BRK-A book value and intrinsic value

[SlowAppreciation]

http://www.semperaugustus.com/2016-sai-letter--sympathy-for-the-dog-old-challenging-dogma-death-of-the-profit-margin-and-a-brief-berkshire-reduxpdf

 

Their letter last year was excellent, and I'd highly recommend reading it

[LongHaul]

A few contrary comments:

 

1. If Berkshire is worth more than book why isn't the book value per share growth greater than 10% while all earnings are retained?  The last 10 years were less.

 

2.  I very much disagree with the multiple of earnings plus investments.  I don't think it is that simple.

 

If there is an insurance company with $200m of assets, $100m of float and $100m of equity that makes $10m per year from underwriting after tax (10% ROE) why is that company worth the assets plus a multiple of earnings?  For my example this would be $200m + $100m (10x $10m) = $300m

 

My example is extreme but something to think about because BRK does require some cash and fixed income investments that earn lower returns.  In addition there are corporate taxes on everything.

 

3.  Brk is really big now. 

 

 

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]

Hi Longhaul, in the last 11 years (incl. 2006 till end of 2016) BV increase in avg 10,46%. This includes marketcrash 2008/9. Marketvalue in same time moves up with an avg of 11,7%

[John Hjorth]

Valuehalla,

 

Have you applied simple avarage calculation or Internal Rate of Return in your post?

 

 

 

 

[NeverLoseMoney]

This is from Berkshire's 2014 annual letter:

 

This cheery prediction comes, however, with an important caution: If an investor’s entry point into Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares have occasionally reached – it may well be many years before the investor can realize a profit. In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire is not exempt from this truth.

 

Buffett himself thought in 2014 that a price approaching 2x BV was "unusually high". Semper Augustus thinks that 1.8x BV is fair (using the figures from their "Two-Pronged Approach").

 

FWIW: I'm long Berkshire, but I've decreased my position recently. It looks reasonably valued to me.

[Valuehalla]

Hi John Hjorth, my figures above simple avg calculation: all single %-increases/decreases per year added and than divided by 11

 

Internal rate per B share:

BV 10,16 % p.a. increase over 11 years: beginning 2006 till end 2016

beginning of 2006 BV = 39,57 $; end of 2016 114,74 $ = 11 years, eleventh root of 289,9 % = 10,16 %

 

Correct?

[John Hjorth]

Hi John Hjorth, my figures above simple avg calculation: all single %-increases/decreases per year added and than divided by 11

 

Internal rate per B share:

BV 10,16 % p.a. increase over 11 years: beginning 2006 till end 2016

beginning of 2006 BV = 39,57 $; end of 2016 114,74 $ = 11 years, eleventh root of 289,9 % = 10,16 %

 

Correct?

 

I agree with you on your calculations and methology, Valuehalla,

 

My basis for calculation:

 

Progress numbers on the inside of the front cover of the 2016 Annual Report.

 

According to those figures USD 100.00 of book value year end 2015 has grown to USD 289.92 of book value at year end 2016. Putting that into the Excel IRR function gives you an IRR of 10.16 per cent over those specific 11 years.

 

Acid test:

 

Book value per A share end of year 2005: USD 59,377 [Annual report 2005, p. 55]

Book value per A share end of year 2016: USD 172,108 [Annual report 2016, p.32]

 

Putting those figures into Excel IRR function gives you an IRR of 10.153 per cent.

 

- - - o 0 o - - -

 

With regard to market price progress, I get an IRR of 9.63 per cent over those specific 11 years. [<- Important: Lower than per share book value progress!]

 

Please check you calculations.

 

[Valuehalla]

B share on 31.12.2005 = 59,08 $

B share on 31..12.2016 = 162,98 $

 

11 years internal rate = 9,66 % p.a.    ...so confirmed by my side for John H.

 

i agree: much upside potential  8) even to close the gap in grow-rates BV and MV

[LongHaul]

Book Value per share from 1/1/07 - 12/31/16 has grown at a CAGR (not a simple average) at 9.4%.

