2017 YE intrinsic value versus Market Value

[plato1976]

could you elaborate why?

 

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

[Dynamic]

could you elaborate why?

 

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

 

I'd be interested too, though I tend to agree that 10-11% is about the most I'd expect for the CAGR of IV (and BV other than the one-off boost from the tax bill). For me, that's sufficient long term return with high certainty, and the limited downside and the potential for decent compounding are the reasons I felt it was better than cash for the long term and provided essentially similar 'dry powder' for any huge bargain in the short term.

 

Even the last 14.25 years, with a deep recession and plenty of opportunism and big acquisitions has seen only 10.36% CAGR in Book Value (prior to any tax boost) but in an environment of low interest rates and low price inflation. I'm not complaining though - 10.36% over 14.25 years is 4.07x growth in total, which is very respectable, and repeated for another 14.25 years would exceed a 16-fold growth over 28.5 years.

[Dynamic]

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.

 

My intuition is that the tax cut provides a boost to BV that is higher (as a percentage) than the boost to IV, especially if some of the benefit does indeed pass back to the customers either by regulation (utilities) or by being competed away (e.g. in pursuit of market share).

 

So I'd imagine that the gap between BV and IV, having widened gradually over time, has suddenly narrowed slightly assuming the one-time tax cut comes into law.

 

For that reason I'd not expect the buy back threshold to be raised to 1.3x BVPS for at least a couple of years if not longer.

 

But my intuition may be wrong.

[Jurgis]

could you elaborate why?

 

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

 

I'd be interested too, though I tend to agree that 10-11% is about the most I'd expect for the CAGR of IV (and BV other than the one-off boost from the tax bill). For me, that's sufficient long term return with high certainty, and the limited downside and the potential for decent compounding are the reasons I felt it was better than cash for the long term and provided essentially similar 'dry powder' for any huge bargain in the short term.

 

Even the last 14.25 years, with a deep recession and plenty of opportunism and big acquisitions has seen only 10.36% CAGR in Book Value (prior to any tax boost) but in an environment of low interest rates and low price inflation. I'm not complaining though - 10.36% over 14.25 years is 4.07x growth in total, which is very respectable, and repeated for another 14.25 years would exceed a 16-fold growth over 28.5 years.

 

Dynamic already covered a lot of bases. Why would future returns from current P/B be higher than historical 10.X%?

I'll add couple more headwinds and considerations

- Size. It's getting more and more difficult to grow as the size increases.

- Competitiveness. Both Warren and Charlie are continuously talking about moat erosion and competitiveness across the the board (AXP, COST, etc.). I'll add even KO and KHC to this.

- Huge cash pile that is difficult to invest at great returns. (Contra argument: market will crash and then they will invest. Contra contra argument: see that 10.X% return even with crash in between).

- Soft insurance and reinsurance markets that may not change

- Elevated security prices of everything including stocks in BRK portfolio. (Contra argument: banks and AAPL may not be very expensive and may return more than 10% annualized for some time).

- Even at the great recession Buffett got BRK-only prefs at ~9% coupon. Considering that a once-a-huge-crisis opportunity, why and how future opportunities be better than that (so you could get to 10+% return)? (Contra argument: float is like leverage so 9% on that is levered return for the company.)

 

 

[gfp]

Even at the great recession Buffett got BRK-only prefs at ~9% coupon. Considering that a once-a-huge-crisis opportunity, why and how future opportunities be better than that (so you could get to 10+% return)? (Contra argument: float is like leverage so 9% on that is levered return for the company.)

 

Seems like the return on those great recession prefs was substantially above the 9-10% dividend yield.  They all included warrants - even the RBI preferred shares paid back today ($3.3 Billion cash coming to BRK today), came with penny warrants on QSR stock.

[plato1976]

wondering of anyone did a recent calculation of Berkshire's earning power (esp. with the tax reform factor counted in);

I actually think such a calculation helps valuation more than a pure book-value based approach.

