Buffett letter?

[jay21]

 

The easiest way (for me at least) is to watch/read the WEB interviews. People ask him why he bought Intel or GM and he will mention that they were not his purchases. This used to happen all the time with Lou's portfolio, BAC was a Lou position that people always asked Buffett about.

 

AFAIK these are the current holdings that WEB's picks. Anyone see any errors:

 

WFC

KO

IBM

PG

WMT

PSX

MCO

WPO

COST

MDLZ(kraft spin off)

KRFT

GCI

GE

USB

PSX(cop spin off)

COP

JNJ

 

Going off memory: MTB, USG, LEE, Media General, Verisk Analytics

 

Phillips 66 was dumped by Buffet I believe, and then Tedd and Tod both picked it up.

[Kiltacular]

Kiltacular,

 

The subtraction of goodwill is not inconsistent with Buffett's idea that the insurance businesses are worth more than they are carried for on Berkshire's books.

 

Goodwill (for the insurance businesses) = Price Berkshire was willing to pay for those businesses' float-generation capabilities

 

If you adjust book to reflect the economic value of float, then you must necessarily subtract goodwill so that you don't end up double-counting the value of the float.

 

Best,

Ragu

 

Hi Ragu,

 

Sometimes these types of conversations are difficult online.  With that said, I DO NOT think it is inconsistent with Buffett's commentary / explanation to subtract goodwill for the insurance businesses.

 

I was pointing out that it is VERY conservative if you believe Buffett when he explains that there is a lot of "economic goodwill" for the insurance companies -- at least w/r/t GEICO -- that IS NOT on Berkshire's consolidated balance sheet.

 

The goodwill that is on Berkshire's balance sheet related to the insurance companies is -- from memory -- mostly related to the purchase of General Re.  The goodwill represents the portion of the purchase price in excess of what can be allocated to the purchased assets once those assets that are indentifiable are written up to fair value.

 

What Buffett explained about GEICO in the letter I referenced was that there is a huge amount of "goodwill" that is not on Berkshire's balance sheet but would be if Berkshire "rebought" GEICO now (well, in 2010).

 

Subtracting the goodwill related to the insurance companies that is on Berkshire's balance sheet is very, very conservative if you believe Buffett about GEICO. And, GEICO's "economic goodwill" (what would be balance sheet goodwill if Berkshire rebought GEICO today on the same basis that it bought it when it did) is likely more related to GEICO's ability to produce enormous underwriting profits on premium volume than it is related to GEICO's ability to produce float.  Though, that is likely not true for the Gen Re purchase -- which was for the float (very long-tailed) -- and less for the underwriting profits.

 

Again, this is wordy and likely worthless.  The point is simply that subtracting the goodwill that is on the balance is very, very conservative IF you believe Buffett about GEICO.

 

My 2 cents.

[ragu]

The point is simply that subtracting the goodwill that is on the balance is very, very conservative IF you believe Buffett about GEICO.

 

Kiltacular,

 

IMO, this has very little to do with conservatism and all to do with assigning a value to Berkshire's float. If you assign a value to Berkshire's float and adjust Berkshire's BV upwards accordingly, then you must subtract goodwill.

 

Why? Because they represent the same thing i.e. the value of the float, only at different points of time (goodwill: at the time of acquisition, estimate of the value of float on the books: current).

 

It's the estimation of the value of the float that will take care of the discrepancy between goodwill on the books and current economic value. If the estimate is reasonable, then that number will be larger, likely significantly larger, than the goodwill on the books. 

 

Best,

Ragu

 

[Kiltacular]

IMO, this has very little to do with conservatism and all to do with assigning a value to Berkshire's float. If you assign a value to Berkshire's float and adjust Berkshire's BV upwards accordingly, then you must subtract goodwill.

 

Why? Because they represent the same thing i.e. the value of the float, only at different points of time (goodwill: at the time of acquisition, estimate of the value of float on the books: current).

 

It's the estimation of the value of the float that will take care of the discrepancy between goodwill on the books and current economic value. If the estimate is reasonable, then that number will be larger, likely significantly larger, than the goodwill on the books.

 

Hi Ragu,

 

I see how you're looking at it -- well explained.  But, what you say is true if Berkshire simply always writes a combined ratio of 100.  No underwriting losses but also, no underwriting profits.

 

But, I would add, again, that in the case of GEICO, the discrepancy you describe is not just attributable to GEICO's float. 

 

So, while I would agree with you that if we're just talking about valuing Berkshire's float, you are correct, I was adding the idea in my original comment that, even if you subtract the goodwill on the books associated with the insurance companies, it isn't insane to think that this is conservative (and I'll amend that with) if you consider that the value of GEICO [if not the other insurance operations] is not just its existing float and its future float but also its ability to create massive underwriting profits.