 

That is pretty good but not great.

 

Now Berkshire is bigger and buying Airlines.

 

I own Berkshire but have modest expectations at this point.

[John Hjorth]

B share on 31.12.2005 = 59,08 $

B share on 31..12.2016 = 162,98 $

 

11 years internal rate = 9,66 % p.a.    ...so confirmed by my side for John H.

 

i agree: much upside potential  8) even to close the gap in grow-rates BV and MV

 

Thanks, Valuehalla, and so far, so good. : - )

 

And: Yes, that's the real point here, as duly noted by you above: Within the last specific 11 calendar years, the gap between book value and market value has actually shrinked - not widened!

[John Hjorth]

Book Value per share from 1/1/07 - 12/31/16 has grown at a CAGR (not a simple average) at 9.4%.

 

That is pretty good but not great.

 

Now Berkshire is bigger and buying Airlines.

 

I own Berkshire but have modest expectations at this point.

 

Longhaul,

 

I don't like these airline investments either ... - but honestly: Does it really matter in the whole picture? - To me, this is just a pretty thing, -with a few freckles ... - and there will most likely be more of them as time goes by.

 

To me, over time, the balance sheet has become less and less relevant for valuation of this thing. Everybody on this board should by now know that by just reading the board, that there are material hidden values on both sides of the BRK balance sheet - some easy to quantify, others not.

 

This behemoth has been built by two extraordinary brilliant men, who have been practically all in in this investment the most of their adult life. It's built to generate cash - the more, the merrier - to do new aquisitions.

 

It's an enormous compounding machine. Period.

 

And it certainly - by no mean - has lost it's momentum.

 

Facts:

 

Cash flow from operating activities this century [uSD B]:

 

2000:      2.947

2001:      6.574

2002:    11.135

2003:      8.438

2004:      7.405

2005:      9.446

2006:    10.195

2007:    12.550

2008:    11.252

2009:    15.846

2010:    17.895

2011:    20.476

2012:    20.950

2013:    27.704

2014:    32.010

2015:    31.491

2016:    32.525

 

Total:  278.839 [<- ~USD 279 B!]

 

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I haven't checked - perhaps XOM to some extent can compete with this ... AAPL was most likely too young and too small at the beginning of the century to come even just close.

 

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Yes, all the cash and T-bills is a drag right now, also.

 

Somebody is just waiting for the next turmoil to arrive - spending the time having fun doing HBO stuff and the likes..."The market is down today, so my wife just gave me coins to my 1.89 breakfast at McD, not for my 3.21 breakfast" [or something like that] - Hilarious.

[Valuehalla]

John, could you pls add your source of the cashflow figures?

[Guest longinvestor]

Book Value per share from 1/1/07 - 12/31/16 has grown at a CAGR (not a simple average) at 9.4%.

 

That is pretty good but not great.

 

Now Berkshire is bigger and buying Airlines.

 

I own Berkshire but have modest expectations at this point.

 

Longhaul,

 

I don't like these airline investments either ... - but honestly: Does it really matter in the whole picture? - To me, this is just a pretty thing, -with a few freckles ... - and there will most likely be more of them as time goes by.

 

To me, over time, the balance sheet has become less and less relevant for valuation of this thing. Everybody on this board should by now know that by just reading the board, that there are material hidden values on both sides of the BRK balance sheet - some easy to quantify, others not.

 

This behemoth has been built by two extraordinary brilliant men, who have been practically all in in this investment the most of their adult life. It's built to generate cash - the more, the merrier - to do new aquisitions.

 

It's an enormous compounding machine. Period.

 

And it certainly - by no mean - has lost it's momentum.

 

Facts:

 

Cash flow from operating activities this century [uSD B]:

 

2000:      2.947

2001:      6.574

2002:    11.135

2003:      8.438

2004:      7.405

2005:      9.446

2006:    10.195

2007:    12.550

2008:    11.252

2009:    15.846

2010:    17.895

2011:    20.476

2012:    20.950

2013:    27.704

2014:    32.010

2015:    31.491

2016:    32.525

 

Total:  278.839 [<- ~USD 279 B!]