 

Here is one that's almost 2 years old, which reached roughly 24B after tax real earning power:

http://www.nasdaq.com/article/berkshire-hathaway-estimating-earnings-power-cm568376

 

2 years later (and esp after the tax reform), the owner's earning looking forward must be much higher. My rough estimation is that we are trading at 15-16x, which is not expensive for such a quality company w/ 100B cash/cash equivalent... Welcome other detailed calculation from anyone who's interested in this topic

 

 

 

Even at the great recession Buffett got BRK-only prefs at ~9% coupon. Considering that a once-a-huge-crisis opportunity, why and how future opportunities be better than that (so you could get to 10+% return)? (Contra argument: float is like leverage so 9% on that is levered return for the company.)

 

Seems like the return on those great recession prefs was substantially above the 9-10% dividend yield.  They all included warrants - even the RBI preferred shares paid back today ($3.3 Billion cash coming to BRK today), came with penny warrants on QSR stock.

[Swedish_Compounder]

Normalized earning power after tax reform might be around 25 BUSD, assuming average investment gains of 3 BUSD.

 

To this comes undistributed earnings from the stock portfolio of can it be 6 BUSD

 

To this comes expected float increase of shall we estimate on average 7 BUSD the coming years.

 

So, my conclusion is that earning power including the cash flow effect from increased float is at least 38 BUSD at the moment.

 

 

[Dynamic]

Thanks for your opinion, Swedish_Compounder, and welcome to CoBF.

[Valuehalla]

******* UPDATED 30.12..2017******** sorry i made a mistake, now corrected

 

Estimation of Bookvalue for yearend 2017:

 

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

 

Q4 till yearend:

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

Portfolio gains (Q3 till Yearend) of estimated 12 B less 21 % def. tax                                    = app.  9,48 B

KHC adj. MV 25,32B-15,3B=10,02B less 21% def. tax                                                          =          7,92 B

Taxreform: reduction of app. 86B def. taxliabilities end of Q3 (now 21% instead of 35%)        = app.  34,4B

 

leads to a bookvalue estimanted in total: 364,057 B (KHC adjusted) =  147,576 $ per B share

leads to a bookvalue estimated in total: 356,137 B (not adjusted) = 144,366 $ per B share

 

So Friday 29th Dec closing price of 198,22 $ is 34,3 % above BV (KHC adjusted).

 

 

[Dynamic]

Estimation of Bookvalue for yearend 2017:

 

...

 

leads to a bookvalue estimated in total: 357,657 B (not adjusted) = 144,98 $ per B share

 

So Friday 29th Dec closing price of 199,56$ is 34,6 % above BV (KHC adjusted).

 

And on those assumptions the 'soft floor' at 1.2x unadjusted Book Value Per Share is expected to rise after about late Feb 2018 to $174 per BRK.B ($261,000 per BRK.A). Compared to today's price, that's 87% of today's price, so it should provide some reasonable downside protection against more than about a 13% decline.

 

If organic BV growth rate is 10% cagr over a further five quarters, BV would be 1.1265 x 2017YE BVPS, which would be around $163 at 2019Q1 (reported in May 2019). 1.2x BV would then be $196, meaning the soft floor would be around today's price.

 

That's only a projection, and the mark-to-market element of the equity holdings may materially affect the actual reported BV, but to me it looks like a pretty good bet that within 18 months the soft price floor will be around today's price. That sort of downside protection may fall somewhat (perhaps by 15-20%) in the event of a market crash, but nonetheless, I feel it's a better bet than cash and I recently spent our 10.5% cash position buying in at $196 before the tax cut was confirmed.

[Charlie]

Berkshire Hathaway Is Ending the Year With a Bang:

 

https://www.barrons.com/articles/berkshire-hathaway-is-ending-the-year-with-a-bang-1514299999

 

 

Cheers!  :)

 

 

[Guest longinvestor]

The topic of IV sooner rather than later, turns into a discussion about BV. Which is not very wrong currently but could well be over the next decade. Buffett says that he's focused on earnings per share. I look forward to that number for 2017. And the next decade.

