to spend some time considering how he tells us to evaluate Berkshire if for no other reason than someday he will be gone. Straight from the annual: Pre-tax earnings per share $12,304.  Put a 10x multiple on those for $123,040 of value per A share.  Investments per share: $159,794.  Fair value: $282,834. If you buy Berkshire at that price for an A Share, what would you expect to get as a CAGR in the following 10 years -- I'd guess Buffett would say about 7%.

 

On (2) -- If it doesn't make sense, you're arguing with the best investor ever explaining his "masterpiece" to you.  Buffett's method (prior to this year, where he finally tells the investor its okay to apply a multiple to the underwriting profits) gives only a relatively small value to the insurance operations and their "intrinsic" ability to add new float and to give ongoing underwriting profits.  Using Buffett's method if actually very conservative unless you think float is going to run off quickly.  In this year's letter he calls the insurance operations the best in the world -- why would he lie?  If you think he's right, his method of the two columns probably vastly understates the value of the insurance operations.  It isn't that complicated and probably undervalues Berkshire (based on what I would guess are Buffett's assumptions about the "3rd column".  As Munger would say, "your smart and Buffett's right -- figure it out."  Buffett has explained this for a long time...way back when Berkshire's deferred tax and float liabilities were much smaller...they've only grown...never been paid off -- was he right back then?  When can we say "yes"?

 

On (3) Berkshire's GAAP tax (and therefore the reported tax rate) don't come close to matching up with actual cash paid for taxes.  Make some adjustments and you'll see.  See the top of page 57 of the annual for cash paid for taxes versus "income tax" near bottom of page 38.  Cash paid for taxes hasn't exceeded 60% of GAAP reported tax expense in last 3 years.  How long does the deferral have to last before it has a high present value?...It isn't "on / off" and it isn't 100% of the deferral.  But, is it 80% or 5% -- because we can't know, it doesn't make sense to me just throw up our hands...what if we had this discussion 20 years ago...what was the present value of the deferred tax then?  This is like Buffett's example of float being a revolving fund. 

 

On (4) I feel that investors vastly overstate the value of a company's ability to create "organic" growth.  Berkshire's method proves how irrelevant that approach actually is.  The better question is why, if so many other companies have such terrific organic growth -- growth that comes without additional capital investment -- where is all the extra money going?  What aren't the financial statements capturing?  The excellent tech companies -- MSFT, GOOG, AAPL -- are counter examples...they throw off excess cash and it just builds on the balance sheet -- they are true organic growers.  But, they're also held back by the fact that they don't know what to do with the excess cash.  Berkshire has two solutions -- buy new businesses and invest in others via the stock market.

 

 

 

 

 

[Guest longinvestor]

The irony in this wordy thread is that reasonable estimates of BRK today has it selling at 30-50% discount to IV. While we are rueing missed opportunities in 1965.

 

Can you explain how Berkshire would be valued at $480-$680 billon? Thanks.

 

Using two of the three pillars of IV

 

Portfolio=$160k;

+Earnings=$12k x 10 = $280K per A share (30% above today)

 

+Earnings=$12k x 12 = $304k per A share (50% above today)

 

Actually the multiple deserves to be much higher for a business that has grown earnings at a 23.4% clip for 50 years and this decade looks on pace for 15%+. In my mind, for the earnings multiple, comparables are premier conglomerates, DHR, ITW; They are selling at 18x. Berkshire is better in important ways than these two. (I am intimately familiar with DHR, worked there for a meaningful length of time) .

 

Some more IV to chew on (few want to go there); a factor of >1.0 for the third/qualitative pillar of IV needs to be included based on the historically disproportionate retention of earnings over the past 7 years, but we will let time tell if that was deserved or not. 1 dollar is being turned into 1+ dollars as we speak. So as to not double count, I think a higher multiple of earnings will cover that. (higher than what I used above).  I suspect that it will all show through the continuing earnings growth. Willing to wait for that.

 

Thanks for your explanation. A few follow-ups.

 

(1) I would be careful not to equate "Berkshire is trading at a 30-50% discount to intrinsic value" with "intrinsic value is 30-50% higher than today's price" -- they are not the same. The first statement implies, as I said, that Berkshire is worth $480-$680 billion. The second statement implies (and I think is what you meant) that Berkshire is worth $440 billion - $510 billion, a far more reasonable range. (In my opinion.) Your second statement implies a 22-33% discount to intrinsic value.

 

(2) I have seen this "two column" analysis before but one part of it does not make sense to me: Why is that $260 billion investment portfolio considered all belonging to shareholders? It is encumbered in two important ways: Deferred taxes on gains in the equity portfolio ($25 billion) and, more importantly, $88 billion belongs to policyholders in the form of float.

 

You would correctly argue that both of these will be paid at some indeterminate future time, and thus shouldn't be counted 100% against the investments - and I would agree. That means the $113 billion of liabilities are worth somewhere between $0 and $113 billion. I'm not sure what the final figure should be, but I know it should be something. If you disagree, I would ask you: Would you rather own $260 billion of cash and securities with no liabilities against them or with $113 billion of liabilities against them? Yet I never see this deducted in the two-column analysis. Deducting $40-60 billion would lower your intrinsic value by $25K-35K per share.

 

(3) Berkshire's operating earnings figure is pre-tax, I think the multiples you're citing for DHR and ITW are after-tax. They both also have much lower tax rates than Berkshire, which hurts the apples-to-applies comparison. (Pre-tax earnings at ITW and DHR are more valuable in that sense.)

 

Berkshire has some great businesses in there for sure, but remember that to generate that 15% per annum growth, he's had to invest a tremendous amount of capital -- it's not happening organically. To double that earnings stream again will require a massive investment.  So I would find it hard to swallow an argument that values those businesses at much more than 12x pre-tax earnings, which is roughly 19x after-tax earnings. Most of them are earn good returns, but aren't growing a whole lot anymore.

