2018 Valuation

[Lemsip]

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.

[rolling]

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.

[investmd]

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.

[longinvestor]

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...

[wachtwoord]

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.

[AdjustedEarnings]

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.

[rolling]

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

[AdjustedEarnings]

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).

[rolling]

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.

[aws]

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.