Corner of Berkshire & Fairfax Message Board

General Category => Berkshire Hathaway => Topic started by: khturbo on March 07, 2019, 05:28:56 AM

Title: 2018 Valuation
Post by: khturbo on March 07, 2019, 05:28:56 AM
Hi all. I just posted a writeup on the valuation at EOY 2018:

https://concentratedcompounding.com/brk/

My model is attached in the post. I'd love to get all your thoughts on it!
Title: Re: 2018 Valuation
Post by: Lemsip on March 07, 2019, 08:09:52 AM
Looks interesting and good work.

I have not yet digested the whole thing but at first glance I think it looks over conservative.
You are valuing at $202 per B share whereas Buffett, chronically reluctant to repurchase unless there is a huge discount to IV-  has been buying shares upto $207.9 in the recent past.
Also Ajit Jain recently put down $20m of his own money at $198 per B. Neither of these would happen if their general valuation was not somewhere  in the $240-260 per B range which is also the general range from Semper Augustus using 3 different methods.
Title: Re: 2018 Valuation
Post by: khturbo on March 07, 2019, 08:43:22 AM
It's a good point. I've been thinking about that a bit. My clearest answer is that if you were to discount it at 8% or 9%, the value would be much, much higher. Arguably, using a 10% discount rate for Berkshire is too high, especially in a world of 2.5% 10-year yields and a stock market that might make 7-8% through the next cycle. So I think where I say "fair value," I'm actually kind of saying that my opportunity cost is probably around 10%, so for me to be interested I'd need to see a 10% IRR, and low $200s is the price where I see that, using fairly conservative assumptions.

I went back and discounted everything back to 9% instead of 10% (admittedly an imperfect exercise) and got a value of ~$235. I think that kind of makes sense. Like you probably shouldn't make 10% on BRK over time given the risk profile. So if you think a fair return is somewhere below 9% then it's probably worth ~$250-260 or so.
Title: Re: 2018 Valuation
Post by: SHDL on March 07, 2019, 03:17:46 PM
Thanks for sharing.  I personally took a somewhat less sophisticated approach but my bottom line was more or less in line with yours.

My rough estimate is that the company effectively earned around $32 bn during 2018:

- 17.2 bn from the railroad, utilities/energy, and MSR segments
- 12.0 bn in look-through earnings from the stock portfolio
- 1.5 bn in interest income earned by the insurance group
- 1.6 bn in insurance underwriting profits
- (0.2 bn) in other losses

So on a $490 bn market cap we have about a 6.5% earnings yield.  Combine that with modest assumptions about growth and inflation going forward (say 3% real growth, 13% ROE, and 2% inflation), and we can probably expect a long term nominal IRR of around 10%.  Not too bad, all things considered. 

PS:  On your question about the 13% tax rate on dividends in the blog post, my guess is that state/local taxes are the culprit. 
Title: Re: 2018 Valuation
Post by: khturbo on March 08, 2019, 05:49:07 AM
Thanks for those inputs SHDL. I generally agree with those thoughts.

On the 13% tax rate issue, someone posted a link in the comments that talks about special tax rates for insurers. Looks like they didn't get much relief on the dividends from tax reform, unfortunately.
Title: Re: 2018 Valuation
Post by: AdjustedEarnings on March 08, 2019, 07:42:55 AM
I'm as much of a fanboy as anyone else on this board so it took me longer than it should have to realize/accept that BRK is simply too big for anyone to run, including Buffett. I don't care about short term stock performance but on a longer term basis, it has under performed for the last 10 years and also the last 17 years (if that's not long term then I don't know what is). I picked these dates to coincide roughly with the last two stock market bottoms. No one can handle this much cash (which is why I picked the bottoms because that's when you're ideally positioned to put it to work). The problem gets worse on a daily basis and, despite their advice to others, they've been quite stubborn on returning any kind of cash at all... which means the problem only gets worse.

Buffett is rational but also human. He's had tremendous success investing in and acquiring businesses. So I think there's some inertia to move the thought process along (the switch from net-nets to good businesses also took a LONG time for the same reason; difficult to change what's working). Every fact would tell you that the ability to put money to work is behind them... Ted/Todd under performing with smaller books, WEB under performing, major mistakes in IBM and KHC with large commitments (counting opportunity cost here as I know they didn't lose $$), Coca Cola (this used to be a good investment but total return since investing is now pedestrian given that the stock has been flat since 1998 so the only return is the dividend; their own advice to not do anything for tax reasons appears to have been ignored here since WEB has complained that if they sell KO they'll have a large tax bill and would need a much better investment to make up the tax hit), General Re IRR most likely not good though difficult to quantify, BAC worked out great, but GE didn't. GS was just okay. So taken together, the fall of 2008 investments were just okay. Probably under performed the SP500. BNSF was terrific. But PCP was only slightly above average. Add to that, the mistakes of omission as told by WEB: Google, AMZN, MA/V, etc.  How will they do better with MORE money?

Honest hypothetical question: If any name other than WEB was associated with this collection of assets and performance, how fast would investors be screaming A C T I V I S T? In fact, if you ignore size, isn't this the type of thing that WEB attacked in his partnership days (Sanborn map, separating business from securities)

I know I'm going to invite a lot of criticism here. I like WEB/CM and their whole philosophy more than most but I'm just trying to state the facts, to be clear eyed, and view these things outside of WEB and CM's quips and quotes. At this point, it seems Berkshire will plod along with subpar returns on assets due to, size and cash drag. Best that we can hope for is a nice deal for $80 billion+ but that just seems kind of foolish (or two deals for $40 billion but tough to imagine 10 deals for $8 billion in any reasonable time frame). How many $80 billion+ deals are there? and how many of them go for prices that WEB will pay? Deals at that size (when they come around once every 5 years) are heavily negotiated. So, in my mind, I simply adjust long-term ROE down (unfortunately) by 200 bps on a forward basis, which means 1.3x BV may well be the right price. That's my view anyway.
Title: Re: 2018 Valuation
Post by: SwedishValue on March 08, 2019, 10:37:38 AM
I think the thread starter’s analysis is good and thought through. I disagree with putting such big discounts on BNSF etc., so in the end I come up with a higher value.

However, I also mostly agree with adjustedvalue. At some point Buffett needs to adress what to do with the cash if interest rates stay low and no elephant appears. His reasoning and unwillingness to repurchase a meaningful amount of Berkshire shares suggests to me that the excess cash problem is likely to increase.

Buffett and Munger have previously stated that material buybacks would be in the cards if no other options were found and Berkshire was trading at a significant discount. My impression was that ”material buybacks” would mean that the cash pile would be kept roughly the same as a result of the buybacks. I’ve come to revise this position considering the very limited use of the repurchase program so far.

I think that over time, Berkshire will spend somewhere between 2% and 5% of their owner earnings on share buybacks (probably above 10% whenever Berkshire is significantly undervalued, but most of the time Berkshire stock will not trade at a discount big enough). Until we see another significant economic meltdown, cash is likely to increase in excess of 20 BN USD per year. If a meltdown comes five years from now, we can only hope that there are deals out there for the excess 200 BN USD in cash that Berkshire will have by then.

If interest rates stay low and valuation levels stay where they are now (or higher), I think it is unlikely Berkshire will do anything with its cash rather than hoarding it. Although it is very strange to me. Up until recently I’ve been under the impression that it would be better to spend the money repurchasing your own undervalued stock rather than hoarding cash. At some point I just have to admit I’ve been wrong.
Title: Re: 2018 Valuation
Post by: Jurgis on March 08, 2019, 11:05:26 AM
I'm as much of a fanboy as anyone else on this board so it took me longer than it should have to realize/accept that BRK is simply too big for anyone to run, including Buffett. I don't care about short term stock performance but on a longer term basis, it has under performed for the last 10 years and also the last 17 years (if that's not long term then I don't know what is). I picked these dates to coincide roughly with the last two stock market bottoms. No one can handle this much cash (which is why I picked the bottoms because that's when you're ideally positioned to put it to work). The problem gets worse on a daily basis and, despite their advice to others, they've been quite stubborn on returning any kind of cash at all... which means the problem only gets worse.

