BRK-A book value and intrinsic value

[shalab]

In the annual report - it mentions:

 

shareholder equity:  283,001 Billions

class A equivalent: 172,108 $/share

 

If including KHC 13.1 Billion and BAC Warrant Gains 10 Billion, the shareholder equity will be 306 B. The current price including these two looks undervalued to me.

 

Question: is the BAC gain reflected in book value/share or not?

 

 

 

[redskin]

BAC warrants are on the books at fair value.

[John Hjorth]

BAC warrants are on the books at fair value.

redskin,

 

What's your actual basis [Annual Report 2016] for posting this?

[redskin]

pg. 49 of annual report.

[aws]

BAC warrants are on the books at fair value.

redskin,

 

What's your actual basis [Annual Report 2016] for posting this?

 

The warrants are listed in as an other investment in note 5.  They are listed at fair value, and this amount is included in the insurance segment balance sheet.

 

Notes to Consolidated Financial Statements

(Continued)

(5)  Other investments

Other investments include preferred stock of Bank of America Corporation (“BAC”), warrants to purchase common stock of

BAC and preferred stock of Restaurant Brands International, Inc. (“RBI”) and in 2015 also included preferred stock of Wm.

Wrigley  Jr.  Company  (“Wrigley”)  and  The  Dow Chemical  Company (“Dow”). Other investments  are classified  as

available-for-sale and carried at fair value and are shown in our Consolidated Balance Sheets as follows (in millions

 

 

[John Hjorth]

Thanks a lot, redskin & aws,

 

That actually skipped my attention. The accounting treatment is actually material here.

[shalab]

Thanks guys - then the only adjustment is for KHC. 283 + 13 = 296B. So the IV is anywhere from 430B - 475B on 31st Dec 2016. Current market cap 419B. Another 20-24 B will hit the books by end of this year. (if there is no major cat issue or stock market crash). So we are looking at a book value of 315 - 320 B by end of the year. Using the usual multiples - the IV will be anywhere from 470B - 505B without considering acquisition of other businesses, appreciation of stock price in 2017 etc. One can look at 10-20% gains for this year.

 

If there is corporate tax reform or other changes - things should get even better.

 

Thanks a lot, redskin & aws,

 

That actually skipped my attention. The accounting treatment is actually material here.

[Valuehalla]

So if we adjust KHC by fair value,  the BV per B-share is 120,01 $ for 31.12.2016 ?

[John Hjorth]

So if we adjust KHC by fair value,  the BV per B-share is 120,01 $ for 31.12.2016 ?

Yes, Valuehalla. [i get 120.04, to be specific - immaterial diff].

[Guest longinvestor]

One more year of BRK selling for less than IV. May this go on until the day I retire! Please, Sir Market!! Until then, please direct everybody towards the FANG stocks.

[cubsfan]

One more year of BRK selling for less than IV. May this go on until the day I retire! Please, Sir Market!! Until then, please direct everybody towards the FANG stocks.

 

I'm with you!

[ValueMaven]

So the B shares are trading at 1.4x BV? 

 

What do you think they are trading at to IV? 

 

Sincerely,

ValueMaven

[John Hjorth]

ValueMaven,

 

Book value per share ["raw" - without adjustments] for B is : 172,108/1,500 = 114.74 [for reference, please see p. 34 in the 2016 AR]

 

Market price at Friday closing: 170.22, so it's trading at 1.48 x BV.

 

Soft buy back treshold : 137.69 [114.74 x 1.2].

 

So it's trading 23.6 per cent above soft buy back treshold. [[[[170.22 - 139.69]/137.69] *100] percent].

[ValueMaven]

Still seems fairly cheap to me...although, not the bargain price the stock offered us in early Jan/Feb of 2016!!

 

Sincerely,

ValueMaven

[Valuehalla]

Total BV 31.12.2016 = 283,001 B

 

Add to adjust KHC till 31.12.2016    13,1 B  for fairvalue

 

Add further till today (Jan+Feb):

 

Add for Investment gains app              8 B    (1,876 B for KHC incl.)

Add for Operative Jan+Feb app            3 B

 

TOTAL BV today                          307,101 B

 

This means BV per B share = 124,51 $ (KHC adjusted)

 

Folks pls comment, correct ?

 

If its correct 170,22 $ (B closing price Friday) is 36,7 % over (KHC adjusted) BV and seems very cheap to me.

 

ATTENTION: A friend of mine made the remark, that in this calculation deffered taxes are not embedded. True! But its a simplification and time is always on the side of the profitable companies. So I think BV was even higher on this day, because of the accumulation of Apple shares before 31th Jan, which was not know at this time.

