Author Topic: BRK-A book value and intrinsic value  (Read 26833 times)

longinvestor

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Re: BRK-A book value and intrinsic value
« Reply #20 on: February 26, 2017, 04:44:11 PM »
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The gap between MV and BV shall increase over time.

The gap between BV and intrinsic value (IV) will increase over time as Buffett pointed out in the AR. However % change in BV most likely will track % change in IV over the long term while the absolute difference between BV and IV will continue to grow. Thus % change in BV is still a good proxy for % change in IV. Assuming MV tracks IV over long periods of time, you can actually see this phenomenon at work in longinvestor's table.

Estimating IV of BRK is fraught with uncertainty; assumptions needed makes it so.

MV and IV absolutely converge; over the very long term. In their 50th year letter, they clearly state this. The only catch with using MV is it is backward looking! I believe that the earnings growth as presented newly in this year's AR is a much better proxy for IV. But again, it takes us to using proper multiples etc. 

BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers. Why I say so: the absolute $ of retained earnings over the past 10 years is significantly different from their prior 40 years of existence. You can see this from the Shareholder's equity table (page 39); Current balance is $211,777; 2005:$47,717; So roughly 80% of all historical retained earnings have been retained in the last 10 (last 7 heavily); This marked non-linearity being played out surely adds to the BV distortion in the future, but I don't know exactly how; someone with a stronger accounting knowledge can weigh in. 
« Last Edit: February 26, 2017, 04:47:34 PM by longinvestor »


Munger_Disciple

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Re: BRK-A book value and intrinsic value
« Reply #21 on: February 26, 2017, 04:58:34 PM »
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MV and IV absolutely converge; over the very long term.

Of course, I agree. But year to year, MV varies wildly as evidenced by -12.5% return in 2015 and +23.4% in 2016 unlike intrinsic value. But over the very long term, they do converge as we can see from the table on page 2 of AR.

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BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers.

I think % change in BV will continue to work as a proxy for % change in IV imo. If Berkshire has a loser that goes to 0, both BV and IV of the loser go 0.
« Last Edit: February 26, 2017, 05:00:39 PM by Munger_Disciple »

longinvestor

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Re: BRK-A book value and intrinsic value
« Reply #22 on: February 26, 2017, 05:07:37 PM »
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MV and IV absolutely converge; over the very long term.

Of course, I agree. But year to year, MV varies wildly as evidenced by -12.5% return in 2015 and +23.4% in 2016 unlike intrinsic value. But over the very long term, they do converge as we can see from the table on page 2 of AR.

Quote
BV worked as a proxy and may still work now; But the accounting distortion (winners/losers) makes it less useful over the next 25 years (I think). Especially if they have a lot of big winners and few losers.

I think % change in BV will continue to work as a proxy for % change in IV imo. If Berkshire has a loser that goes to 0, both BV and IV of the loser go 0.

How about winners? If a winner goes up 20x purchased price, BV remains 1x; Geico is the example Buffett talks about. How about when Geico goes to 100x?

Munger_Disciple

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Re: BRK-A book value and intrinsic value
« Reply #23 on: February 26, 2017, 05:17:36 PM »
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How about winners?

In the case of winners as a whole, both the BV and IV increase. BV increases because of the reinvested earnings. IV increases due to the return on those reinvested earnings (in other words, earnings power of the entity increases). But the ratio of IV/BV remains fairly steady. If the return on incrementally reinvested earnings is above average, one dollar of added book value will increase IV by more than one dollar.

Cigarbutt

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Re: BRK-A book value and intrinsic value
« Reply #24 on: February 26, 2017, 06:11:28 PM »
I’m new here and already ready to duel!
Sorry longinvestor and Valuehalla, I disagree here. In a way, this is a relatively minor point because, as value investors, we have to come up with a range of intrinsic values for an investment but a P/B ratio is useful and the way to come to « adjusted » ratios is important. Let’s dissect this. You seem to imply that, using BRK as a reference, P/B will significantly rise over time. Mr. Buffett’s comments seem to imply this also. He explains the disconnect between devaluations which need to be recognized and revaluations which are not, at the controlled subsidiary level.
True but, with all due respect,  I think that this « disconnect » or « overage » is much much smaller than is implied here.
Here’s my take. Apologies, I cannot be clear and concise like Munger_Disciple but I hope to improve.
For the « first half », it is said that book value approximated the value of marketable securities which were marked to market. Isn’t it common acceptance that Mr. Buffets holdings then were under-valued or at least fairly valued by the markets? My understanding is that Mr. Buffett’s record did not happen because of his tendency to buy and hold over-valued securities.  Implying then that the capacity to build a portfolio of undervalued securities warrants perhaps some kind of premium to BV. That notion points in the opposite direction of a « disconnect » for the « first half ».
More importantly though, the notion of goodwill (recognized or not) means that the earning power is superior to stated tangible book value. For the superior subsidiary itself, overtime, the gap between its book value and reported earnings clearly get « disconnected » and gets wider with time. See’s was a spectacular example of that. However, this unrecognized earning power, over time, will get recognized by the entity controlling the subsidiary, ie BRK. The extra cash is sent to the head office. Remember BRK’s  equity is largely retained earnings. They have not distributed dividends. They have never bought back stock at a high premium and when they issued stock, WB and CM always underlined that they aimed to issue at around fair value.  Of course, if you use this extra cash to buy other assets that are undervalued, there will be a tendency (especially if you pay less than IV) for the gap to grow, to some and limited extent, but, like a growing deferred depreciation liability, it will have an underlying tendency to reverse. I would submit also that, over time and perhaps especially for the more recent period, BRK purchased acquisitions by paying at least a moderate amount of goodwill/intangibles (think PCC, Duracell and others).
What are the numbers saying?
Let’s compare the CAGR (geometric) of BV vs IV for two periods :
The non « disconnect » period from 1965 to 1990       BV   23.1%     MV   28.7%
The « disconnect » period  from 1991 to 2016            BV   15.3%     MV   13.7%
The numbers suggest actually the opposite ie the disconnect, as recognized by the market for BRK shares, was more important when BRK was putting more emphasis on securities versus outright purchases. (!)
My take is that over time growth in BV for BRK should approximate closely growth in IV (as measured by the market or by more objective measures of IV over long periods of time). What Mr. Buffett describes is a very interesting concept and, at the margin, may create an unrecognized premium but, as the above reasoning and calculations above show, I submit that this effect is small and not significant for instance in relation to Mr. Market’s expectations.  In my humble opinion, the first 26 years were characterized by the Mr. Market’s recognition of the potential for BRK to continue to compound at a high rate, whereas, the last 26 years (especially since 2000) were characterized by lower expectations because, among others, of the sheer size that BRK reached.
With all due respect, I submit that, for BRK, it may not be reasonable to expect a widening gap between book value and price on a ratio basis.
It is interesting to note that, if this notion of a widening gap would apply, BRK’s policy of stock buyback at progressively  higher P/B ratios has never been documented or discussed.
                                   