Buffett is rational but also human. He's had tremendous success investing in and acquiring businesses. So I think there's some inertia to move the thought process along (the switch from net-nets to good businesses also took a LONG time for the same reason; difficult to change what's working). Every fact would tell you that the ability to put money to work is behind them... Ted/Todd under performing with smaller books, WEB under performing, major mistakes in IBM and KHC with large commitments (counting opportunity cost here as I know they didn't lose $$), Coca Cola (this used to be a good investment but total return since investing is now pedestrian given that the stock has been flat since 1998 so the only return is the dividend; their own advice to not do anything for tax reasons appears to have been ignored here since WEB has complained that if they sell KO they'll have a large tax bill and would need a much better investment to make up the tax hit), General Re IRR most likely not good though difficult to quantify, BAC worked out great, but GE didn't. GS was just okay. So taken together, the fall of 2008 investments were just okay. Probably under performed the SP500. BNSF was terrific. But PCP was only slightly above average. Add to that, the mistakes of omission as told by WEB: Google, AMZN, MA/V, etc.  How will they do better with MORE money?

Honest hypothetical question: If any name other than WEB was associated with this collection of assets and performance, how fast would investors be screaming A C T I V I S T? In fact, if you ignore size, isn't think the type of thing that WEB attacked in his partnership days (Sanborn map, separating business from securities)

I know I'm going to invite a lot of criticism here. I like WEB/CM and their whole philosophy more than most but I'm just trying to state the facts, to be clear eyed, and view these things outside of WEB and CM's quips and quotes. At this point, it seems Berkshire will plod along with subpar returns on assets due to, size and cash drag. Best that we can hope for is a nice deal for $80 billion+ but that just seems kind of foolish (or two deals for $40 billion but tough to imagine 10 deals for $8 billion in any reasonable time frame). How many $80 billion+ deals are there? and how many of them go for prices that WEB will pay? Deals at that size (when they come around once every 5 years) are heavily negotiated. So, in my mind, I simply adjust long-term ROE down (unfortunately) by 200 bps on a forward basis, which means 1.3x BV may well be the right price. That's my view anyway.

Good post.

It might be argued that BRK is attractive compared to elevated market/SP500 valuations and future expected returns. I.e. even if you get ~10%ish (or even high single digits) return on BRK, it may outperform the market. Of course, this argument has been made in the past and so far it has not worked.  8)
Title: Re: 2018 Valuation
Post by: khturbo on March 08, 2019, 12:02:41 PM
Lots of good thoughts there adjusted earnings. I actually agree with most of them. It's impossible to prove, but I think that if Buffett would have just steadily repurchased stock starting in 2012 instead of making all the investments that they did then per share IV would be higher than it is today. I also think that might be true of a much longer period maybe back to 1998 or so, but it's impossible to prove. Agreed as well that they could have done better in 2009.

I would say that in tracking performance I prefer to look through the cycle, not trough to peak (or close to peak at least). It makes perfect sense that Berkshire would outperform through the cycle but might underperform trough to peak, which is roughly what it has done. Since it's perceived as non-cyclical the relative valuation should be higher at the bottom and lower at the top. Another way to say it is that a good chunk of the return of the S&P since the bottom in 2009 is due to valuation expansion. That isn't quite true for BRK.

Back to cash deployment that adjusted and swedish point out, I wrote that saying that this assumes all earnings are paid out. I honestly think the biggest risk is that Buffett likes to empire build and keeps a bunch of cash waiting for a deal that never happens, in line with what you guys are saying. I hope I'm wrong and that they'll buy back a ton of stock this year. If they use all fcf to buy back stock they really should hit something like a 10% IRR with lots of certainty. If they just keep a bunch of excess then obviously that would take the IRR down a bit, but hopefully not by more than 1-2% annualized.

And to Jurgis, I think that's right. I've had a couple people mention that the valuation is too low. Like I mention earlier, if you discount it at 9% you get ~$235 in value and something higher obviously if you discount at 8%, which is what I'd guess a market return is. I personally think that BRK will continue to trade in the range of where it is to maybe up 10%, which is roughly the ratio of where it has traded relative to perceived intrinsic value over the last maybe 5 years. I don't think the discount will close, but I think it would be hard for the valuation to go lower by 20% and stay there, so I think you lock in through the cycle returns around the rate that IV increases.

I appreciate all of the thoughts and feedback by you guys!
Title: Re: 2018 Valuation
Post by: Lemsip on March 08, 2019, 12:48:04 PM
A number of comments here about Berkshire underperformance. This of course is very sensitive to the end points used.
As measured at the end of the last calendar year, Berkshire had beaten the S&P by 7 points the previous year and then starting Jan1 of all years since 2010. So far in 2019  we have had a 2.5 month period where Berkshire has flatlined while the S&P has shot up so using the current date as the endpoint gives a different result.
Through a strategy of building up my position when Berkshire has been attractive ( 2011, late 2015 and lately), I have had a modest edge on market returns since 2004 in my personal portfolio.

I think 10%-11% from Berkshire from current prices is a reasonable expectation and more importantly the range of outcomes is narrower than for the average firm. There is no chance of it shooting the lights out but also the safety factor makes it a reasonable candidate for a chunk of the portfolio that will survive adverse periods from a position of strength.

Cash build up  and usage is an issue but there are companies with bigger market cap than Berkshire which are also operating and growing reasonably well with a similar amount of cash ( Alphabet has $110bn , Apple double that). It will take time for Berkshire to return cash but any effects of that will need time to work through. I am encouraged by specific moves to relax the weird book value criteria last summer and the start of buybacks.

Title: Re: 2018 Valuation
Post by: SHDL on March 08, 2019, 01:12:36 PM
I think 10%-11% from Berkshire from current prices is a reasonable expectation and more importantly the range of outcomes if narrower than for the average firm. There is no chance of it shooting the lights out but also the safety factor makes it a reasonable candidate for a chunk of the portfolio that will survive adverse periods from a position of strength.

I agree, and taking this line of thought one step further, I actually think that buying BRK with leverage may be a sensible strategy for some.  The idea is that if you really think BRK is a low risk moderate return investment, then by applying some leverage you should be able to “convert” that into, say, a moderate risk high return investment.  It goes without saying that you need to be careful about what type of leverage you use and how much, but I can see it working quite well for the type of people who hang out around here.  Personally I do something like this by allocating a chunk of money that otherwise would be in my bond buffer to BRK, meaning that I’m effectively buying BRK with money “borrowed” from my bond buffer. 
Title: Re: 2018 Valuation
Post by: Swedish_Compounder on March 08, 2019, 10:45:28 PM
When discussing that Berkshire has not performed that well compared to S&P since 1998, I also think it is important to keep in mind that Berkshires valuation has come down tremendously since then.

In 1998, the look-through earnings were 2 BUSD or so. In 2018, it was at least 35 BUSD (operating earnings + earnings from investees). There has not been much dilution since end of 1998 (around 10%). Look through EPS has grown almost 15% compounded during those 20 years.

My point is that EPS has increased 15-fold, but the stock has increased less than six-fold during the last twenty years. Berkshires valuation multiples have contracted significantly compared to the market valuation.
Title: Re: 2018 Valuation
Post by: Lemsip on March 08, 2019, 11:15:46 PM
Actually if you use portfoliovisualizer and compare an investment in Berkshire vs the Vanguard S&P 500 benchmark, Berkshire is significantly ahead starting 1998,1999,2000 and so on even as you say the valuation has compressed.

https://www.portfoliovisualizer.com/backtest-portfolio

Title: Re: 2018 Valuation
Post by: vinod1 on March 09, 2019, 04:29:12 AM
AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.

Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.

When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.

Vinod
Title: Re: 2018 Valuation
Post by: shalab on March 09, 2019, 11:13:16 AM
khturbo - can you find any utility selling for book value in the market? If yes, I would like to know the names.


You value Geico as follows:

I value Geico by taking TTM premiums of $34.1 billion, multiplying them by a 5% profit margin (being a bit conservative relative to the 94.1% CR historically), subtracting a 21% tax rate, and giving that income stream a 25x multiple. That gets a value of $33.7 billion.


Progressive which is smaller than Geico has a market cap of 42 B and P/B of 4.0.

Overall, I feel you are undervaluing a lot of assets significantly compared to the market.  However, I hope there will be more selling and the prices drop as I and my family will be net buyers for the next 2-3 decades atleast
Title: Re: 2018 Valuation
Post by: shalab on March 09, 2019, 11:20:21 AM
vinod1, I am curious if you use book value multiple for other stocks in your portfolio, if not why not?

I am curious to know as I see many people put an anchor with book value on BRK stock. However, they have no problems issuing buy recommendations for MSFT or AMZN which has lower earning yield and much higher P/B rations.

AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.

Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.

When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.

