Author Topic: berkshire - cheap?  (Read 77626 times)

cubsfan

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Re: berkshire - cheap?
« Reply #30 on: July 17, 2017, 06:11:24 PM »
Do you remember how long ago that was? Reason I ask is the basket has changed significantly since 2009. Was that statement made pre-2009?

I'm pretty sure it was 2012 meeting.


rb

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Re: berkshire - cheap?
« Reply #31 on: July 17, 2017, 06:17:43 PM »
It would have been in the 2011-2014 period.

As with everything WB says he says keep it in perspective. 14x pre tax is a very generic multiple. If you asked me what a US based company is worth without telling me the company I'd say about 14x pre tax. Let me demonstrate:

Take a hurdle rate of 9% (4% for risk free + 5% risk premium), US GDP growth will be about 4%, assume earnings growth will match GDP, and say a tax rate of about 30%. Throw that into a DCF and TADA!: you get a valuation of about 14x pre tax.

LC

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Re: berkshire - cheap?
« Reply #32 on: July 17, 2017, 06:57:54 PM »
Well you count the securities per share but ignore the associated liability that finances those assets. Under this method every insurance company, indeed every financial institution on the planet is grossly undervalued.
Isn't Berkshire generally posting underwriting profits, though? Their float is being paid for because they are better underwriters than other institutions. To other firms the float is a liability but for Brk it is an asset, or at least that is how I understand it.
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rb

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Re: berkshire - cheap?
« Reply #33 on: July 17, 2017, 07:16:48 PM »
No LC. You could capitalize the underwriting profits in the valuation, which Slow Appreciation did. But that comes nowhere near to cancelling the liability.

Let me put it this way. As sure as the sun will come up tomorrow, a tiny part of that float is a payment that GEICO has to make to a body shop in the next week to pay for work that was done on John's car, because John got into an accident 2 weeks ago. Is that payment an asset or a liability to Berkshire? The float is made up of thousands examples like this spread out over time.

Let me put it another way. Let's say that you have insurance company A which has a consistent total ratio of 100.01% and insurance company B which has a consistent total ratio of 99.99%. Does A have a float liability and B have a float asset, thus making B way more valuable than A? Of course not.

Berkshire's present value of float is less then book. But it is still a huge liability and should not be ignored when valuing Berkshire.

longinvestor

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Re: berkshire - cheap?
« Reply #34 on: July 17, 2017, 07:44:08 PM »
No LC. You could capitalize the underwriting profits in the valuation, which Slow Appreciation did. But that comes nowhere near to cancelling the liability.

Let me put it this way. As sure as the sun will come up tomorrow, a tiny part of that float is a payment that GEICO has to make to a body shop in the next week to pay for work that was done on John's car, because John got into an accident 2 weeks ago. Is that payment an asset or a liability to Berkshire? The float is made up of thousands examples like this spread out over time.

Let me put it another way. Let's say that you have insurance company A which has a consistent total ratio of 100.01% and insurance company B which has a consistent total ratio of 99.99%. Does A have a float liability and B have a float asset, thus making B way more valuable than A? Of course not.

Berkshire's present value of float is less then book. But it is still a huge liability and should not be ignored when valuing Berkshire.

From the AR,

So how does our float affect intrinsic value? When Berkshire’s book value is calculated, the full amount
of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to
think of float as a typical liability is a major mistake. It should instead be viewed as a revolving fund. Daily, we
pay old claims and related expenses – a huge $27 billion to more than six million claimants in 2016 – and that
reduces float. Just as surely, we each day write new business that will soon generate its own claims, adding to
float.
If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this
liability is dramatically less than the accounting liability. Owing $1 that in effect will never leave the premises –
because new business is almost certain to deliver a substitute – is worlds different from owing $1 that will go out
the door tomorrow and not be replaced. The two types of liabilities, however, are treated as equals under GAAP.
A partial offset to this overstated liability is a $15.5 billion “goodwill” asset that we incurred in buying
our insurance companies and that is included in our book-value figure. In very large part, this goodwill represents
the price we paid for the float-generating capabilities of our insurance operations. The cost of the goodwill,
however, has no bearing on its true value. For example, if an insurance company sustains large and prolonged
underwriting losses, any goodwill asset carried on the books should be deemed valueless, whatever its original
cost.
Fortunately, that does not describe Berkshire. Charlie and I believe the true economic value of our
insurance goodwill – what we would happily pay for float of similar quality were we to purchase an insurance
operation possessing it – to be far in excess of its historic carrying value. Indeed, almost the entire $15.5 billion
we carry for goodwill in our insurance business was already on our books in 2000 when float was $28 billion.
Yet we have subsequently increased our float by $64 billion, a gain that in no way is reflected in our book value.
This unrecorded asset is one reason – a huge reason – why we believe Berkshire’s intrinsic business value far
exceeds its book value.