 

(4) Regarding use of retained earnings, that could add a plus factor for sure, but I would argue that's partially captured already if you value Berkshire's businesses at a 12x multiple, moreso if you go higher. Looking at the metrics of the PCP deal for example, where Buffett had to pay 25x earnings or something in that neighborhood, tells me that BRK's operating earnings growth must slow pretty dramatically from 15%.

 

Thanks for the discussion, really helpful.

 

This is a good discussion. 

 

On (1) -- Buffett has laid out the numbers as clearly as ever in this year's report.  It's probably worthwhile to spend some time considering how he tells us to evaluate Berkshire if for no other reason than someday he will be gone. Straight from the annual: Pre-tax earnings per share $12,304.  Put a 10x multiple on those for $123,040 of value per A share.  Investments per share: $159,794.  Fair value: $282,834. If you buy Berkshire at that price for an A Share, what would you expect to get as a CAGR in the following 10 years -- I'd guess Buffett would say about 7%.

 

On (2) -- If it doesn't make sense, you're arguing with the best investor ever explaining his "masterpiece" to you.  Buffett's method (prior to this year, where he finally tells the investor its okay to apply a multiple to the underwriting profits) gives only a relatively small value to the insurance operations and their "intrinsic" ability to add new float and to give ongoing underwriting profits.  Using Buffett's method if actually very conservative unless you think float is going to run off quickly.  In this year's letter he calls the insurance operations the best in the world -- why would he lie?  If you think he's right, his method of the two columns probably vastly understates the value of the insurance operations.  It isn't that complicated and probably undervalues Berkshire (based on what I would guess are Buffett's assumptions about the "3rd column".  As Munger would say, "your smart and Buffett's right -- figure it out."  Buffett has explained this for a long time...way back when Berkshire's deferred tax and float liabilities were much smaller...they've only grown...never been paid off -- was he right back then?  When can we say "yes"?

 

On (3) Berkshire's GAAP tax (and therefore the reported tax rate) don't come close to matching up with actual cash paid for taxes.  Make some adjustments and you'll see.  See the top of page 57 of the annual for cash paid for taxes versus "income tax" near bottom of page 38.  Cash paid for taxes hasn't exceeded 60% of GAAP reported tax expense in last 3 years.  How long does the deferral have to last before it has a high present value?...It isn't "on / off" and it isn't 100% of the deferral.  But, is it 80% or 5% -- because we can't know, it doesn't make sense to me just throw up our hands...what if we had this discussion 20 years ago...what was the present value of the deferred tax then?  This is like Buffett's example of float being a revolving fund. 

 

On (4) I feel that investors vastly overstate the value of a company's ability to create "organic" growth.  Berkshire's method proves how irrelevant that approach actually is.  The better question is why, if so many other companies have such terrific organic growth -- growth that comes without additional capital investment -- where is all the extra money going?  What aren't the financial statements capturing?  The excellent tech companies -- MSFT, GOOG, AAPL -- are counter examples...they throw off excess cash and it just builds on the balance sheet -- they are true organic growers.  But, they're also held back by the fact that they don't know what to do with the excess cash. Berkshire has two solutions -- buy new businesses and invest in others via the stock market.

 

I agree with all of your points, notably taking Buffet's numbers as he states it. It is plenty conservative already.

 

On point 4 of yours, couldn't agree more. My comparables, DHR and ITW exactly fit your description. There is a huge false perception of their ability to create organic growth. DHR for ex. is hell bent on using inflated stock to buy growth; Berkshire does it mostly with cash, debt when appropriate and very seldom with stock. BRK's book is squeaky clean (& way understated) versus these. 

 

Berkshire has two solutions -- buy new businesses and invest in others via the stock market.

Besides the above, I went back and read your past post(2014?) on the pre- and post-2008 quality of the subs @ BRK. BNSF versus shoes and such!! This is a big deal.  IMO, a giant reset button was hit in 2008 @ BRK. The market has been really slow to catch on. I believe at the end of this decade the market will wake up to realize that earnings growth has not been materially different from the previous 4 decades. If this is indeed realized what the market would have also missed is that the earnings grew in a meaningfully different way as well...close to 80% of the capital deployed would've been done by someone other than Buffett. (I would chalk Todd C up for the PCP deal). MV/IV convergence and a yet-to-be-determined premium earnings multiple  would be natural outcomes.

[coc]

Thanks for your thoughts guys. After re-visiting some past information and thinking about what you said, I think you're right and I was wrong about the float. Following is from 2007:

 

Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $59 billion of our investments. This float is “free” as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur. Of course, insurance underwriting is volatile, swinging erratically between profits and losses. Over our entire history, however, we’ve been profitable, and I expect we will average breakeven results or better in the future. If we do that, our investments can be viewed as an unencumbered source of value for Berkshire shareholders.

 

So wrong there for me.

 

As for operating earnings, I get where you're coming from but I'm still not sure I have it straight in my head. I suspect somewhere if the railroad, utility, dealership, industrial businesses, candy shop and so on were aggregated and publicly traded, they'd be fairly valued in the 10-12x pre-tax range. In order for the earnings of the group to grow faster than they would independently -- 15%/year for example --  Berkshire HQ must allocate a lot of capital to add new businesses to them. So you can't value Berkshire's cash at 100c on the dollar and value its operating earnings at a premium without double-counting, no?

 

 

[james22]

let's take your example but imagine an investing lifetime instead of 15 years.

 

The time- and dollar-weighted investment horizon of a 25 year-old is only about 12 years.

 

http://media.pimco-global.com/pdfs/pdf/VP001-050107%20Better%20Glidepath.pdf