Vinod
Title: Re: 2018 Valuation
Post by: wachtwoord on March 09, 2019, 01:42:15 PM
Actually if you use portfoliovisualizer and compare an investment in Berkshire vs the Vanguard S&P 500 benchmark, Berkshire is significantly ahead starting 1998,1999,2000 and so on even as you say the valuation has compressed.

https://www.portfoliovisualizer.com/backtest-portfolio

Thanks for the link. Do you know of any such resource to backtest European stocks as well? (The available stocks seem to be restricted to N. American companies)
Title: Re: 2018 Valuation
Post by: vinod1 on March 09, 2019, 02:13:21 PM
vinod1, I am curious if you use book value multiple for other stocks in your portfolio, if not why not?

I am curious to know as I see many people put an anchor with book value on BRK stock. However, they have no problems issuing buy recommendations for MSFT or AMZN which has lower earning yield and much higher P/B rations.

AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.

Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.

When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.

Vinod

shalab,

I do not use Book Value much if at all. To me a business is worth some multiple of owners earnings. 

The multiple is based on how fast and how long owners earnings grow which is a function of its competitive advantage and total addressable market size.

If I cannot estimate owner earnings, it is an automatic pass for me. I find it very difficult to wrap by head around valuation without owners earnings. 

If I use book value, it is mostly as a shortcut once I estimated the IV using the owners earnings x multiple. So if I estimate BRK IV to be $200 and book value is $160, to keep track of it more easily in my head, I use the derived value of 1.25 BV multiple.

Vinod

Title: Re: 2018 Valuation
Post by: DooDiligence on March 09, 2019, 03:05:52 PM
vinod1, I am curious if you use book value multiple for other stocks in your portfolio, if not why not?

I am curious to know as I see many people put an anchor with book value on BRK stock. However, they have no problems issuing buy recommendations for MSFT or AMZN which has lower earning yield and much higher P/B rations.

AdjustedEarnings, SwedishValue, khturbo, Jurgis & Lemsip - Great points.

Most reasonable people estimate future growth in total earnings power at Berkshire to grow at between 8% to 11% (my own range is 8-10% with 9% as my central expectation). To avoid confusion, I say total earnings power instead of IV, because IV is dependent on the growth rate.

When you take a growth rate of 10% or below, the only way it would be worth 1.5x BV or more is if we use a discount rate that is lower than that. Banal observation. But without specifying one's discount rate the justified BV multiple does not convey the full picture. I like how khturbo made it explicit.

Vinod

shalab,

I do not use Book Value much if at all. To me a business is worth some multiple of owners earnings. 

The multiple is based on how fast and how long owners earnings grow which is a function of its competitive advantage and total addressable market size.

If I cannot estimate owner earnings, it is an automatic pass for me. I find it very difficult to wrap by head around valuation without owners earnings. 

If I use book value, it is mostly as a shortcut once I estimated the IV using the owners earnings x multiple. So if I estimate BRK IV to be $200 and book value is $160, to keep track of it more easily in my head, I use the derived value of 1.25 BV multiple.

Vinod

Book value becomes an analog?
Title: Re: 2018 Valuation
Post by: khturbo on March 09, 2019, 05:08:16 PM
Shalab - the purpose of the article was explicitly to not use industry comps but to value the various pieces based on cash flows. You are correct that in almost every case the values are lower than publicly traded comps. I've mentioned to a couple of others, that's because I discounted things back to 10%. I don't think that's necessarily what they're worth, but it's a function of my own personal opportunity cost. If you would have used a market return of 8% or so the value would be above $250. On that note, in the first couple of paragraphs there's a link to my model. You can open it up and change the assumptions to your liking.

One quick note on Geico, that was the value of just the underwriting profit stream. You'd have large value for fixed income investment income and the equity portfolio if it was separate. The value of all that combined would be well over $42bb.

Thanks for the thoughts,

Kyler
Title: Re: 2018 Valuation
Post by: Lemsip on March 09, 2019, 10:35:34 PM
Actually if you use portfoliovisualizer and compare an investment in Berkshire vs the Vanguard S&P 500 benchmark, Berkshire is significantly ahead starting 1998,1999,2000 and so on even as you say the valuation has compressed.

https://www.portfoliovisualizer.com/backtest-portfolio

Thanks for the link. Do you know of any such resource to backtest European stocks as well? (The available stocks seem to be restricted to N. American companies)
Some european companies have US listed ADRs so you can use that if it works.
Also, stockcharts is pretty good for that ( use the perfcharts option) and is one of the few out there that allows you to pick shares including or excluding dividends.
I am Europe based as well and these 2 work for large, well known shares but I don't know of any others which include small-cap or less well traded exchanges.
Title: Re: 2018 Valuation
Post by: rolling on March 10, 2019, 04:11:07 AM
I'm as much of a fanboy as anyone else on this board so it took me longer than it should have to realize/accept that BRK is simply too big for anyone to run, including Buffett. I don't care about short term stock performance but on a longer term basis, it has under performed for the last 10 years and also the last 17 years (if that's not long term then I don't know what is). I picked these dates to coincide roughly with the last two stock market bottoms. No one can handle this much cash (which is why I picked the bottoms because that's when you're ideally positioned to put it to work). The problem gets worse on a daily basis and, despite their advice to others, they've been quite stubborn on returning any kind of cash at all... which means the problem only gets worse.



It has already been mentioned above, but it is not correct to compare bottom to top since down years are also part of the market. Such a top to top comparison would yield different results. I would choose 2007 to 2017 as a much more accurate comparison. This would lead to a BRK CAGR of 9.46 vs 8.1% for Vanguard500. In fact, this BRK return is more or less in line with what most of us (and WEB) expect of Berkshire: a little under 10% IV CAGR for BRK unless interest rates go up

Edit: I used IV and it might not be correct because of discount rates. However, this a "a little under 10% return" stems from the fact that WEB himself seems to be using a 10% hurdle for his investments. In the old days he would ask for a first day 15%, he now seems to ask for 10%. Cash and bond drag together with some comission mistakes explain the underperformance to his hurdle rate. This is why 9-10% tends to be the discount rate applied to berkshire (IMO this discount rate is inappropriate and the motive for the permanent discount in the stock price: if you get almost bond like safety you must have an almost bond like discount rate. The same happens with the sp500 in the long run.
Title: Re: 2018 Valuation
Post by: investmd on March 10, 2019, 07:06:18 AM
When discussing that Berkshire has not performed that well compared to S&P since 1998, I also think it is important to keep in mind that Berkshires valuation has come down tremendously since then.

In 1998, the look-through earnings were 2 BUSD or so. In 2018, it was at least 35 BUSD (operating earnings + earnings from investees). There has not been much dilution since end of 1998 (around 10%). Look through EPS has grown almost 15% compounded during those 20 years.

My point is that EPS has increased 15-fold, but the stock has increased less than six-fold during the last twenty years. Berkshires valuation multiples have contracted significantly compared to the market valuation.

As you say earnings have increased dramatically over 2 decades yet market price of equity has not marched at the same pace. Is there a structural reason to believe that the next 2 decades will be any different? My own "guess" is that at some point BRK will use the mega surplus cash to buy back stock and this will be a driver for the market price. Waiting for an opportunity to deploy the cash motherload has been a reasonable strategy. However, it can't go on for decades - hopefully.
Title: Re: 2018 Valuation
Post by: longinvestor on March 10, 2019, 09:21:03 AM
When discussing that Berkshire has not performed that well compared to S&P since 1998, I also think it is important to keep in mind that Berkshires valuation has come down tremendously since then.

In 1998, the look-through earnings were 2 BUSD or so. In 2018, it was at least 35 BUSD (operating earnings + earnings from investees). There has not been much dilution since end of 1998 (around 10%). Look through EPS has grown almost 15% compounded during those 20 years.

My point is that EPS has increased 15-fold, but the stock has increased less than six-fold during the last twenty years. Berkshires valuation multiples have contracted significantly compared to the market valuation.

As you say earnings have increased dramatically over 2 decades yet market price of equity has not marched at the same pace. Is there a structural reason to believe that the next 2 decades will be any different? My own "guess" is that at some point BRK will use the mega surplus cash to buy back stock and this will be a driver for the market price. Waiting for an opportunity to deploy the cash motherload has been a reasonable strategy. However, it can't go on for decades - hopefully.
In two decades reasonable assumptions such as a market swoon or two, an elephant or two, a large block “private buyback” or two can be made. Munger calls this as “something intelligent “. MV and IV should converge. I believe that it’s better for Berkshire’s problem of plenty that the convergence unfolds over 20 versus 10 years, 10 versus 5...
Title: Re: 2018 Valuation
Post by: wachtwoord on March 10, 2019, 05:03:46 PM
Actually if you use portfoliovisualizer and compare an investment in Berkshire vs the Vanguard S&P 500 benchmark, Berkshire is significantly ahead starting 1998,1999,2000 and so on even as you say the valuation has compressed.

https://www.portfoliovisualizer.com/backtest-portfolio

Thanks for the link. Do you know of any such resource to backtest European stocks as well? (The available stocks seem to be restricted to N. American companies)
Some european companies have US listed ADRs so you can use that if it works.
Also, stockcharts is pretty good for that ( use the perfcharts option) and is one of the few out there that allows you to pick shares including or excluding dividends.
I am Europe based as well and these 2 work for large, well known shares but I don't know of any others which include small-cap or less well traded exchanges.