 

So, if you assume that GEICO will produce large and growing underwriting profits for a long time and that the rest of Berkshire's insurance operations will write at breakeven, I would still argue that you are not double-counting if you write up Berkshire's books for the unrecorded value of GEICO's goodwill even if you subtract the rest of the goodwill associated with the insurance operations that are recorded on Berkshire's books (as Buffett suggests should be done in this year's letter).

 

Does this make any sense?  I may still be double counting it but I don't think I am if the conditions I describe are met.

 

 

[ragu]

Kiltacular,

 

Firstly, thank you for the kind words.

 

 

[...]even if you subtract the goodwill on the books associated with the insurance companies, it isn't insane to think that this is conservative (and I'll amend that with) if you consider that the value of GEICO [if not the other insurance operations] is not just its existing float and its future float but also its ability to create massive underwriting profits.

 

Setting aside the question of whether it is appropriate (or even useful) to add a separate measure of value for GEICO's u/w profits,  I'd suggest that any measure of said value is completely independent of the goodwill paid in acquiring GEICO, because these two measures aren't like for like.

 

Does this make any sense?

 

My understanding is that you believe that adding back an estimate for the value of float still causes the insurance operations to be undervalued because u/w profits are essentially being ignored. Buffett disagrees with the notion that u/w profits ought to be capitalized, although he seems to ignore both float and deferred taxes entirely when coming up with a value for the insurance operations.

 

From the 2008 letter (in the section titled 'Yardsticks'):

 

Berkshire has two major areas of value. The first is our investments: stocks, bonds and cash equivalents. At yearend those totaled $122 billion (not counting the investments held by our finance and utility operations, which we assign to our second bucket of value). About $58.5 billion of that total is funded by our insurance float.

 

Berkshire’s second component of value is earnings that come from sources other than investments and insurance. These earnings are delivered by our 67 non-insurance companies, itemized on page 96. We exclude our insurance earnings from this calculation because the value of our insurance operation comes from the investable funds it generates, and we have already included this factor in our first bucket.

(emphasis supplied)

 

I may still be double counting it but I don't think I am if the conditions I describe are met.

 

I believe you are. If you'd really like to value u/w profits, then you'd need an estimate of what normalized u/w profits over an entire cycle might be and then capitalize them appropriately.

 

Best,

Ragu

[Yours Truly]

As an idea stealer from other respected investors, I feel like Ted, Todd, BB, and maybe Pabrai are the only one I can steal idea from with a good level of confidence simply because they run concentrated portfolio. Watsa would fit in but then we all know in what type of (controversial  to say the least) company he gets into...

 

Ex: I could take an idea from Tepper but then he would have only 2-3% invest in.

 

Tepper relies a lot on credit/bonds, and his stocks are a fraction of his overall portfolio, similar to how Klarman runs his.. so I wouldn't put too much weight into it

 

On the notion of stealing, its best to steal from managers that exhibit high concentration and low turnover such as Sequoia Fund, ESL, BB, Lou Simpson, Chuck Akre, Wedgewood Partners, Weitz value and of course Pabrai/Weschler

[finetrader]

On the notion of stealing, its best to steal from managers that exhibit high concentration and low turnover such as Sequoia Fund, ESL, BB, Lou Simpson, Chuck Akre, Wedgewood Partners, Weitz value and of course Pabrai/Weschler

 

Agree.

thanks for mentioning other managers.

[compoundinglife]

On the notion of stealing, its best to steal from managers that exhibit high concentration and low turnover such as Sequoia Fund, ESL, BB, Lou Simpson, Chuck Akre, Wedgewood Partners, Weitz value and of course Pabrai/Weschler

 

Agree.

thanks for mentioning other managers.

 

One other thing to think about is that (at least in my opinion) someone like Tepper could have hedges or paired trades that might not be obvious, so following him into a long position might not mirror what he is actually doing, where as some of the others mentioned are usually just long their best ideas. I generally try to keep apprised of what my favorite managers are doing, try to figure out their thesis and then wait to see if the price goes below their cost basis.

[Kiltacular]

EDIT:

 

I erased my response because after thinking about it for a few minutes, what Ragu is saying is much more correct that what I was saying.

 

I was double counting.  My example: Using GEICO's book value excludes all of GEICO's float.  If we include all of GEICO's float, then there is not too much "economic goodwill" not included on Berkshire's balance sheet.

 

Ragu...thanks for your patience.

[ragu]

If we include all of GEICO's float, then there is not too much "economic goodwill" not included on Berkshire's balance sheet.

 

Zigackly.

 

Ragu...thanks for your patience.

 

Not at all. Buffett is so rational that is always worthwhile thinking about what he says. Even more so, when it seems odd at first glance.

 

Best,

Ragu