[Guest longinvestor]

From the table of annual % changes in BV versus Market Value vs S&P, wanted to break out the average % change since 1990

 

These are simple averages

Last        BV            MV

3 years    8.47        12.63

5 year 10.43 13.78

10 year 9.68         10.37

15 year 10.87 9.66

20 year 12.32 12.26

25 year 15.74 16.85

 

Why 1990? WEB talks about the pivoting away from investments to wholly owned businesses since then.

 

BV growth rate is moderating down. MV rate is on the mend. Some recent divergence of MV from BV noticed. One would expect this trend to continue as they,

 

1) get bigger primarily through wholly owned businesses (earnings grow)

because of

2) the BV accounting treatment winners-never-marked-up, losers-instantly-marked-down

 

At some point in the future BV becomes meaningless. Why, imo, WEB included the MV in the performance table. And added that earnings + cap gains table this year.

 

I realize there's a lot more to this given the complexity of BRK (float etc.).

 

 

[Valuehalla]

THX for that aspect longinvestor. Seems logical to me. So we can expect a better performance of MV than BV. The gap between MV and BV shall increase over time.

 

Now the MV is app 1,4 above BV; end of 2007 is was 1,74 ... so much room to surge.

 

 

[Munger_Disciple]

The gap between MV and BV shall increase over time.

 

The gap between BV and intrinsic value (IV) will increase over time as Buffett pointed out in the AR. However % change in BV most likely will track % change in IV over the long term while the absolute difference between BV and IV will continue to grow. Thus % change in BV is still a good proxy for % change in IV. Assuming MV tracks IV over long periods of time, you can actually see this phenomenon at work in longinvestor's table. 

[Valuehalla]

Munger-Disciple I agree and see letter page 6:

 

"Charlie and I prefer to see Berkshire shares sell in a fairly narrow range around intrinsic value, ... "

 

so same same  :)

 

consequence: The gap between MV and BV shall increase over time.

 

[Guest longinvestor]

The gap between MV and BV shall increase over time.

 

The gap between BV and intrinsic value (IV) will increase over time as Buffett pointed out in the AR. However % change in BV most likely will track % change in IV over the long term while the absolute difference between BV and IV will continue to grow. Thus % change in BV is still a good proxy for % change in IV. Assuming MV tracks IV over long periods of time, you can actually see this phenomenon at work in longinvestor's table.

 

Estimating IV of BRK is fraught with uncertainty; assumptions needed makes it so.

 

MV and IV absolutely converge; over the very long term. In their 50th year letter, they clearly state this. The only catch with using MV is it is backward looking! I believe that the earnings growth as presented newly in this year's AR is a much better proxy for IV. But again, it takes us to using proper multiples etc. 

 

BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers. Why I say so: the absolute $ of retained earnings over the past 10 years is significantly different from their prior 40 years of existence. You can see this from the Shareholder's equity table (page 39); Current balance is $211,777; 2005:$47,717; So roughly 80% of all historical retained earnings have been retained in the last 10 (last 7 heavily); This marked non-linearity being played out surely adds to the BV distortion in the future, but I don't know exactly how; someone with a stronger accounting knowledge can weigh in. 

[Munger_Disciple]

MV and IV absolutely converge; over the very long term.

 

Of course, I agree. But year to year, MV varies wildly as evidenced by -12.5% return in 2015 and +23.4% in 2016 unlike intrinsic value. But over the very long term, they do converge as we can see from the table on page 2 of AR.

 

BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers.

 

I think % change in BV will continue to work as a proxy for % change in IV imo. If Berkshire has a loser that goes to 0, both BV and IV of the loser go 0.

[Guest longinvestor]

MV and IV absolutely converge; over the very long term.

 

Of course, I agree. But year to year, MV varies wildly as evidenced by -12.5% return in 2015 and +23.4% in 2016 unlike intrinsic value. But over the very long term, they do converge as we can see from the table on page 2 of AR.

 

BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers.

 

I think % change in BV will continue to work as a proxy for % change in IV imo. If Berkshire has a loser that goes to 0, both BV and IV of the loser go 0.

 

How about winners? If a winner goes up 20x purchased price, BV remains 1x; Geico is the example Buffett talks about. How about when Geico goes to 100x?

[Munger_Disciple]

How about winners?