Yes I use the US ADR trick for the seekingAlpha portfolio. Unfortunately the ADRs must be too obscure for these sites to support them (for example Exor). I don't own European stocks because I'm from Europe (US is usually better for business) but there's some very nice holding companies located there as well.

Thanks for the link though.
Title: Re: 2018 Valuation
Post by: AdjustedEarnings on March 12, 2019, 08:29:32 AM
I'm as much of a fanboy as anyone else on this board so it took me longer than it should have to realize/accept that BRK is simply too big for anyone to run, including Buffett. I don't care about short term stock performance but on a longer term basis, it has under performed for the last 10 years and also the last 17 years (if that's not long term then I don't know what is). I picked these dates to coincide roughly with the last two stock market bottoms. No one can handle this much cash (which is why I picked the bottoms because that's when you're ideally positioned to put it to work). The problem gets worse on a daily basis and, despite their advice to others, they've been quite stubborn on returning any kind of cash at all... which means the problem only gets worse.



It has already been mentioned above, but it is not correct to compare bottom to top since down years are also part of the market. Such a top to top comparison would yield different results. I would choose 2007 to 2017 as a much more accurate comparison. This would lead to a BRK CAGR of 9.46 vs 8.1% for Vanguard500. In fact, this BRK return is more or less in line with what most of us (and WEB) expect of Berkshire: a little under 10% IV CAGR for BRK unless interest rates go up

Edit: I used IV and it might not be correct because of discount rates. However, this a "a little under 10% return" stems from the fact that WEB himself seems to be using a 10% hurdle for his investments. In the old days he would ask for a first day 15%, he now seems to ask for 10%. Cash and bond drag together with some comission mistakes explain the underperformance to his hurdle rate. This is why 9-10% tends to be the discount rate applied to berkshire (IMO this discount rate is inappropriate and the motive for the permanent discount in the stock price: if you get almost bond like safety you must have an almost bond like discount rate. The same happens with the sp500 in the long run.

On the first point, there are many stats you could consider that would support either way of looking at it. E.g. For 10 years after the 1973-74 bottom, BRK's performance over the index was higher than it had been before because they'd been able to put money to work before and around this period... so when people say WEB's going to bag elephants in the next recession, I'm looking at 2008-2018 period for evidence of that as that presented a pretty big opportunity. But we can simply leave both approaches (yours and mine) aside and consider these 9 year increments and BRK's out-performance over the SP500 since inception:

1965-1973   17.6%
1974-1982   19.8%
1983-1991   14.3%
1992-2000   9.6%
2001-2009   3.8%
2010-2018   1.6%

Here you've got tops, bottoms, and middles, everything and you can see where things are headed. Size is of course the big problem, but also cash-drag (which is related to size but has a solution in repurchases and/or dividends), and some mistakes of commission. Of course, we don't make money from the past performance of the stock, so when we look to the future period, what factors need to get better? And how much out-performance can we expect realistically in the NEXT 9 year period? I'm more and more becoming convinced that while outperformance may exist, it probably will continue this trend we're seeing here. Now, whether 1% outperformance is worth the risk of not achieving that outperformance is up to debate. 1% can do a lot over decades, but remember 1% will go to 0.5% etc. unless they shrink the capital base (which was the subject of my prior post where I gave reasons for my thinking why it won't happen on any decent timeline).

They have not been short of capital in the 2010-2018 period. So, repurchases would've made these results better. That was probably also true in the period before that, 2001-2009. Only ways to shrink the capital base are sizeable repurchases, dividends (when appropriate), and occasional acquisitions when they can be found. I do feel that the time has come to make acquisitions the "special case" rather than the default case and move repurchases up to default case when the stock is not overvalued:

As to bond-like safety, I'm not sure why you'd assume that. What exactly is providing bond-like safety here? It's not a bond. It might be safe in our minds but that doesn't make it a bond. (Every borrower thinks they're going to pay their mortgages/debt, but that doesn't make them all AAA/FICO 800+ either. Same logic) Also, bonds pay coupons, Berkshire doesn't; and that is what is being discounted in the bond price. So you're relying on reinvestment and the results of that re-investment skill is what you're seeing in the table above. If BRK had traded at bond yield type discount rates in 2010, you can imagine what the outperformance profile would look like. BTW, "stocks discount rates should equal bond yields" was also the reasoning given for buying SP500 in 1999 in the book Dow 36,000. It seems logical on the surface, but it's not right just from a plain mathematical standpoint.
Title: Re: 2018 Valuation
Post by: rolling on March 12, 2019, 10:26:04 AM
It has already been mentioned above, but it is not correct to compare bottom to top since down years are also part of the market. Such a top to top comparison would yield different results. I would choose 2007 to 2017 as a much more accurate comparison. This would lead to a BRK CAGR of 9.46 vs 8.1% for Vanguard500. In fact, this BRK return is more or less in line with what most of us (and WEB) expect of Berkshire: a little under 10% IV CAGR for BRK unless interest rates go up

Edit: I used IV and it might not be correct because of discount rates. However, this a "a little under 10% return" stems from the fact that WEB himself seems to be using a 10% hurdle for his investments. In the old days he would ask for a first day 15%, he now seems to ask for 10%. Cash and bond drag together with some comission mistakes explain the underperformance to his hurdle rate. This is why 9-10% tends to be the discount rate applied to berkshire (IMO this discount rate is inappropriate and the motive for the permanent discount in the stock price: if you get almost bond like safety you must have an almost bond like discount rate. The same happens with the sp500 in the long run.

On the first point, there are many stats you could consider that would support either way of looking at it. E.g. For 10 years after the 1973-74 bottom, BRK's performance over the index was higher than it had been before because they'd been able to put money to work before and around this period... so when people say WEB's going to bag elephants in the next recession, I'm looking at 2008-2018 period for evidence of that as that presented a pretty big opportunity. But we can simply leave both approaches (yours and mine) aside and consider these 9 year increments and BRK's out-performance over the SP500 since inception:

1965-1973   17.6%
1974-1982   19.8%
1983-1991   14.3%
1992-2000   9.6%
2001-2009   3.8%
2010-2018   1.6%

Here you've got tops, bottoms, and middles, everything and you can see where things are headed. Size is of course the big problem, but also cash-drag (which is related to size but has a solution in repurchases and/or dividends), and some mistakes of commission. Of course, we don't make money from the past performance of the stock, so when we look to the future period, what factors need to get better? And how much out-performance can we expect realistically in the NEXT 9 year period? I'm more and more becoming convinced that while outperformance may exist, it probably will continue this trend we're seeing here. Now, whether 1% outperformance is worth the risk of not achieving that outperformance is up to debate. 1% can do a lot over decades, but remember 1% will go to 0.5% etc. unless they shrink the capital base (which was the subject of my prior post where I gave reasons for my thinking why it won't happen on any decent timeline).

They have not been short of capital in the 2010-2018 period. So, repurchases would've made these results better. That was probably also true in the period before that, 2001-2009. Only ways to shrink the capital base are sizeable repurchases, dividends (when appropriate), and occasional acquisitions when they can be found. I do feel that the time has come to make acquisitions the "special case" rather than the default case and move repurchases up to default case when the stock is not overvalued:

As to bond-like safety, I'm not sure why you'd assume that. What exactly is providing bond-like safety here? It's not a bond. It might be safe in our minds but that doesn't make it a bond. (Every borrower thinks they're going to pay their mortgages/debt, but that doesn't make them all AAA/FICO 800+ either. Same logic) Also, bonds pay coupons, Berkshire doesn't; and that is what is being discounted in the bond price. So you're relying on reinvestment and the results of that re-investment skill is what you're seeing in the table above. If BRK had traded at bond yield type discount rates in 2010, you can imagine what the outperformance profile would look like. BTW, "stocks discount rates should equal bond yields" was also the reasoning given for buying SP500 in 1999 in the book Dow 36,000. It seems logical on the surface, but it's not right just from a plain mathematical standpoint.
[/quote]
Thank you for the answer.

