2017 YE intrinsic value versus Market Value

[Guest longinvestor]

With the run up, some of these thoughts are surely swirling.

 

Chime in.

[SlowAppreciation]

$197/share (current price)

• $66/share stocks
  
• $36/share cash (after taking out $20b for dry powder)
  
• $12/share KHC (marked to market)
  
• $11/share fixed income
  
• $1/share Pfds/Warrants
  

= $127/share book - $10/share deferred tax (new rate)

= $117/share book

 

$197 - $117 = value of operating businesses

$81 = value of operating businesses

 

2016 Earnings operating businesses earned $8.50, so implied multiple on the operating businesses is 9.5x. This seems low, and I think it deserves a higher multiple, which in and of itself would give us a ~15% discount to current prices.

 

Then factor in if you think BRK will benefit further from lower taxes not just at their operating businesses, but also with their stock holdings. AAPL, WFC, BAC, AXP in particular will benefit. And then do you think the portfolio has more room to run? Berkshire's stock portfolio trades at 19x earnings, whereas the S&P is at 25. Maybe this says more about the market's valuation than Berkshire's, but I certainly wouldn't say Berkshire's stock portfolio is overvalued.

 

So let's call it $220/share - $240/share.

[Dynamic]

I answered 'materially undervalued 10-30%'

 

But that depends on the implied forward return when priced at IV. To me that implied forward return is maybe 7-10% without a great deal of near term downside protection.

 

So even though I think that IV is more than 11% over current market price of $195-$200 per B share, I'm reluctant to buy or to sell at the current price, a price that reasonably well accounts for the expected tax cuts.

[scorpioncapital]

 

 

 

So let's call it $220/share - $240/share.

 

And nothing says in a bull market you can't trade at 2x IV or $440 to $480 per share. Although that's not something you are counting on. But an overshoot is also possible.

 

[Dynamic]

I'd say a large overshoot of IV is possible in many companies, but unlikely to reach 2xIV nowadays in the case of Berkshire given Buffett and Munger's stated intention that they would seek to discourage extreme undervaluation or overvaluation so that incoming/outgoing shareholders do not benefit disproportionately from the misfortune of their counterpart in the trade. I think

 

Nonetheless there's a wide enough trading range to really load up when it's cheap and to lighten up when it's more fully valued. In my case, I last bought just under $125 (Feb 2016, which was <1.25x last reported BV at the time, and later turned out to be <1.2x BV at year end) but I sold a good chunk at a somewhat undervalued $140 (May 2016) to load up on Apple, which was extremely cheap at $95 at the time.

 

I'd have needed a much higher price to sell Berkshire and hold the cash, and so far that hasn't happened (except for a temporary need to 'demonstrate I had £X cash available to be withdrawn' for a one-off purpose a few years ago, which required me to sell a lot of my shares and show it had been in my account and available for withdrawal for a specified period, then I was able to buy back later).

 

If I had used borrowed money such as a mortgage extension to buy extra Berkshire (which I've not done yet but might consider in future at prices <1.3xBV) then I might be tempted to sell to cash at 1.55-1.60xBV to pay off the loan or lock in gains, depending on circumstances due to the different risk profile.

[frankyt81]

Warren Buffet said in the last AGM that he thinks he can compound IV for the next 10 years in the 10% range, if interest rates rise a bit.

 

https://youtu.be/Pwdph0qVb4Q?t=1h11m52s

 

Under this assumption you can get a 10% compounder for 10-20% discount. Not too bad in today's environment.

[rolling]

Berkshire 2 column intrinsic value has been coumpounding at around 9,5% a year. Without tax change that is the return to be expected on that estimate. With the tax change that number might increase to about 10,5-11%. If you use such an high discount rate berkshire is trading around fair value. However berkshire is safer than many bonds: widely diversified, loads of cash available, conservative capital alocation. In addition, since it does not pay dividends the coupons are automatically reinvested without tax payment.