 

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C.f.

I haven't checked - perhaps XOM to some extent can compete with this ... AAPL was most likely too young and too small at the beginning of the century to come even just close.

interesting number. With a portion of that cash, they 've generated about $200 B of earnings so far and another $200B over the next decade. Buffett calls that "rabbits making rabbits!

[John Hjorth]

John, could you pls add your source of the cashflow figures?

Valuehalla,

 

The source is the Annual Reports on the BRK website. Just grab the 2016 Annual Report, and in the cash flow statement you find the figures for 2016, 2015 and 2014, then you grab the 2013 Annual Report, where you get the figure for 2013, 2012 and 2011, then on to the 2010 Annual Report for the next three years, and so on.

 

Please note that these figures are after taxes paid, i.e. not including deferred taxes expensed in the income statement.

 

Over time, I have found that studying the income statement [result of the capital allocation] including movements in  book equity, combined with study of the cash flow statement [the capital allocation] is more rewarding towards understanding what's going on in BRK. The balance sheet naturally matters still for details and certain posts in the balance sheet.

[Valuehalla]

Thx a lot !

[John Hjorth]

interesting number. With a portion of that cash, they 've generated about $200 B of earnings so far and another $200B over the next decade. Buffett calls that "rabbits making rabbits!

 

longinvestor,

 

It could be mice also - they are also extremely reproductive! I remember a post from you on this board about 1 - 2 years ago, where you posted - with reference to the BRK cash flow : "Just follow the money!" - In short: We are all "money dogs", with the nose in the track - for money!

 

1. I expect earnings and cash flow to stay relatively at this level [2016 level] untill next major aquisition makes a change,

2. Perhaps a major dent on the way forward short term related to Cat Insurance,

3. Economic consequenses of political US hot topics must be expected for BRK [Global trade, corporation taxes etc.] I have absolutely no clue where this will end up.

4. The possibility of a US or global recession. Again, I have no clue.

5. Nuclear event to destroy material value at BRK.  Again, I have no clue.

 

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Not much different from what I'm thinking about what else I've poured money into.

 

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You're welcome, Valuehalla.

[Guest longinvestor]

interesting number. With a portion of that cash, they 've generated about $200 B of earnings so far and another $200B over the next decade. Buffett calls that "rabbits making rabbits!

 

longinvestor,

 

It could be mice also - they are also extremely reproductive! I remember a post from you on this board about 1 - 2 years ago, where you posted - with reference to the BRK cash flow : "Just follow the money!" - In short: We are all "money dogs", with the nose in the track - for money!

 

1. I expect earnings and cash flow to stay relatively at this level [2016 level] untill next major aquisition makes a change,

2....

 

The $200b over next 10 years is based on flat earnings! And no further acquisitions.

 

But take a look at the consolidated earnings for swings. There are a couple that add up to about -$3B. Buffett tells us to ignore yoy changes. But I look at the doubling in earnings every 4 to 5 years since 1999.  ;)

 

 

[LC]

 

If there is an insurance company with $200m of assets, $100m of float and $100m of equity that makes $10m per year from underwriting after tax (10% ROE) why is that company worth the assets plus a multiple of earnings?  For my example this would be $200m + $100m (10x $10m) = $300m

 

 

Absolutely correct! I should have removed the "tied up" assets from the valuation...will lower the IV!

[Valuehalla]

It miss up some postings from me... something was canceled ?????

[John Hjorth]

Valuehalla,

 

The board has been down for some time [basically 1st April - 3rd April], and some posts have unfortunately been lost, unrecoverable. If you are able to, please just repost your post about your considerations about BRK IV, based on cash flow considerations.

 

I did not get the opportunity to reply to your post before the board went unavailable.