1) BRK outperformance vs SP500: it is quite obvious that the outperformance by definition cannot last forever.  My point was that expected return is capped (on the downside and on the upside) at about 10%/year, and this is because Buffett himself seems to have chosen that hurdle. In fact, it seems that if he cannot get his 10% he would rather not invest and keep cash on hand.
2) outperformance perspectives: it really depends on the return you expect from the sp500. If you expect 9-10% a year, berkshire makes no sense at current prices. if you expect 5-6% bekshire is a much better option. I would point, however, that Buffet himself stated in this year's letter that there are much better opportunities out there instead of berkshire
3) acquisitions vs repurchases: agreed, it sometimes feels like empire building. I would add that in hindsight I cannot understand why berkshire kept such a cashdrag in the last 10 years. It would have been better for them to just buy the SP500 and use the float leverage to make it worth it
4) BRk safety: stems from over 100B cash on hand and discipline to only invest it when expecting an over 10% yield and a diversified high quality asset base.

5) bond-like safety: here I disagree. I don't see safety on the coupon, I see safety as: probability of not losing money. Lets look at bonds:
Portugal 30 year: 2.46%; greece 25 year: 4.7%; italy 30 year: 3.6%
yes, you are supposed to receive money every year, but what is safer? a diversified bond portfolio like this or just investing in berkshire? (I used country debts because it was an easier comparison, but the same could be done with other risky bonds).

On the other hand, on berkshire you get 9-10% counpounded (and only pay taxes on the sale, so the post tax result is even better). On the SP500 I don't have an estimate.

Is this a correct discount rate? if you believe the risk is lower on BRK/SP500 you should use a lower discount rate.

If you use 30 year AAA bonds it seems to stand at 3.8%. Here the risk is certainly higher for BRK/SP500. But does it explain an over 5%/year difference?

so
"stocks discount rates should equal bond yields": no
"stock discount rates should equal similar safety bond yields": yes

Title: Re: 2018 Valuation
Post by: AdjustedEarnings on March 12, 2019, 12:52:46 PM
5) bond-like safety: here I disagree. I don't see safety on the coupon, I see safety as: probability of not losing money. Lets look at bonds:
Portugal 30 year: 2.46%; greece 25 year: 4.7%; italy 30 year: 3.6%
yes, you are supposed to receive money every year, but what is safer? a diversified bond portfolio like this or just investing in berkshire? (I used country debts because it was an easier comparison, but the same could be done with other risky bonds).

On the other hand, on berkshire you get 9-10% counpounded (and only pay taxes on the sale, so the post tax result is even better). On the SP500 I don't have an estimate.

Is this a correct discount rate? if you believe the risk is lower on BRK/SP500 you should use a lower discount rate.

If you use 30 year AAA bonds it seems to stand at 3.8%. Here the risk is certainly higher for BRK/SP500. But does it explain an over 5%/year difference?

so
"stocks discount rates should equal bond yields": no
"stock discount rates should equal similar safety bond yields": yes

I'm not saying there's safety in the coupon either. Safety is in the strength of the issuer. I'm thinking generally of US Govt bonds, but I'll use AAA if you prefer that. So, if we use that math on your numbers, 30 year AAA bond at 3.8% yield, 10% compounded growth in BRK, contending that the proper discount rate for BRK is 3.8%, then are you saying that the fair value today ought to be $1151? i.e. 202*(1.1^30)/(1.038^30)? Or do you have a slower growth rate for BRK after a few years from now?

If the AAA is long-term assumed to be at 3.8%, we're assuming rates stay very low. In that environment BRK will find it difficult to get 10% even if Buffet WANTS IT. Just because he wants it doesn't mean he can get it (e.g. last few years) or that it can become our assumption (in my opinion anyway).
Title: Re: 2018 Valuation
Post by: rolling on March 12, 2019, 03:39:13 PM
5) bond-like safety: here I disagree. I don't see safety on the coupon, I see safety as: probability of not losing money. Lets look at bonds:
Portugal 30 year: 2.46%; greece 25 year: 4.7%; italy 30 year: 3.6%
yes, you are supposed to receive money every year, but what is safer? a diversified bond portfolio like this or just investing in berkshire? (I used country debts because it was an easier comparison, but the same could be done with other risky bonds).

On the other hand, on berkshire you get 9-10% counpounded (and only pay taxes on the sale, so the post tax result is even better). On the SP500 I don't have an estimate.

Is this a correct discount rate? if you believe the risk is lower on BRK/SP500 you should use a lower discount rate.

If you use 30 year AAA bonds it seems to stand at 3.8%. Here the risk is certainly higher for BRK/SP500. But does it explain an over 5%/year difference?

so
"stocks discount rates should equal bond yields": no
"stock discount rates should equal similar safety bond yields": yes

I'm not saying there's safety in the coupon either. Safety is in the strength of the issuer. I'm thinking generally of US Govt bonds, but I'll use AAA if you prefer that. So, if we use that math on your numbers, 30 year AAA bond at 3.8% yield, 10% compounded growth in BRK, contending that the proper discount rate for BRK is 3.8%, then are you saying that the fair value today ought to be $1151? i.e. 202*(1.1^30)/(1.038^30)? Or do you have a slower growth rate for BRK after a few years from now?

If the AAA is long-term assumed to be at 3.8%, we're assuming rates stay very low. In that environment BRK will find it difficult to get 10% even if Buffet WANTS IT. Just because he wants it doesn't mean he can get it (e.g. last few years) or that it can become our assumption (in my opinion anyway).
Ok, I now understand the difference in our conclusions. I was not comparing berkshire to risk free bonds. Berkshire bonds could be considered low risk but, by definition, brk stock could not have the same risk. My assumption was berkshire stock/sp500 both being safer than many bonds and as safe as some others, and so we should use a similar discount rate to the latest. IMO it would probably be reasonably conservative, in the current environment, to discount the sp500 at 6% and brk at 7%. But from 7 to 9% you get a big difference (if I'm not mistaken, in 15 years that would amount to a 37% difference in present value)

Ps: those numbers for the AAA I used seem to be wrong, the numbers for the country debts are correct, which does not change much.
Title: Re: 2018 Valuation
Post by: aws on March 12, 2019, 04:26:01 PM
If anyone is interested, I whipped up a quick spreadsheet comparing the CAGR of Berkshire vs. the S&P 500 Total Return index.  I calculated the CAGR since 1988 for both, and also recalculated the CAGR if you started counting in each subsequent year, so since 1989, since 1990, etc.  All are current up thru today's close.

The summary is that Berkshire is a bit behind in almost every measurement period since 2008, and behind in 9 out of the 31 total periods.  But a lot of that is because of the ~12% underperformance YTD.  If I rerun the numbers cutting off at 12/31/18 then Berkshire is only behind for three measurement periods.
Title: Re: 2018 Valuation
Post by: wachtwoord on March 12, 2019, 04:34:30 PM
Thanks for sharing AWS.
Title: Re: 2018 Valuation
Post by: khturbo on April 10, 2019, 06:41:25 AM
https://concentratedcompounding.com/brk2/

Here's a follow up looking through all the risks, or in this case, the lack thereof. Hard to find anything that is even close to similarly not risky as Berkshire.
Title: Re: 2018 Valuation
Post by: james22 on April 10, 2019, 10:35:30 AM
Nice, thanks.
Title: Re: 2018 Valuation
Post by: IceCreamMan on April 25, 2019, 01:43:03 PM
Buffett sat down in his office for a rare newspaper interview with the FT, lasting nearly three hours.
At the outset, he was asked which would be the better investment to put in a child’s account — a
share in Berkshire, or a share in the S&P? He did not hesitate: “I think the financial result would be
very close to the same.”


Should this be taken literally, or is this under-promise, over-deliver?

This quote was taken from a recent interview that gfp posted in a different thread:
https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62
Title: Re: 2018 Valuation
Post by: StubbleJumper on April 25, 2019, 02:08:08 PM
Buffett sat down in his office for a rare newspaper interview with the FT, lasting nearly three hours.
At the outset, he was asked which would be the better investment to put in a child’s account — a
share in Berkshire, or a share in the S&P? He did not hesitate: “I think the financial result would be
very close to the same.”


Should this be taken literally, or is this under-promise, over-deliver?

This quote was taken from a recent interview that gfp posted in a different thread:
https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62


Interesting that he should say that.  A quick and dirty logic check would be to look at the difference between compounding money at say 8% vs 9% over a 20 year period (ie, the time for a child to become an adult).  It's not very close to the same at all, unless there truly is no material difference in returns (which might be the intent of his message).  I think that I would be biased towards putting the money into BRK, but that's driven by an underlying assumption of a small advantage for BRK returns.