 

So it is an high grade, tax efficient, coumpounding long term bond. As such the discount rate should be the same you would use for an equally safe bond. That might be around 4%. A discount rate of 6% would be conservative in current environment for such a bond. As such intrinsic value is way higher than current value.

[Guest longinvestor]

Berkshire 2 column intrinsic value has been coumpounding at around 9,5% a year. Without tax change that is the return to be expected on that estimate. With the tax change that number might increase to about 10,5-11%. If you use such an high discount rate berkshire is trading around fair value. However berkshire is safer than many bonds: widely diversified, loads of cash available, conservative capital alocation. In addition, since it does not pay dividends the coupons are automatically reinvested without tax payment.

 

So it is an high grade, tax efficient, coumpounding long term bond. As such the discount rate should be the same you would use for an equally safe bond. That might be around 4%. A discount rate of 6% would be conservative in current environment for such a bond. As such intrinsic value is way higher than current value.

4 to 6% discount rate, I agree with. IV is way over as you point out. Why, imo, there is a buyback threshold at all. We live in times where they're not able to pull off the buyback. A time will come when they might well be able to.

[frankyt81]

I meant with 10-20% discount the margin of safety to IV, not a discount rate.

[StubbleJumper]

Warren Buffet said in the last AGM that he thinks he can compound IV for the next 10 years in the 10% range, if interest rates rise a bit.

 

https://youtu.be/Pwdph0qVb4Q?t=1h11m52s

 

Under this assumption you can get a 10% compounder for 10-20% discount. Not too bad in today's environment.

 

 

He talked about still managing berkie in 10 years?  There's a high likelihood that he'll need to communicate his management and investment decisions with the aid of a Ouija Board...

[DooDiligence]

Warren Buffet said in the last AGM that he thinks he can compound IV for the next 10 years in the 10% range, if interest rates rise a bit.

 

https://youtu.be/Pwdph0qVb4Q?t=1h11m52s

 

Under this assumption you can get a 10% compounder for 10-20% discount. Not too bad in today's environment.

 

 

He talked about still managing berkie in 10 years?  There's a high likelihood that he'll need to communicate his management and investment decisions with the aid of a Ouija Board...

 

It'd be cool if he left a set of 10 envelopes labeled by year to be opened by T & T & whoever on New Years day with instructions / predictions written with fortune cookie / horoscopic accuracy.

 

These metaphorical Ouiji boards would then be presented at annual meetings!

 

Here's to hoping this is all a long ways off (mainly because I just like the guy...)

[Dynamic]

It'd be fun, though if it's only as accurate as a fortune cookie or a horoscope, it would be nothing more than fun Barnum statements and certainly not useful like the wisdom in his shareholder letters. I'm sure he could do better! The best fortune cookie I ever had read "Help! I'm trapped in a fortune cookie factory"

[Guest longinvestor]

Wow, tough crowd. From the comments, it appears to me that folks don't take 5 minutes to watch the video clip referred. Buffett said none of these things. Buffett was very hesitant to put out a projection. In fact, this question about what the IV growth was, over the past10 years, stumped him a bit. probably 10% was the best he could come up with. He clearly doesn't want to get into putting IV numbers out. The only specific number that he did put out was from the 2014 AR,  1,826163% growth in market value over50 years as roughly being the IV growth also.

 

 

[Dynamic]

That YouTube clip is worth revisiting.

 

Warren was pretty clear that it would be tough to hit 10% if interest rates remained as they were in May 2017 (i.e. practically zero short term, and I guess less than 3% long term from vague memory). Maybe 10% over the next 10 years if interest rates were a little higher (but not dramatically higher). Since then we've heard that rates are likely to be eased upwards over time, though they could easily plummet again if there's another economic bust.

