2017 YE intrinsic value versus Market Value

[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 

[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.