SlowAppreciation

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Re: BRK-A book value and intrinsic value
« Reply #25 on: February 27, 2017, 07:23:29 AM »
So I get around $290k/share for BRKA and $192/share for BRKB, which means BRK is still trading at ~13% discount to IV.

I just apply a 10x multiple on the operating businesses, though each group probably deserves a slightly different multiple.

Operating Earnings
  • Underwriting: $2.1b
  • BHE: $2.7b
  • BNSF: $5.7b
  • MSR: $8.4b
  • Financial Product: $2b
  • Total Operating Earnings: $21b @10x multiple = $210b

Cash & Investments
  • Cash: $86.3b
  • Investments: $120.4b
  • Fixed Income: $23.8b
  • Preferred/Warrants/KHC: $32.6b
  • Total Investments: $263.3b

$210b + $263b = $473b
current Mkt cap = $420b
Discount to IV = 13%

Valuehalla

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Re: BRK-A book value and intrinsic value
« Reply #26 on: February 27, 2017, 10:24:42 AM »
Hi Cigarbutt, I agree with most what you write. Maybe there is a misunderstanding. The BV is for me just one lighttower among others on the investmentocean.

If the MV is below the BV (or maybe below BV + adjusted 20% or maybe + adjusted from year to year plus a little % more) we just buy in this case 1$ for less than 1 $.

If the MV is above BV + adjustment, my next or better additional lighttower is the IV, referring to future earningpower.

Every investment decision is also always your personal subjective decision: You have to compare it with YOUR individual other opportunities. Also imo you shall understand and like the businessmodel and management, as a fundamental.

« Last Edit: February 27, 2017, 10:27:05 AM by Valuehalla »
BRK FFH MKL LVLT CTL BAC WFC BMY MRK MCD MO PM

Cigarbutt

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Re: BRK-A book value and intrinsic value
« Reply #27 on: February 27, 2017, 10:39:00 AM »
Valuehalla,
Fair enough.

Valuehalla

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Re: BRK-A book value and intrinsic value
« Reply #28 on: February 27, 2017, 05:55:06 PM »
Cigarbutt, let me add something concerning the subject "first half" and "second half": In "first half" we do not need an adjustment on BV to find a minimum line, but it is useful for the "second half": we need it, but its maybe a method like someone use a kitchenknife to amputate a blind gut, instead of a surgeon who does it in a delicate way. So the adjustment of 20 % is just a point of orientation. I think the more BRK grows in the way it has done in the second half, the 20 % shall be increased a little bit year by year.

In consequence of this (BV+20%) see page 6 of the letter:

"The authorization given me does not mean that we will “prop” our stock’s price at the 120% ratio. If
that level is reached, we will instead attempt to blend a desire to make meaningful purchases at a value-creating price with a related goal of not over-influencing the market"

BV+ 20 % is a soft initial-point, let me call it lighttower  8) Its light is the bargain-flashlight of BRK. The more closer MV comes to our lighttower, the more you can be sure to buy BRK is a good decision.

But take as an advise from longtime holder, whatever the MV is...over the time : BRK was, BRK is and BRK will be a good investment.
« Last Edit: February 27, 2017, 06:14:36 PM by Valuehalla »
BRK FFH MKL LVLT CTL BAC WFC BMY MRK MCD MO PM

Cigarbutt

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Re: BRK-A book value and intrinsic value
« Reply #29 on: February 28, 2017, 05:41:11 AM »
Valuehalla,
This may rapidly turn into a circulation discussion. I respect your position.
Amen to your last line. If everybody had invested in BRK in 1965, all would be at least a 100x richer ?!
One of Mr. Buffett's messages is that a small difference over time can make a big difference. I like snowballs too.
Are you aware of the rice bet and chessboard story?
If interested, here is a link: http://www.singularitysymposium.com/exponential-growth.html
The recurrent compounding that you refer to (gradually increasing difference between BV and IV) is much less than 100% per year. But small differences do matter. With a 2.8% (20.8-19.0) difference of MKT performance vs BV, over 52 years, BRK achieved a return differential of 1,088,276% (1,972,595-884,319)! So, compounding with no end in sight makes me uncomfortable especially without a defined rational basis. I tend to think that trees don't grow to the sky.
I hope I did not insult you with my exaggerated example. We're all going after the truth, aren't we?