 

The question after at 1:18 is relevant now with the latest US tax bill going through government. Tax savings at the utilities would pass direct to the customers, which is only right, as we're allowed an after tax return on equity and if taxes were raised we'd be compensated for that. Unrealised gains in securities would accrue to us directly. Other businesses - to some extent the savings get competed away, and to some extent it does not. It's certain that some would be competed away and some would flow to shareholders and it's very industry-specific whether it's competed out and to what extent.

[SlowAppreciation]

Warren Buffet said in the last AGM that he thinks he can compound IV for the next 10 years in the 10% range, if interest rates rise a bit.

 

https://youtu.be/Pwdph0qVb4Q?t=1h11m52s

 

Under this assumption you can get a 10% compounder for 10-20% discount. Not too bad in today's environment.

 

Yep, I think this is fair. ~11-13% CAGR moving forward for a very stable company that in some respects I'm more comfortable owning today than a S&P500 index fund.

[Valuehalla]

I voted for undervalued, because:

 

Bookvalue at end of Q3 was 308,257 B, which is 124,957 $ per B share (not KHC adjusted)

 

Q4 till yearend, anticipated taxreform will come true:

Operative gains less tax (conservative estimation)                              = app.  4,00 B

Portfolio gains (till today!) of more than 10 B less 20 % def. tax          = app.  8,00 B

KHC adj. MV 25,55B-15,3B=10,25B less 20% def. tax                        =        8,20 B

Taxreform: reduction of app. 86B def. taxliabilities end of Q3              = app. 37,00 B

 

leads to a bookvalue estimanted in total: 365,457 B (KHC adjusted) =  148,144 $ per B share

leads to a bookvalue estimated in total: 357,257 B (not adjusted) = 144,82 $ per B share

 

So this means Friday closing price of 196,44$ is just 32,6 % above BV (KHC adjusted)

 

197 $ is a bargain price, if taxreform will come true !

 

(even if not anticipated a big investment of 100B cash in near future it is a bargain)

[sleepydragon]

$197/share (current price)

• $66/share stocks
  
• $36/share cash (after taking out $20b for dry powder)
  
• $12/share KHC (marked to market)
  
• $11/share fixed income
  
• $1/share Pfds/Warrants
  

= $127/share book - $10/share deferred tax (new rate)

= $117/share book

 

$197 - $117 = value of operating businesses

$81 = value of operating businesses

 

2016 Earnings operating businesses earned $8.50, so implied multiple on the operating businesses is 9.5x. This seems low, and I think it deserves a higher multiple, which in and of itself would give us a ~15% discount to current prices.

 

Then factor in if you think BRK will benefit further from lower taxes not just at their operating businesses, but also with their stock holdings. AAPL, WFC, BAC, AXP in particular will benefit. And then do you think the portfolio has more room to run? Berkshire's stock portfolio trades at 19x earnings, whereas the S&P is at 25. Maybe this says more about the market's valuation than Berkshire's, but I certainly wouldn't say Berkshire's stock portfolio is overvalued.

 

So let's call it $220/share - $240/share.

 

UNP is trading at 22 pe. So I give 20 PE to the 8.5 earning, this is a $300 stock price.

[LC]

Why would you apply UNP's multiple to the entirety of Berkshire's operating earnings?

 

My guess it that UNP's multiple would only be applicable to BNSF's operating earnings.

[sleepydragon]

Why would you apply UNP's multiple to the entirety of Berkshire's operating earnings?

 

My guess it that UNP's multiple would only be applicable to BNSF's operating earnings.

 

I am just saying 20 seems a reasonable PE (compared to S&P500's current pe)

[LC]

Why would you apply UNP's multiple to the entirety of Berkshire's operating earnings?

 

My guess it that UNP's multiple would only be applicable to BNSF's operating earnings.

 

I am just saying 20 seems a reasonable PE (compared to S&P500's current pe)

Ah ok I misunderstood you.