LC

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Re: berkshire - cheap?
« Reply #35 on: July 17, 2017, 08:04:01 PM »
Rb: I don't understand your point (then again I am pretty dense...)

If we take your example of company A (underwriting losses) and B (underwriting gains) and simplify the problem:

Imagine they both write their first business today.
Let's remove all investments of the float, assume they only hold cash.

Let's go forward 1000 years of this behavior, and then look at the companies.

Company A will now be bankrupt due to underwriting losses. Company B will have printed money continuously.

If we go back to time zero, we see the underwriting performance of A to be a huge liability which has wiped out the company, but a huge asset to B.
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rb

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Re: berkshire - cheap?
« Reply #36 on: July 17, 2017, 08:36:04 PM »
Rb: I don't understand your point (then again I am pretty dense...)

If we take your example of company A (underwriting losses) and B (underwriting gains) and simplify the problem:

Imagine they both write their first business today.
Let's remove all investments of the float, assume they only hold cash.

Let's go forward 1000 years of this behavior, and then look at the companies.

Company A will now be bankrupt due to underwriting losses. Company B will have printed money continuously.

If we go back to time zero, we see the underwriting performance of A to be a huge liability which has wiped out the company, but a huge asset to B.
Yes I think you're misunderstanding what I'm trying to say. First of all no insurance company would just keep their float in cash. Secondly, I think there's some confusion around the words asset and liability where you're thinking more of a figurative sense of the words and I'm saying more of the financial sense of the words.

Let me clarify my A and B example a bit more by adding a couple more assumptions. 1: Both companies are behaving like insurance companies and the float is invested in a diversified portfolio of bonds and stocks. 2: Lets assume that both companies have floats of 100 billion.

I know my example is a bit extreme but it's so for a reason. Basically what i was trying to get with my example is that the financial performance of the two companies is essentially the same. Because one has a perpetual underwriting profit makes it a bit more valuable than the other which has a perpetual underwriting loss. But perpetual underwriting profits do not vanish a float liability which in my (updated) example would mean that one company is $100B more valuable than the other. Obviously incorrect.

Also if that were true then a hot stock tip: Progressive has had an underwriting profit for at least 10 years. Take out float liability and it's trading at 1/2 book. Happy days!

Basically, the quote from WB in the AR is spot on. All that means as I've been saying is that float is less then book but still a meaningful liability for BRK. I actually like this discussion because I've been thinking and struggling for a while to get to a good model to discount BRKs float. I hope this thread will help me get closer.

Final thought. If float was an asset rather then a liability then it means it has financial value. In turn that means the someone is willing to pay BRK to have those obligations taken off their hands. Obviously not true. There's nobody there, and WB would agree to that deal in a second. In fact large chunks of BRK float are made up of the obligations of other insurance companies that BRK took over. However those companies paid BRK (handsomely?) to do that.

Jurgis

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Re: berkshire - cheap?
« Reply #37 on: July 17, 2017, 08:53:59 PM »
Great post, rb.
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LC

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Re: berkshire - cheap?
« Reply #38 on: July 17, 2017, 09:01:26 PM »
I've got a couple of thoughts but it's a bit late here so I'll put one here and mull over the rest for tomorrow. The reason I took out the investing portion when comparing 2 insurance companies is this:

Imagine an insurance company with negative underwriting profits. They are essentially a leveraged investment company. They pay X% for financial obligations, and try to invest to make X+Y%. The only value they add is via investing.

Take away their investing arm, and they will eventually drown. So their only real asset is their ability to invest profitably.

So why write insurance business? To grow AUM. So we can think of the liability associated with float as the cost for an investment manager to increase their AUM.

So if we look at it from that perspective, let's go back to underwriting profitably. Imagine investing with a fund manager. You pay him a % to invest with him. At some point you will redeem your investment, but when is that a REAL liability to his business? I can think of 3 scenarios:
-your clients will all jump ship in a crisis
-your performance is consistently just plain bad

and most importantly,
-your cannot replace any leaving AUM

Maybe I'm rambling but that's a thought I had.
« Last Edit: July 17, 2017, 09:09:25 PM by LC »
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longinvestor

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Re: berkshire - cheap?
« Reply #39 on: July 17, 2017, 09:27:14 PM »
I'm no accountant.

Can someone build a simple model for what Buffett calls "dramatically lower liability to GAAP" replacing the word "dramatic" with ratios between 0.1 to 0.9 of GAAP reported liability and offset the goodwill $15.5B and the "float growth capability acquired using that goodwill resulting in $64 Billion of additional float since 2000 that in no way is reflected in the book" and what is the range of additional IV we are talking about.

I'm getting ridiculous numbers, enough to keep me awake!

« Last Edit: July 17, 2017, 09:34:50 PM by longinvestor »