[Swedish_Compounder]

Yes Longinvestor, this is very interesting, because Berkshires repurchase criteria is linked to book value, but Buffetts method for valuing Berskhire is not linked to book value, which he has stressed several times in recent years. However, this does not seem to have been understood by the masses and once the shift in perception comes, whenever it comes, it will lead to higher valuation.

 

Another potential for higher valuation comes from the fact that there are "hidden" earnings in the form av earnings retained by the stock portfolio investees, which are not included in Berkshires income statement. If they sell a large chunk of their shares to finance major acquisitions, I think this will also be positive for the Berkshire valuation, since those earnings are fully included in the income statement. 

 

In fact, I Believe Buffett is even more focused on cash flow per share than earnings per share. Thus, the increase in float is a contribution as important as the earnings. In below video  he elaborates on this subject.

 

https://www.youtube.com/watch?v=dssTPawSe-c

 

One thought experiment I have made is regarding how large repurchases Berkshire can make once they decide to pursue that course of action (which Munger has mentioned is likely to happen one day). Since they will after the tax act be less "punished" for Selling stocks when they are selling above their intrinsic value, I would say that the following would be a possibility if they started today and focused on repurchases for ten years (which they will not do now, but most likely one day once all earnings can not be profitably reinvested, perhaps 10-20 years into the future, perhaps earlier):

 

Starting Point assumptions, (current, under new tax rate):

- Cash generation including float increase of 32 BUSD

- Excess cash of BUSD 90

- Stock portfolio of at least BUSD 150 (after deducting deferred tax under the new tax rate)

- Assuming that the underlying business momentum and some smaller acquisitions lead to increased cash flow by 6% per year

- Assuming that the stock portfolio increases in value by 6% per year

- Market cap of BUSD 500

 

Under above assumptions, Berkshire could easily buy back 10% of the stock each year for ten years, if digging into their excess cash and trimming their equity holdings a bit. If assuming that the Berkshire stock goes up by 10% or so per year. That would lead to a reduction in share count by close to 66% and earnings would go up by 80%. Under these assumptions, earnings per share would go up by (1/0,9^10)*(1,06^10)= 414% increase or close to 18% annually compounded. We need to deduct some dividend income because of reduced equity holdings, but I still think we could see 16 - 17% compounded EPS growth.

 

This is of course just a though experiment, but one day I think something in that direction will happen and I think after running for some time it will fundamentally change the view of how the company is valued, partly because of the fact that implementation of such strategy would mean that the repurchase criteria can no longer be linked to P/B.

 

In fact, if there are enough shares for sale and the price of the stock does not go up too much, I think such a program could run for several decades and lead to market beating returns for a very long time. The Danish Insurance Company TopDanmark did this for 18 years and the result can be seen on the link below. Despite relatively poor development in profits, the share increased by 15,7% per annum for 18 years due to aggressive share buybacks.

 

https://valueandopportunity.com/2017/03/29/topdanmark-as-a-cannibal-soon-to-be-set-on-a-dividend-diet/

 

[Guest longinvestor]

Great post, Swedish_compounder. Buffett 's telegraphing of this metamorphosis underway is slowly being understood. You're absolutely correct that there will be the mother of all stock buybacks in the future.  I agree that it will be swallowing up a significant percentage of the shares out there. Buffett is loathe to taking this action but will make it really easy for the guy coming after him.

[Valuehalla]

Swedish Compounder , thanks for your post. Very interesting point of view on the future of BRK. Sounds great.

[Swedish_Compounder]

Thanks for your kind comments Valuehalla and Longinvestor. It feels great to have found a place with other ”Buffett nerds” after more than ten years on my own, without anyone to discuss my thaughts with and get new insights and angles from.

[Charlie]

https://finance.yahoo.com/news/berkshire-may-37-billion-book-190553392.html

 

"Barclays on Monday also raised its price target for Berkshire Class A shares to $357,000 from $322,500,

three weeks after the shares reached $300,000 for the first time. It raised its target for Berkshire Class B

shares to $238 from $215."

 

Berkshire has now a market cap of 500 billions.

 

Cheers!  :)