 

I generally agree- I don't know if 20 is the right multiple but I think in today's environment that 9.5x is probably too low

[Dynamic]

Yep, I think this is fair. ~11-13% CAGR moving forward for a very stable company that in some respects I'm more comfortable owning today than a S&P500 index fund.

 

Just thinking through sanity-checking that estimate, re-evaluating BRK.B and deciding if it's worth investing more today...

 

First, looking in the rear-view mirror.

In my case, my original purchase at $49.71 (post-split equivalent price) on 15th July 2003 has compounded at 10.01% CAGR to $196.44.

 

Book Value per B share has gone from a split-adjusted $30.662 in 2003Q2 to $124.95 in 2017Q3 (i.e. 14.25 years, so CAGR = 10.36%), before adjusting for tax changes potentially inflating BVPS, but perhaps having a smaller effect on inflating IV.

 

If, as Valuehalla suggests, the tax changes and mark-to-market adjustments cause BVPS to reach about $148.14 per B share, let's say by year end, it changes the growth in BV to 4.83x in 14.5 years, or 11.48% CAGR, helped by this one-time boost and the generally good rate of compounding.

 

I paid 1.62x BV just after 2003Q2, and it's now at 1.57x BV without adjusting for the tax changes that might be coming. I'd normally not be too keen to pay that price nowadays, aiming to wait for a bigger margin of safety. However, this thread is helping me re-evaluate and adjust my thinking for the current circumstances.

 

In the intervening 14+ years we've had one sizeable financial crisis that presented some rich pickings for Berkshire among temporarily distressed companies, where we'd expect it to do especially well. We've seen a lot of whole company acquisitions and plenty of capital spending at utilities with a reasonable but regulated return on equity, and we've seen float and earnings grow at a good clip too.

 

For reference S&P500 Total Return (SP500TR) has risen 3.57x (or 9.23% CAGR) over the same period. In Aug 2003, Shiller P/E was 24.64, and in Nov 2017 it was 31.29. So I'd imagine the S&P500 has benefited slightly from an upward multiple re-rating over that period, while BRK.B is similarly rated, yet the S&P500 still trailed BRK.B's return slightly, showing the value of the robust growth in fundamentals at BRK.

 

Looking forward in the long term

In my concentrated retirement portfolio I'm certainly not nervous about retaining my 55% BRK.B weighting at 1.6xBVPS, feeling more comfortable in BRK than S&P500. It's the only company I'm happy to hold above 50% weighting (in fact I'd be happy to go to 100% or a little more at a real bargain price e.g. <1.3x BVPS).

 

I would probably revise ValueHalla's figure for my own use and say that I could reasonably anticipate 9%-13% CAGR for BRK.B (or perhaps I should rephrase that as not expecting more than 7-10% CAGR above inflation and for inflation to be in the 2-3% range) from a starting point of Friday's closing price of $196.44.

 

That seems like a decent return over the long term 10-15 year horizon, with a fairly high certainty attached to it, and it will still allow me value-trading opportunities to boost my compound return when I see other quality companies trading at large discounts to IV with decent prospects of re-rating.

 

I prefer to use real-terms figures rather than predict inflation, and I project our potential retirement date and draw-down using a 3.5% real rate of return (based on my 'low-end' portfolio valuation, which is typically below market price and based on a low-ball estimate for each stock's value derived from fundamentals) and 3.5% average draw-down (again as percentage of the low-end valuation, not market valuation) to produce a certain income (adjusted upwards by CPI inflation index from a figure we set in 2015 currency) without reducing the real value of our portfolio (until we have unusually large expenses, perhaps medical or care expenses towards the end of our lives). In practice, I intend to keep a cash buffer to avoid drawing down heavily during severely depressed markets and further reduce the small chance of suffering a reducing income during retirement.