SJ
Title: Re: 2018 Valuation
Post by: SHDL on April 25, 2019, 02:24:33 PM
He did also say something like among those things that one could expect to slightly outperform the S&P, BRK should be among the safest.  So I think on a risk adjusted basis he personally much prefers BRK. 
Title: Re: 2018 Valuation
Post by: james22 on April 25, 2019, 06:11:06 PM
Buffett sat down in his office for a rare newspaper interview with the FT, lasting nearly three hours. At the outset, he was asked which would be the better investment to put in a child’s account — a share in Berkshire, or a share in the S&P? He did not hesitate: “I think the financial result would be very close to the same.”

Should this be taken literally, or is this under-promise, over-deliver?

This quote was taken from a recent interview that gfp posted in a different thread:

https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62

It is Buffett playing avuncular, at his investor's expense.

And it should be taken as inconsistent with his belief that's he taking advantage of a partner if he buys them out.

I really look forward to his successor arguing BRK expects to outperform the S&P 500, without fear of being immodest.
Title: Re: 2018 Valuation
Post by: Lemsip on April 25, 2019, 10:01:31 PM

Should this be taken literally, or is this under-promise, over-deliver?


Buffett has been saying this almost verbatim at least since the mid 80s. I wouldn't take it literally but as a prudent reminder to keep expectations modest.

I much prefer it to management teams offering confident forecasts of shareholder return of 15% over 5 years etc.

Berkshire will deliver a 10% or so return in almost all market environments over a 10 year period ( more if you enter during a weak period). Good enough for me as a bedrock holding in a portfolio.

Amidst all the criticism of Berkshire performance etc, I just did an IRR calculation on my position for the last 4 years. With significant buys in Aug-Dec 2015 and July 18-Feb 19, the IRR is 17.4% in GBP and 11.7% in USD.  And this with an endpoint where Berkshire has been flatlining since the new year, is sitting on gobs of cash and the business is chugging along well.

I'd take it anytime.
Title: Re: 2018 Valuation
Post by: james22 on April 25, 2019, 10:32:22 PM
I much prefer it to management teams offering confident forecasts of shareholder return of 15% over 5 years etc.

I guess I do too, as long as I'm buying shares. And/or Buffett is buying shares back.

But at some point I'll be looking for share appreciation.

And it's a little dishonest of Buffett unless he believes it. He is otherwise misleading shareholders as to Berkshire's prospects when he offers to buy their shares back.

Title: Re: 2018 Valuation
Post by: Lemsip on April 25, 2019, 10:49:12 PM
I much prefer it to management teams offering confident forecasts of shareholder return of 15% over 5 years etc.

I guess I do too, as long as I'm buying shares. And/or Buffett is buying shares back.

But at some point I'll be looking for share appreciation.

And it's a little dishonest of Buffett unless he believes it. He is otherwise misleading shareholders as to Berkshire's prospects when he offers to buy their shares back.

Considering the fact that no one including Buffett can predict the future market conditions with 100% accuracy, it is sensible to be realistic about the prospects of a very large company.  Assuming average endpoint conditions, the realistic expectation is the return on shareholder equity that berkshire earns which is around 10%.  As for misleading shareholders, it couldn't be further from the truth. He has already bought back shares at these levels so obviously thinks this is well below intrinsic value. It is just that some people would want him to buy a lot more - but they are not privy to the other options he is considering in capital allocation in any given quarter.

There is no upside for a CEO talking up future returns. I posted by 4 year returns above and I am more than happy to have those numbers in a portion of my portfolio. Having Berkshire as a significant weight especially helped in 2018 when it beat the market by almost 7 points and helped me to a mid single digit positive return on my portfolio when most investors lost money in the markets ( including in bonds).
Title: Re: 2018 Valuation
Post by: Dynamic on April 25, 2019, 11:04:08 PM
@Lemsip - I notice those dates as periods when  Berkshire was particularly cheap within its moderately narrow range and when I also took advantage. The decline in GBP also boosted those returns.

My overall IRR with Berkshire stock alone is a little lower but still market beating when compared with total return index purchases and sales I could instead have made on the same dates for SP500TR and FTSE100-TRI, this over a period since July 2003 when I purchased around 1.6* Book Value and left the position untouched for 11.25 years. Even if I'd only held the original not-especially-cheap July 2003 position until now, about 15.75 years on, despite a P/BV decline, my CAGR on that tranche alone would still exceed the SP500TR by 0.37% and the FTSE100-TRI by 3.33% giving me $4.26 per dollar invested vs $4.04 S&P or £5.26 versus £3.25 in FTSE. That has made a solid foundation for portfolio growth as my default purchase in which I feel safer in terms of value preservation than the index yet earn about the same return or a few percent more by improving my buy and sell prices since that original purchase.
Title: Re: 2018 Valuation
Post by: Lemsip on April 26, 2019, 01:46:48 AM
@Dynamic, I have also held Berkshire from 2002 but my recordkeeping till 2015 was haphazard at best so hard to calculate the overall IRR but suffice it to say the investment has worked well and allowed me to sleep at night.

You make a crucial and often underappreciated point about the relatively small range of price that Berkshire usually experiences. In the list of stocks I follow it has the lowest range between highs and lows in the last 1 year ( a particularly volatile one in the markets) apart from Unilever ( 18% and 15%)

What this means in practical terms is that if you are a buyer or a seller, the difference between picking the absolute best time to buy or sell in any year is much less than the average stock so over the long term, you are unlikely to be penalised much for unfortunate timing, when evaluated over a 5 year period.

Finally one of the characteristics of Berkshire is that it has to be held as a 5 year+ position to evaluate performance.  It's the wrong business for quarterly excitement. It can go through long-ish periods of price stagnation and in retrospect they tend to be good opportunities to lock-in safe and significant returns.
Title: Re: 2018 Valuation
Post by: Paarslaars on April 26, 2019, 02:26:05 AM
Buffett sat down in his office for a rare newspaper interview with the FT, lasting nearly three hours.
At the outset, he was asked which would be the better investment to put in a child’s account — a
share in Berkshire, or a share in the S&P? He did not hesitate: “I think the financial result would be
very close to the same.”


Should this be taken literally, or is this under-promise, over-deliver?

This quote was taken from a recent interview that gfp posted in a different thread:
https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62

Even if the return would be the same, I believe BRK would do it with less variance than the S&P, so it would still be the preferred investment.
Title: Re: 2018 Valuation
Post by: Dynamic on April 26, 2019, 07:13:20 AM
@Dynamic, I have also held Berkshire from 2002 but my recordkeeping till 2015 was haphazard at best so hard to calculate the overall IRR but suffice it to say the investment has worked well and allowed me to sleep at night.
Haha, I have a similar situation for some of the same sort of period. I've managed to piece together most of my client ledger, but I'm missing a few exact dates and prices from early trades in the the time before I switched my broker to allow non UK trading. Luckily my exact Berkshire purchases are ones I kept track of, and Yahoo Finance helped out with historical exchange rates to convert them to USD.

Mine was in an ISA so no need to keep records for tax purposes and BRK.B gave me the added advantage of no dividends to reinvest and pay withholding tax on, giving me a further advantage over an S&P500 index fund. There turned out to be other advantages over the equivalent index fund investments based on what I could fund with the proceeds in 2014-2015 when the index was lagging considerably, perhaps more by luck than judgement.

Quote
You make a crucial and often underappreciated point about the relatively small range of price that Berkshire usually experiences. In the list of stocks I follow it has the lowest range between highs and lows in the last 1 year ( a particularly volatile one in the markets) apart from Unilever ( 18% and 15%)

What this means in practical terms is that if you are a buyer or a seller, the difference between picking the absolute best time to buy or sell in any year is much less than the average stock so over the long term, you are unlikely to be penalised much for unfortunate timing, when evaluated over a 5 year period.

I agree with that and what @Paarslaars said, and would add that in addition to this, I'm happy knowing what I'm buying in Berkshire, the integrity and honesty of my business partners and the diversity of its earnings streams, with its relatively consistent IV compounding rate in all economic climates being close to that of the S&P500 long term and with the price being below a conservative estimation of IV by a relatively consistent margin over time.

With an index fund I'm less certain of that, but make up for some of the uncertainty with a little extra decorrelation among the constituents, but I feel Berkshire is the better bet for me almost all of the time (or if I feel it's a little pricey I may just wait in cash until it's in the lower part of its range). It's also why I'm entirely happy holding a 100% weighting in Berkshire for the long term.

So while BRK.B is a bedrock of meeting my long-term compounding goals, since I became more active as an investor I have also found BRK.B to be useful currency in funding rare high-conviction opportunities (e.g. 25%+ cagr) where I might want to put in, say 25% of my portfolio.