[John Hjorth]

Valuehalla,

 

I'm reluctant to new approaches for valuing Berkshire, for more than one reason:

 

1. Mr. Buffet him self has in several shareholder letters giving methodical overall guidance to shareholders about how to make own judgements about their investment.

2. There have never been any "promises" about the future of Berkshire, because there is no formal strategy as such - except for capital allocation and overall adaption to existing conditions in a broad sense. We do not even get any formal and structured short term [for the coming year or so] guidance. I'm not even sure of the existense of an internal budget consolidated at group level. Personally I do not think it exist.

 

What matters to me, is on running basis to have some kind of perception the relationship between book value per share, the soft buy back treshold, market price and intrinsic value based on already existing valuation methods for Berkshire. Here I'm talking about ranges for for each number, without trying to make it an exact science with calculation results with double underlining and x decimal places.

 

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Personally, I consider Berkshire a buy right now, compared to much else, under the recent market conditions. Right now I expect to buy a lot more going forward, which naturally might be subject to change.

 

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My earlier posts about the Berkshire cash flow was ment as comments about what has been discussed many times everywhere, also on this board: The drag on returns because of size.

 

Personally I think many investors underestimate the value going forward of two very special Bershire characteristics - in combination:

 

1. The enormous cash flow from operating activities,

 

combined with:

 

2. Outstanding capital allocation skills at the 4 persons taking care of that particular part of the whole business,

 

thereby making it possible to grow - without issuance of new shares.

 

rb posted about it yesterday in the topic "Anchor defensive holdings".

 

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On this board fellow board members has posted speculations about the next large Berkshire aquisition, including my own bablings and thoughts on this topic.

 

My point then was that there is today no privately held US company large enough to move the needle for Berkshire, that with a reasonable probability could be considered an volunteer aquisition target.

 

I looked on this side of the Atlantic also, based on advice from rb, especially Germany. I found out, that many of the large and good privately held German companies were controlled by foundations, who would likely never sell.

 

So to me, the next large Berkshire aquisition most likely will be a company today listed. That I do not expect to take place unless the price appears to be right for the Berkshire investment team. Most likely that will not happen before we are in the next material downturn.

 

Untill then I do not expect a material increase in cash flow from operating activities - it will be lumpy going forwards, in steps, combined with macro effects on that figure.

[Cigarbutt]

This is a follow-up related to the expected increasing divergence between reported book value and intrinsic value.

 

-In his annual report, Mr. Buffett seems to suggest that this ratio (IV/BV) will increase over time because of unrecognized goodwill related to profitable acquired subsidiaries. Maybe he meant that this has not been recognized fully yet. But his "new" emphasis on buying whole firms has been applicable since the early 1990's. I know that the market is not efficient. 25 years is a long time for value to be recognized. Isn't it? Even for the crowd?

 

-Some here seem to support that hypothesis.

 

-This premise has very real implications for BRK valuation and trigger to buy. (especially if one of your input, like BRK to buyback its shares, is the MKT/BV ratio)

 

So, for the quasi-autistics, I prepared an accounting exercise.

I work under the assumption that, long term, CAGR of MKT will approximate (gravitate to) CAGR IV.

My hypothesis is that the value of consolidated subsidiaries will be recognized over time in the books even if the inherent goodwill is not revalued up because the superior earning power of the sub will be recognized eventually at the parent level as retained earnings.

 

What you do with retained earnings is critical but that sub-question is dealt with in the second scenario below.

 

So, let's say we have two hypothetical firms with comparable assets valued on the books at 100 millions and having no liabilities. The ROE (=ROA in this case) is 10%. The two firms are allowed by the "Great Accounting Regulator" (GAR) to transfer on their books two identical sets of "superior" assets held privately (BV=50 millions). GAR, however, allows them to "recognize" the assets in a conservative way at 50 millions and no goodwill (the conservative recognizer, CR) OR in an aggressive way at 100 millions, assets (50) and GW (50) (the aggressive recognizer, AR).

