Author Topic: berkshire - cheap?  (Read 78690 times)

rb

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Re: berkshire - cheap?
« Reply #40 on: July 17, 2017, 09:45:08 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 "$64 Billion of float growth capability acquired using that goodwill since 2000 which is in no way captured 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!
Well that's the million dollar question isn't it? Btw, I don't think accounting has anything to do with it.

Let me propose another thought experiment. Because i think the underwriting profit murks the waters a lot. Let's put BRK in an underwriting loss. So I'll give BRK a 2 billion underwriting loss as opposed to 2 billion profit. Through my newfound powers I'll also increase the return of the securities portfolio by 4 billion a year. Ignore the tax effects and all other peculiarities.

In this case basically the profitability of BRK doesn't change. So it's value doesn't not change. Should make analysis easier though.


LC

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Re: berkshire - cheap?
« Reply #41 on: July 17, 2017, 09:56:18 PM »
It's value may change. All earnings are not created equal. If you think their underwriting earnings are more or less valuable than their investment portfolio earnings, then I would think their value would change.
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longinvestor

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Re: berkshire - cheap?
« Reply #42 on: July 17, 2017, 10:05:08 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 "$64 Billion of float growth capability acquired using that goodwill since 2000 which is in no way captured 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!
Well that's the million dollar question isn't it? Btw, I don't think accounting has anything to do with it.

Let me propose another thought experiment. Because i think the underwriting profit murks the waters a lot. Let's put BRK in an underwriting loss. So I'll give BRK a 2 billion underwriting loss as opposed to 2 billion profit. Through my newfound powers I'll also increase the return of the securities portfolio by 4 billion a year. Ignore the tax effects and all other peculiarities.

In this case basically the profitability of BRK doesn't change. So it's value doesn't not change. Should make analysis easier though.

BTW, Buffett did not say that the float was an asset. It is just a dramatically lower liability than GAAP suggests.

Also, Goodwill of $15.5B came about in 2000 because of acquisition of GenRe (I think)? Also, my understanding is that many of Jain's policies written end up being costless and claimless!  Like the March Madness, Hole in one's etc. You collect, wait out the event, no? If there is ever a payout it gets paid over a very long time. Think Lloyds. I believe Buffett uses the term "long enduring" in this sense. 
« Last Edit: July 17, 2017, 10:12:21 PM by longinvestor »

thelads

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Re: berkshire - cheap?
« Reply #43 on: July 18, 2017, 02:15:01 AM »
Apologies in advance, as what I am about to propose may well be wrong. But I think of this simply as a choice of liability. It has debt like qualities, and is a source of financing. The point I think Buffett is making is that this is a long lived liability. Like a revolving credit facility, but one that is drawn almost all the time and whose size stays constant or grows. The alternative source of financing could be debt or equity, but both are higher cost. I have no idea what the right average life or duration of this liability should be, though if we look back to 1995, the float has only grown at GEICO, so you can say its at least 20 years. Probably a lot longer, but that depends on your view of automous driving, etc, other things affecting float. But just for arguments sake, lets say the right proxy is a 30 year bond as a replacement for float. What yield would need to be paid on that? Not just today, but in a normal environment? Even if we took a conservative price of say 2.5%, with a 30 year, zero coupon bullet bond, the fair value of such float (if labeled as a bond instead) would be ~50 cents on the dollar.

I may be wrong, but I think this is roughly the calculation he is doing, though what tenor as a proxy he uses, and what cost of debt, I don't know. But this also matches his comment that the float value is lower in a ZIRP world. All very intuitive I think also, but with this framework you can at least put a range of value on things. You can build a quick bond calculator to test this yourselves. It is obviously very sensitive to the interest rate you use. Obviously there is substantial value to growth in the float too.

The other thing that is really nice about float as a form of financing is that it is uncorrelated to other sources of financing, is non recourse, and doesn't have covenants or knock outs associated (except in a big tail event) - all of which allows WEB to operate counter cyclically even more so than he would otherwise.