BRK.B is usually trading at a similar or lesser discount to IV than when I bought it, so I'm usually gaining around 10% a year (way better than holding cash) while I'm waiting, I'm usually paying a price towards the lower end of Berkshire's trading range, and I'm very unlikely to lose very much purchasing power in the short term even if I happen to come across that other big opportunity within months of purchasing more Berkshire.

I'd imagine I'd be very unlikely to lose more than 10-15% this way by the time it came to sell some BRK.B, and I'd be much more likely to gain while waiting, and that the margin of safety in the High Conviction Opportunity would far outweigh my low-likelihood 15% loss in any case.

So I've emotionally prepared myself to eat the loss and not paralyse myself through loss-aversion into missing out on the HCO. It's a matter of my own temperament that I've prepared my mind and twisted my thinking to overcome my loss-aversion instinct enough to relish the taking of a certain 15% loss in BRK.B over a few months as part and parcel of the process of locking in a high conviction opportunity for a much larger potential gain in the future.

I guess I give my self a little dopamine reward when I recognise I've overcome such a cognitive bias just as I do when cutting my losses (or sub-par gains) in selling positions where my original thesis has changed. I think the most loss I've actually taken on my most recent Berkshire purchase to buy into a high return opportunity is just short of a 5% loss in about a month, and far more often I've gained purchasing power (e.g. 15% in 3 months) while waiting.

I think having Berkshire as the bedrock of my portfolio doing all the compounding that I need and expect also helps me to remain focused on waiting for opportunities that truly meet my high conviction threshold instead of just buying things that look reasonably priced but don't really scream out as bargains.

Quote
Finally one of the characteristics of Berkshire is that it has to be held as a 5 year+ position to evaluate performance.  It's the wrong business for quarterly excitement. It can go through long-ish periods of price stagnation and in retrospect they tend to be good opportunities to lock-in safe and significant returns.

Yes, I'd agree that the index can go on a tear from time to time, while Berkshire stagnates, and I'd expect Berkshire's IV to compound close to or slightly lag the index when the index is rising, but to materially beat the index most times when the index is falling. There can often be a time lag between the index recovering from a down period and Berkshire's price recovering fully, so you can certainly find yourself regaining ground very much slower than the index in times like the last few months!
Title: Re: 2018 Valuation
Post by: longinvestor on April 26, 2019, 07:42:22 AM

Should this be taken literally, or is this under-promise, over-deliver?


Buffett has been saying this almost verbatim at least since the mid 80s. I wouldn't take it literally but as a prudent reminder to keep expectations modest.

I much prefer it to management teams offering confident forecasts of shareholder return of 15% over 5 years etc.

Berkshire will deliver a 10% or so return in almost all market environments over a 10 year period ( more if you enter during a weak period). Good enough for me as a bedrock holding in a portfolio.

Amidst all the criticism of Berkshire performance etc, I just did an IRR calculation on my position for the last 4 years. With significant buys in Aug-Dec 2015 and July 18-Feb 19, the IRR is 17.4% in GBP and 11.7% in USD.  And this with an endpoint where Berkshire has been flatlining since the new year, is sitting on gobs of cash and the business is chugging along well.

I'd take it anytime.

Very true indeed, the boilerplate comparison versus the index is for a mass (general) headline number. As uber concentrated investors in Berkshire, I've found it nearly impossible to not take advantage of price mislocations over the past 10 years. Like you, I've caught the bottom of every pull back over this time frame. Good news for me is that we have been in accumulation phase of our life during this time. My return has closely mirrored the index over this period but...

.. starting points for the comparison have mattered. Data from the annual letter page 2.

10 year: January 1, 2009 to January 1, 2019: BRK 13.15%; S&P 13.66%
9 Year: January 1, 2010 to January 1, 2019: BRK 14.3%; S&P 12.23%

5 Year: January 1, 2014 to January 1, 2019; BRK 12.52%; S&P 8.9%
3 Year: January 1, 2016 to January 1, 2019: BRK 16.03%; S&P 9.8%

Much of the ballyhoo about Berkshire's relative (under) performance can be explained by a wild swing back in the S&P in a single calendar year: 2010; That difference was 23.8% (2.7% BRK versus Index 26.5%). It is humorous to see how many headlines have been spawned about Berkshire's emergent underperformance.

Just wait until January 1, 2020 and the 10 year clock will be reset and the world will see clearly that Berkshire has been breaking away for a long time. 10 years to be exact! I can't wait.


Title: Re: 2018 Valuation
Post by: Lemsip on April 26, 2019, 08:10:24 AM
@Dynamic, I have also held Berkshire from 2002 but my recordkeeping till 2015 was haphazard at best so hard to calculate the overall IRR but suffice it to say the investment has worked well and allowed me to sleep at night.


Mine was in an ISA so no need to keep records for tax purposes and BRK.B gave me the added advantage of no dividends to reinvest and pay withholding tax on, giving me a further advantage over an S&P500 index fund. There turned out to be other advantages over the equivalent index fund investments based on what I could fund with the proceeds in 2014-2015 when the index was lagging considerably, perhaps more by luck than judgement.


Same here. As of 6th of April the entirety of my large BRK position is in ISAs  with a little bit in a SIPP. No capital gains ever. 
Per the BRK proxy, after my latest buying spree at a recent cost basis of $198 ( between July 18 and Feb 19), I now own more shares than one of the BRK directors !

 If I had to pay capital gains on the accumulated gains there it would be an uncomfortable amount - that is what compounding over more than 15 years and full use of ISA allowances will do for you ! I will need to sell a bit from time to time to fund living expenses from next year but fortunately do not have to consider tax consequences. So all academic studies of performance vs S&P etc notwithstanding, BRK has definitely worked very well in setting things up comfortably for me. Of course it has also hedged against the local currency shenanigans over the last 3 years as an added bonus.
Title: Re: 2018 Valuation
Post by: Viking on September 08, 2019, 10:27:34 AM
Here are links to a couple of presentations. Thanks to the original posters for providing the links (i have forgotton who they were :-). I thought it would be good to add these to this thread.

1.) Semper Augustus Feb 2019: https://static.fmgsuite.com/media/documents/9f6a56c7-a1a3-4eb2-94b3-fe89cc110254.pdf
- page 72

Semper Augustus Feb 2018: https://static.fmgsuite.com/media/documents/8e6a3c88-859d-483b-bbf0-dda6f5e24fc1.pdf
- page 45

2.) Empire (Tilson): https://assets.empirefinancialresearch.com/uploads/2019/08/Berkshire-Hathaway-analysis-Whitney-Tilson-8-21-19.pdf

3.) Check Capital: https://www.checkcapital.com/Research_Reports/BRKB_Report_0819.pdf
Title: Re: 2018 Valuation
Post by: longinvestor on September 09, 2019, 07:19:33 AM
Buffett and Munger have often decried and ridiculed the EMH. The market is often but not always efficient. Now, it won’t take a keen observer to see that the Berkshire Hathaway stock itself is evidence that EMH doesn’t apply here. Is all known financial information priced in? There’s some irony here but someone will prosper from this inefficiency! It appears that one person’s words / actions have bigger sway over Mr. Market than anything else! So much for the EMH.
Title: Re: 2018 Valuation
Post by: Okonomen on September 09, 2019, 07:31:15 AM
Can someone explain to me how BRK can pay only ~10% cash taxes annually? Should we use this as the tax rate in the valuation model instead of the more common 25%?
Title: Re: 2018 Valuation
Post by: thepupil on September 09, 2019, 08:05:47 AM
The delta between the cash paid for taxes and income tax expense relates to the increase in the deferred tax liability.

the deferred tax liability has 2 major components:

1. Increase in DTL related to unrealized gains on investments: To the extent that Berkshire defers realization of gains indefinitely on large positions (I think this applies to some, but not all of the material equity positions), we can assume that this tax expense has very low present value.

2. Increase in DTL related to the companies, primarily  Burlington Northern and Berkshire Energy.

Page 96 of the most recent 10-K shows the breakdown between the two (obviously things will change in the subsequent quarters, but it gives you a feel). $18 billion of the $60 billion DTL ( about 30% again as of 12/2018) is related to unrealized gains on the equity portfolio. About 50% ($28/$60 billion) relates to property plant and equipment. This is associated with Berkshire Energy and Burlington Northern. This is helpful
https://ftalphaville.ft.com/2016/04/29/2160510/warren-buffett-a-dream-deferred/

Essentially, the key input for determining the "correct" cash tax rate for the railroad and utility is if they are able to keep increasing their ability to re-invest. Will they keep the asset base high such that they keep running on the treadmill of outspending depreciation expense.