For CR, the ROA (acquired tangible assets)=20% and for AR, the ROA (acquired tangible assets)=20% also.

I know the example is artificial but helps to answer the basic question perhaps. Controls: share count remains constant and no dividend.

 

-Scenario 1    Over time, earnings at the consolidated level are re-invested on a prorata basis back into the tangible assets.

 

Ratio of (reported BV CR)/(reported BV AR) = 0,75 at the beginning. (150/200)

Let's see what happens over time.

 

 

                  AR                                                                                CR

 

 

yr BVbeg NI BVend       yr BVbeg NI BVend               Ratio BV CR / BV AR

 

1 200  20         220               1              150          20            170                                0,77

2 220          22,67 242,67                       2              170          22,67        192,67                            0,79

3 242,67 25,69 268,36                       3              192,67      25,69        218,36                            0,81

4 268,36 29,11 297,47                       4              218,36      29,11        247,47                            0,83

10 512,72 61,70 574,12                       10            462,72      61,70        542,42                            0,91

15 915,19 115,36 1030,55       15            865,19      115,36      980,55                            0,95

 

 

-Scenario 2    Over time, earnings at the consolidated level is re-invested differently for CR (not based on a prorata of tangible assets)

  -for CR, consolidated earnings are re-invested preferentially in the "superior sub" ie all superior sub earnings are invested back in the superior sub.

  -for AR, keep scenario 1 assumption for re-invested earnings

 

Ratio of (reported BV CR)/(reported BV AR) = 0,75 at the beginning. (150/200)

Let's see what happens over time.

 

 

                  AR                                                                                CR

 

 

yr BVbeg NI BVend       yr BVbeg NI BVend               Ratio BV CR / BV AR

 

1 200  20         220               1              150          20            170                                0,77

2 220          22,67 242,67                       2              170          23            193                                0,80

3 242,67 25,69 268,36                       3              193          26,50        219,5                              0,82

4 268,36 29,11 297,47                       4              219,50      30,59        250,09                            0,84

10 512,72 61,70 574,12                       10            493,82      75,18        569,00                            0,99

15 915,19 115,36 1030,55      

 

Note: numbers not audited.

So what's the point?

 

Conclusions

For scenario 1, the "gap" between the two (AR and CR) will narrow and not widen. The conservative firm will eventually recognize the value of the superior sub through retained earnings even if the value is not recognized through an upward revaluation of goodwill at the sub level.

For scenario 2, if, like BRK, you have superior capital allocation skills, this gap will narrow even faster.

 

Corollary for BRK.

I think that the hypothesis of an expected gap or divergence of IV over reported BV based on this unrecognized goodwill recognition of superior subs has to be rejected.

 

I happen to think that BRK is a good buy at present level if you think long term. But I would dampen my expectations.

The key aspects going forward will reside (assuming margin of safety is preserved) in the capacity to make significant acquisitions at good/fair prices and in the capacity to maintain superior abilities in capital allocation. Not a given.

Given the size of BRK now though, I would submit that, long term, BRK return will tend to gravitate to the return of the market as a whole. That may still be a satisfactory outcome. But, long term, outsized returns are not to be expected. IMOHO.

Somehow, I wish I could have invested in BRK in 1965, but I was not born then. Now is a different story.

Good luck.

 

 

[John Hjorth]

Cigarbutt,

 

First off all, Berkaholics are quasi-autistics! - I like your humor.

 

I really need some time to think about the contents of your post. I'll get back to you here then.

[no_free_lunch]

Tilson has an updated IV presentation out.  He has them at $296k per A share, based on I believe year-end numbers.  So probably a bit higher now.

 

http://www.tilsonfunds.com/BRK.pdf

[SlowAppreciation]

I did a short BRK writeup on my blog http://www.slowappreciation.com/blog/2017/4/16/berkshire-hathaway-brkb for those who might be interested. Probably nothing too new or insightful for those here, as I try to write for a little bit of a wider audience, but thought I would share anyway.