 

Shorter term outlook - likely price-action and potential opportunity cost over next 12-18 months

Assuming the tax bill is passed, I can really see reported BVPS reaching $145 to $150 per BRK.B either at 2017YE or 2018Q1. This does indicate that BRK.B is likely to have a soft price floor at 1.2x BVPS of around $174-$180 pretty soon, though a market crash could plausibly see the price fall 10-20% below such a soft floor if the mark-to-market prices of securities held fall sharply and the mark-to-market component of BV falls with it.

 

Within a year of sound business growth at Berkshire, I could quite easily envisage the BVPS being around $160-$165 (around 10% above ValueHalla's estimate if the tax cut goes through) and the soft price floor of 1.2xBVPS being around $192-$198. If this is true, it would imply there's little downside risk over about a 1-year horizon, short of a market crash, which I'd see as a positive to BRK's long-term value that we can ride out.

 

We started today with just over 10% cash in our portfolio and we're saving heavily, adding cash at about 8% of our current portfolio valuation each year, about two thirds of which is straight cash and one third since a couple of months ago is a cash/employer European style option scheme that can be exercised in late 2022. The latter will see us save at about 14% of our current portfolio value over 5 years (ending 2022), and it cannot be worth less than the cash saved and could be cashed out at our discretion for the cash saved in the event of a market crash or other source of deep value high certainty opportunities.

 

I've just invested substantially all of our cash position in BRK.B at an average price of about $196.69 (£147.19 GBP after commissions) bringing our BRK holding to about 65% portfolio weighting and our cash to <0.1%.

 

Downside risk appraisal:

Most likely, I think our downside risk on this purchase in the next year is about 8-12% unless the tax bill fails to be brought into law (perhaps <5% chance of the bill failing, in which case maybe it's 25-30% short term downside, and gradually reducing this downside as BVPS should most probably rise by 10% CAGR organically). In about 12-15 months' time assuming the tax bill passed plus 10% 'organic growth' in BVPS and IV (beyond the effects of the one-off tax cut), I'd imagine the 'soft floor' of 1.2x BVPS will have reached about our $196 buy price and should typically continue to increase at about 10% per year in typical years. I imagine the tax cut will (with >85% probability) stimulate the economy enough to stave off a market crash for at least another 18 months, but we may well have a market crash at any time between about 18 months and 8 years from now (I cannot guess when, but some time between mid 2019 and late 2025 seems quite plausible, given the typical frequency of such things). In the event of a crash, the mark-to-market element of BV may fall enough to see us dip below 1.2x last-reported BV, then to see reported BV drop accordingly in the next quarter. I'd expect to see Berkshire deploying cash wisely and in large quantities and coming out of the crash stronger than they went in.

 

[Valuehalla]

Great post Dynamic

 

IMO there are probably two one-time events that will boost the market-price heavily in near future:

 

1) Tax-reform as calculated above, will drive Bookvalue BV one time

 

2) Big Elephant acquisition (maybe 150 B?) , which will drive Intrinsic value IV one time, or in other words the percentage the IV is above BV. WEB said that over time the gap between IV and BV will grow. That is because of the simple fact that aquisitions which belongs 100 % to BRK will drive the BRK grows by generating earnings and not by generating higher marketprices for BV.

 

So IMO its also likely that BRK management will increase the factor of x 1.2 over BV for buybacks maybe to x 1.3 soon.

 

The reasons why the preformance of BRK is just little better than S&P 500 in last time, is because there was no elephant and we sit on the cash.

 

I am also more than 50 % in BRK, full invested. The function to keep cash is outsourced to BRK in my case

 

[Jurgis]

I doubt that BRK return will be more than 10% annual for next 10 years. JMO though.

[Valuehalla]

Jurgis, i agree in that way, that BRK intrinsic value will increase app 10 % or a little more during next 10 years in average. Could be 15 % as well. But will not be below 7.

 

But that doesnt mean that we will not get 25 % higher market price during next 6 month. The valuation is cheap now.

 

 

 

[Jurgis]

I have no opinion about BRK price in next 6 months.

 

Best  8)