Burlington Northern's D&A is about $2.3 billion / year. It's capex has been $2.6B (2010) - $5.6B (2015) and averaged above $3B or so, so a delta between the cash tax rate and income tax expense rate appears sustainable for now.

Berkshire Energy's depreciation is running at about $3 billion. It's capex is running at $6 billion (2010: $2.5 billion, 2014: $6.5 billion, LTM: $6 billion). Again there appears to be a sustainable difference between capex and depreciation.

I think that explains the high level, but I could be wrong on the exact particulars.

Honestly, I don't pay a whole lot of attention to it. I just use what the market values class 1 railroads and large high quality utilities as proxies for value for each of those and assume that Berkshire doesn't sell all of its unrealized investments at a gain very quickly. My rang of intrinsic value is squishy and my sizing is non-binary so being super precise on that hasn't been an emphasis for me.
Title: Re: 2018 Valuation
Post by: cubsfan on September 09, 2019, 08:25:09 AM
Pupil - wow, what a great explanation. Thank you!
Title: Re: 2018 Valuation
Post by: Dynamic on September 09, 2019, 09:38:43 AM
Seconded. Thanks pupil
Title: Re: 2018 Valuation
Post by: thepupil on September 09, 2019, 10:02:33 AM
thinking about it some more, the key is actually can each of those (BE and BNSF) outspend their tax depreciation, not their accounting depreciation....I think.

Anyways, I know why the difference exists, but am not rigorous enough to project how that will change over time, because I more or less choose to value those subs on comps at market value in base case NAV and haircut them in the bear case NAV.
Title: Re: 2018 Valuation
Post by: Okonomen on September 09, 2019, 02:42:26 PM
The delta between the cash paid for taxes and income tax expense relates to the increase in the deferred tax liability.

the deferred tax liability has 2 major components:

1. Increase in DTL related to unrealized gains on investments: To the extent that Berkshire defers realization of gains indefinitely on large positions (I think this applies to some, but not all of the material equity positions), we can assume that this tax expense has very low present value.

2. Increase in DTL related to the companies, primarily  Burlington Northern and Berkshire Energy.

Page 96 of the most recent 10-K shows the breakdown between the two (obviously things will change in the subsequent quarters, but it gives you a feel). $18 billion of the $60 billion DTL ( about 30% again as of 12/2018) is related to unrealized gains on the equity portfolio. About 50% ($28/$60 billion) relates to property plant and equipment. This is associated with Berkshire Energy and Burlington Northern. This is helpful
https://ftalphaville.ft.com/2016/04/29/2160510/warren-buffett-a-dream-deferred/

Essentially, the key input for determining the "correct" cash tax rate for the railroad and utility is if they are able to keep increasing their ability to re-invest. Will they keep the asset base high such that they keep running on the treadmill of outspending depreciation expense.

Burlington Northern's D&A is about $2.3 billion / year. It's capex has been $2.6B (2010) - $5.6B (2015) and averaged above $3B or so, so a delta between the cash tax rate and income tax expense rate appears sustainable for now.

Berkshire Energy's depreciation is running at about $3 billion. It's capex is running at $6 billion (2010: $2.5 billion, 2014: $6.5 billion, LTM: $6 billion). Again there appears to be a sustainable difference between capex and depreciation.

I think that explains the high level, but I could be wrong on the exact particulars.

Honestly, I don't pay a whole lot of attention to it. I just use what the market values class 1 railroads and large high quality utilities as proxies for value for each of those and assume that Berkshire doesn't sell all of its unrealized investments at a gain very quickly. My rang of intrinsic value is squishy and my sizing is non-binary so being super precise on that hasn't been an emphasis for me.

Thanks for a great explanation. On (1) it seems like in a valuation one should not subtract the DTL on investments as it seems fair to assume that BRK will never ever sell their portfolio securities?

On page K-96 in the BRK AR 2018 we can see the detailed deferred tax net liability.

If I may ask, what would you assume in a BRK valuation? 25% tax on current pretax earnings + subtraction of the net tax liability? Some day it will reverse due to accelerated depreciation that cannot go on forever, but this will also boost accounting earnings. I just think this sounds somewhat too conservative
Title: Re: 2018 Valuation
Post by: thepupil on September 09, 2019, 02:54:24 PM
I would value BNSF and BE separately and not have to deal with this issue outside of that. I value them at UNP and XLU multiples (earnings/revenue/tangible book/book etc.) and multiply by 0.5x and 0.75x for scary bear case and bear case. 1.0x for "the market's assessment for what this type of business is worth". Throughout my ownership of Berkshire (about 8 years) Berkshire has traded at a discount to NAV (when I mark up BE and BNSF) and been growing earnings faster than the market. I piggy back off others work for thoughts on the quantum of that discount.

I discount the DTL related to securities almost completely. KO and WFC won't be sold. losses from new stock picks can be realized to realize other winners). Berkshire is my and my family's largest postition, so I care a lot about the company, but I jsut don't spend time on figuring this type of stuff out (25% tax rate or 18% tax rate or 10% tax rate.

Sorry. the US corp rate is 21%, so I'd just take that and apply some haircut.

valuation is a range, not a point, as are earnings.
Title: Re: 2018 Valuation
Post by: Okonomen on September 10, 2019, 10:28:29 AM
I would value BNSF and BE separately and not have to deal with this issue outside of that. I value them at UNP and XLU multiples (earnings/revenue/tangible book/book etc.) and multiply by 0.5x and 0.75x for scary bear case and bear case. 1.0x for "the market's assessment for what this type of business is worth". Throughout my ownership of Berkshire (about 8 years) Berkshire has traded at a discount to NAV (when I mark up BE and BNSF) and been growing earnings faster than the market. I piggy back off others work for thoughts on the quantum of that discount.

I discount the DTL related to securities almost completely. KO and WFC won't be sold. losses from new stock picks can be realized to realize other winners). Berkshire is my and my family's largest postition, so I care a lot about the company, but I jsut don't spend time on figuring this type of stuff out (25% tax rate or 18% tax rate or 10% tax rate.

Sorry. the US corp rate is 21%, so I'd just take that and apply some haircut.

valuation is a range, not a point, as are earnings.

Thanks for the insights!

What I don't get is why Pershing Square, who recently initiated a position, thinks that nearly half of BRK's IV is from their insurance ops. When I do the calculations I get no where near that value for the insurance ops. They generate around 2 bio. USD in pretax earnings (underwriting profits) through Geico, GenRe, BH etc and by looking at peers a 17x multiple seems fair on their after tax earnings so approx 25 bUSD assuming 25% tax. Last comes the float where I only look at it as a fixed income play and I do not consider dividends from their equity portfolio. So let's say: 123 bio. USD float generating 2% after tax interest and the float grows by 7% a year so that makes: (123 bUSD * 0,02)/0,07 = 35 bio. USD. So a combined 60 bio. USD and thus no way near half of the IV. Am I missing some major insights regarding their insurance ops?
Title: Re: 2018 Valuation
Post by: thepupil on September 10, 2019, 10:34:50 AM
they are including the equity portfolio, fixed income portfolio and cash,  as part of the insurance operations.

Since the end of 2007, we estimate that Berkshire has averaged a nearly 7% annual rate of return on its insurance investment portfolio while holding an average of 20% of its portfolio in cash. Berkshire has been able to produce investment returns that significantly exceed its insurance company peers as the combination of the company’s long-duration float and significant shareholders’ equity allow it to invest the substantial majority of its insurance assets in publicly traded equities, while its peers are limited to invest primarily in fixed-income securities. We believe these structural competitive advantages of Berkshire’s insurance business are enduring and will likely further expand.
Title: Re: 2018 Valuation
Post by: Okonomen on September 10, 2019, 03:34:16 PM
they are including the equity portfolio, fixed income portfolio and cash,  as part of the insurance operations.

Since the end of 2007, we estimate that Berkshire has averaged a nearly 7% annual rate of return on its insurance investment portfolio while holding an average of 20% of its portfolio in cash. Berkshire has been able to produce investment returns that significantly exceed its insurance company peers as the combination of the company’s long-duration float and significant shareholders’ equity allow it to invest the substantial majority of its insurance assets in publicly traded equities, while its peers are limited to invest primarily in fixed-income securities. We believe these structural competitive advantages of Berkshire’s insurance business are enduring and will likely further expand.

Thanks for the input! So it's insurance ops earnings (around 1,5 bUSD after tax with multiple X) + return on float (around 3 bUSD ex portfolio dividends with multiple X) + market portfolio value (215 bUSD) + cash (around 100 bUSD excess cash) and thus with no regards to the float value of 123 bUSD other than what it can produce in returns afaik