John Hjorth

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Re: berkshire - cheap?
« Reply #44 on: July 18, 2017, 02:46:12 AM »
Great discussion - thank you all,

- - - o 0 o - - -

I think I read somewhere in the past, that Bershire lags analyst coverage... - not! It's actually one of the best covered companies in the world! - due to this board! That's meant as a compliment to my fellow board members!

- - - o 0 o - - -

Personally, I have a habit of thinking of the float and the deferred taxes in the Berkshire balance sheet as financial obligations basically free of interest [without discounting them], however the nature of those obligations separately are very different, and and the same time a bit similar.

I have never moved myself into the for me mentally unknown territory to try to estimate their net present value. If I should try to do it with the float, I would most likely use the provision triangles that we have access to from the 10-Ks, and try to discount the payouts using a WACC.

This approach is basically a calculation based on a liquidation perspective of the liability, based on hindsight [histocal experience] projected to the future, the provision triangles are naturally dynamic over time etc.etc.

After all, what rb is pursuing, is a method for doing a rough estimate of the overall discount to apply to the Berkshire float, so I think - with all the flaws inherent in this method - that it's better to try that than just doing nothing, if you're pursuing to do the discount.

Edit:

The percentage table on lower part of p. 91 in the 2016 10-K will be where to start, and then decompose total float on GEICO, Gen Re, BHRG & BH Primary to do the math.

Edit 2:

Total float year end 2016 is stated to USD 91.6 B, ref. the February 25 2017 Press Release. At p. 87 at the top in the 2016 10-K  there is a specification of the part of the float, totalling USD 76.918 B, ref. that separate post in the Berkshire balance sheet year end 2016.
« Last Edit: July 18, 2017, 05:19:37 AM by John Hjorth »
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vinod1

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Re: berkshire - cheap?
« Reply #45 on: July 18, 2017, 05:14:52 AM »
“[If] I were offered $7 billion for [$7 billion of] float
and did not have to pay tax on the gain, but would
thereafter have to stay out of the insurance business
forever—a perpetual noncompete in any kind
of insurance—would I accept that? The answer is
no. That’s not because I’d rather have $7 billion of
float than have $7 billion of free money. It’s
because I expect the $7 billion to grow.”

—Warren Buffett, 1996 Annual Shareholders’
Meeting, as quoted in Outstanding Investor Digest.

“If you could see our float for the next 20 years and
you could make an estimate as to the amount and
the cost of it, and you took the difference between
its cost and the returns available on governments,
you could discount it back to a net present value.”

—Warren Buffett, 1992 Annual Shareholders’
Meeting, as quoted in Outstanding Investor Digest.


I wrote up BRK in 2010, here is the extract related to the float valuation:

The key question concerns the value of float. Float is money an insurance company holds but does not own. Float arises because premiums are received before losses are paid and this interval can be of several years. During this interval, the insurer can invest the money for its own gain. The premiums are often not sufficient to cover all the costs and insurance company has to part with some of the returns generated out of float to make up for the shortfall.

To get an understanding of the theoretical basis for assigning value to float, let us take an example. Assume you are offered the following proposition: You are offered $100 to be paid back after the end of 50 years. You do not have to pay any interest and also get to keep all the money earned in the interim from investing the $100. The only restriction is that you can only invest in high quality investment grade bonds and treasuries.

How much would a smart business man be willing to pay for such an offer? If you can estimate the market rates of interest for long term bonds are going to be about 4% then the business man should be willing to pay about $86. (The business man can invest $14 at 4% for the 50 year period to end up with $100.)

Of course, the business man would not go through the trouble of investing to end up with no profit so he is going to offer something a little lower to make relatively low risk profit.

Insurance float for Berkshire is a lot like this example with few additional benefits. First, the $100 amount is likely to grow around the nominal GDP growth rate of 4-5%. Second, as long as the business is not wound up there is no need to pay back the $100. The effective length of the investment is longer than 50 years. Third, there is a strong possibility of getting paid something like 1-2% for the privilege of holding the money.

So what would a business man offered this proposition pay for this? It should be obvious that it would be at least $100 without even performing any complicated math.