 

In the case of winners as a whole, both the BV and IV increase. BV increases because of the reinvested earnings. IV increases due to the return on those reinvested earnings (in other words, earnings power of the entity increases). But the ratio of IV/BV remains fairly steady. If the return on incrementally reinvested earnings is above average, one dollar of added book value will increase IV by more than one dollar.

[Cigarbutt]

I’m new here and already ready to duel!

Sorry longinvestor and Valuehalla, I disagree here. In a way, this is a relatively minor point because, as value investors, we have to come up with a range of intrinsic values for an investment but a P/B ratio is useful and the way to come to « adjusted » ratios is important. Let’s dissect this. You seem to imply that, using BRK as a reference, P/B will significantly rise over time. Mr. Buffett’s comments seem to imply this also. He explains the disconnect between devaluations which need to be recognized and revaluations which are not, at the controlled subsidiary level.

True but, with all due respect,  I think that this « disconnect » or « overage » is much much smaller than is implied here.

Here’s my take. Apologies, I cannot be clear and concise like Munger_Disciple but I hope to improve.

For the « first half », it is said that book value approximated the value of marketable securities which were marked to market. Isn’t it common acceptance that Mr. Buffets holdings then were under-valued or at least fairly valued by the markets? My understanding is that Mr. Buffett’s record did not happen because of his tendency to buy and hold over-valued securities.  Implying then that the capacity to build a portfolio of undervalued securities warrants perhaps some kind of premium to BV. That notion points in the opposite direction of a « disconnect » for the « first half ».

More importantly though, the notion of goodwill (recognized or not) means that the earning power is superior to stated tangible book value. For the superior subsidiary itself, overtime, the gap between its book value and reported earnings clearly get « disconnected » and gets wider with time. See’s was a spectacular example of that. However, this unrecognized earning power, over time, will get recognized by the entity controlling the subsidiary, ie BRK. The extra cash is sent to the head office. Remember BRK’s  equity is largely retained earnings. They have not distributed dividends. They have never bought back stock at a high premium and when they issued stock, WB and CM always underlined that they aimed to issue at around fair value.  Of course, if you use this extra cash to buy other assets that are undervalued, there will be a tendency (especially if you pay less than IV) for the gap to grow, to some and limited extent, but, like a growing deferred depreciation liability, it will have an underlying tendency to reverse. I would submit also that, over time and perhaps especially for the more recent period, BRK purchased acquisitions by paying at least a moderate amount of goodwill/intangibles (think PCC, Duracell and others).

What are the numbers saying?

Let’s compare the CAGR (geometric) of BV vs IV for two periods :

The non « disconnect » period from 1965 to 1990      BV  23.1%    MV  28.7%

The « disconnect » period  from 1991 to 2016            BV  15.3%    MV  13.7%

The numbers suggest actually the opposite ie the disconnect, as recognized by the market for BRK shares, was more important when BRK was putting more emphasis on securities versus outright purchases. (!)

My take is that over time growth in BV for BRK should approximate closely growth in IV (as measured by the market or by more objective measures of IV over long periods of time). What Mr. Buffett describes is a very interesting concept and, at the margin, may create an unrecognized premium but, as the above reasoning and calculations above show, I submit that this effect is small and not significant for instance in relation to Mr. Market’s expectations.  In my humble opinion, the first 26 years were characterized by the Mr. Market’s recognition of the potential for BRK to continue to compound at a high rate, whereas, the last 26 years (especially since 2000) were characterized by lower expectations because, among others, of the sheer size that BRK reached.

With all due respect, I submit that, for BRK, it may not be reasonable to expect a widening gap between book value and price on a ratio basis.

It is interesting to note that, if this notion of a widening gap would apply, BRK’s policy of stock buyback at progressively  higher P/B ratios has never been documented or discussed.

                                   

 

[SlowAppreciation]

So I get around $290k/share for BRKA and $192/share for BRKB, which means BRK is still trading at ~13% discount to IV.

 

I just apply a 10x multiple on the operating businesses, though each group probably deserves a slightly different multiple.

 

Operating Earnings

• Underwriting: $2.1b
  
• BHE: $2.7b
  
• BNSF: $5.7b
  
• MSR: $8.4b
  
• Financial Product: $2b
  
• Total Operating Earnings: $21b @10x multiple = $210b
  

 

Cash & Investments

• Cash: $86.3b
  
• Investments: $120.4b
  
• Fixed Income: $23.8b
  
• Preferred/Warrants/KHC: $32.6b
  
• Total Investments: $263.3b
  

 

$210b + $263b = $473b

current Mkt cap = $420b

Discount to IV = 13%