A conservative value of this float can be calculated mathematically with a few assumptions. Assuming no growth in float in the future; that float earns at the treasury bond rate (4%); discounted at the treasury bond rate; and that the insurance segment would not liquidated in the foreseeable future; the present value of the float is simply the amount of float i.e. $100 using the constant growth dividend model.

There are two caveats to this calculation of the value of float.

(1) Shareholder incurs an additional cost for the float through an insurer due to tax penalty. This cost has been estimated at around 1% by Buffett.

(2) There is uncertainty in the true cost of float as it a near certainty that there would be periods of underwriting losses. Both these complications however should not alter the final value in the above calculation as it would be possible to conservatively earn enough above the Treasury bond rate on the float to mitigate this additional cost.

Vinod

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racemize

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Re: berkshire - cheap?
« Reply #46 on: July 18, 2017, 05:27:15 AM »
The issue here is that this would add one or two hundred billion to berkshire IV, but the market simply doesn't value Berkshire or any insurance this way. Or saying it another way, this boost in value now would likely come at an extreme cost in value growth in the future.

vinod1

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Re: berkshire - cheap?
« Reply #47 on: July 18, 2017, 05:33:04 AM »
To put it more concisely, if you are given $100 today and every year going forward you would be given another $3 to $4 for the next 100 years with the caveat that you might also have to give back $3 to $5 once every 10 years (to simulate underwriting loss), what would you pay for that privilege?

I would pay $100 for that. Note that, you would get that $100 back immediately to be paid back in 100 years.

Vinod
The fundamental algorithm of life: repeat what works. –Charlie Munger

vinod1

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Re: berkshire - cheap?
« Reply #48 on: July 18, 2017, 05:42:41 AM »
The issue here is that this would add one or two hundred billion to berkshire IV, but the market simply doesn't value Berkshire or any insurance this way. Or saying it another way, this boost in value now would likely come at an extreme cost in value growth in the future.

This would only add about $90 billion in float value which the float amount at end of 2016. Part of this float value shows up in the goodwill so you have to account for that. Part is always held in cash equivalents always. This part would not have full face value. If you make these adjustments, I think the market is valuing BRK in this manner, at least implicitly from the P/BV multiple.

When you estimate value of BRK from various methods they tend to cluster together closely. So float based valuation does not radically increase BRK valuation.

Vinod
« Last Edit: July 18, 2017, 05:46:13 AM by vinod1 »
The fundamental algorithm of life: repeat what works. –Charlie Munger

longinvestor

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Re: berkshire - cheap?
« Reply #49 on: July 18, 2017, 06:54:28 AM »
The issue here is that this would add one or two hundred billion to berkshire IV, but the market simply doesn't value Berkshire or any insurance this way. Or saying it another way, this boost in value now would likely come at an extreme cost in value growth in the future.

This would only add about $90 billion in float value which the float amount at end of 2016. Part of this float value shows up in the goodwill so you have to account for that. Part is always held in cash equivalents always. This part would not have full face value. If you make these adjustments, I think the market is valuing BRK in this manner, at least implicitly from the P/BV multiple.

When you estimate value of BRK from various methods they tend to cluster together closely. So float based valuation does not radically increase BRK valuation.

Vinod

Which brings us full circle to the theme of this thread. All of the methods used to value BRK , as elegant and/or conservative have resulted in Mr. Market being wrong to grossly wrong about BRK's value. The grossest error is the use of the near universal "let's put a 10x multiple on the Pre-tax earnings". Semperaugustus comes closer than most in properly valuing Berkshire. Being elegant in paper calculations doesn't preclude being ridiculously wrong. In a world where ridiculousness is rampant to unhinged on the other side. Think FANG.

Berkshire's float is invested neither in bonds nor securties but increasingly in long lived assets, whose earnings in turn are invested in other businesses (the real estate within BHE as an example), plus arguably their own kind of deferred tax float. Buffett calls this rabbits making more rabbits.

It all adds up to the 20% earnings growth we're seeing since 1999.

Thank heavens the market is wrong!
« Last Edit: July 18, 2017, 06:56:14 AM by longinvestor »