Author Topic: BRK Valuation  (Read 14988 times)

Every Banana Counts

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Re: BRK Valuation
« Reply #20 on: June 23, 2020, 11:00:58 AM »

I think focusing on the potential downside in Berkshires valuation is a good way of thinking about it’s attractiveness today. It is unlikely that Berkshires book value will be lower in five years, and that it will also be selling at a price to book that is lower than it is today. Between 2004 - 2019 Berkshire grew it BV/ share by an average of roughly 80% over every 5 year period. During this time there has never been a 5 year period where BRK’s BV/ share has declined. Berkshire also sold at an average Price to Book of about 1.3 between the years 2013 & 2019. Warren has publicly stated that this is an attractive P/B from a valuation standpoint. To add to this point, as BRK’s fully owned businesses continue to grow the P/B BRK should be selling for should continue to grow as well. It would be reasonable to expect BRK to sell at a P/B greater in 5 years than it has typically sold in the past. Berkshire has a ton of cash, employs some amazing people, and owns many diverse businesses that provide useful & necessary services to people around the globe. Berkshire seems to me a safe place to protect your downside, and to likely make an acceptable return as well.


villainx

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Re: BRK Valuation
« Reply #21 on: June 23, 2020, 11:13:10 AM »
This part of what you mentioned Castanza is interesting:

an under performance in the short term is insignificant to me in the long term

I am similar age to you early 30's.  However, Berkshire has underperformed for a pretty long time---I believe the past 10 or so years.  If you think that underperformance continues for another 5-7 years we are at 15 years of underperformance.  Just to get back to even with VFIAX or something is no easy chore.  I am long Berkshire because I believe that it is undervalued today and things will be done sooner rather than later. Some things that come to mind off hand are buybacks and making an acquisition.

Can we move this topic to the general news?  Or new topic?  I was looking for discussion on this, what to do with BRK now, with expectation that transition sometime in future, and what that transition means, risks, rewards, etc.  I'm very curious to see what folks here think.  Part of it is that I am so completely unsure of BRK in the future without Buffett, that I've been stopping myself from adding.

Thrifty3000

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Re: BRK Valuation
« Reply #22 on: June 23, 2020, 11:31:54 AM »
At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).

Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.

I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).

For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.

bizaro86

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Re: BRK Valuation
« Reply #23 on: June 23, 2020, 11:49:26 AM »
For those mentioning precision railroading post WEB, you're assuming the BNSF management wanted to implement it but Buffett stopped them? I am having trouble believing that because Buffett is generally very hands off. So why would he get involved for this?

Maybe BNSF has a better reason not to do it, or maybe they wanted to wait it out to see how it affects customers in the rest of the industry?

I believe that is the reason given during the 2019 annual meeting. PSR is fancy jargon used by the RR majors for effing their customers.

I think there's a balance there. The idea of scheduling trains to run at a specific time vs whenever the customer wants is probably less convenient for the customers, but seems fair.

I dont expect the common carrier airlines to fly whenever its convenient for me. I either fly on their schedule or pay to fly privately.

Railroads also have historically had a bunch of unnecessary costs in the system. As an example, Hunter Harrison moved most of CP HQ staff from expensive downtown office space to a building they already owned at the rail yards.

I think the kindly neighbour vibe (from both WEB and the BNSF management) is ok, but there is some level of profit maximizing that is appropriate as well.

vinod1

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Re: BRK Valuation
« Reply #24 on: June 23, 2020, 12:27:58 PM »
At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).

Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.

I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).

For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.

Thanks for laying out the assumptions. Without knowing one's estimates of earnings, growth rate of earnings and discount rate, it is difficult to know where there is disagreement if any.

In the base case as of Q1, 2020, I have normalized earnings as $12.5 per share, excluding any earnings from float. Growth rate of 8.5%.

To me, it looks like any differences in IV estimates for BRK really boil down to

1) The value of float. This is harder to assess as it is dependent on interest rates and investment opportunities. One simple and likely very conservative way is to assume that $60-80 billion would always remain in cash and as long term interest rates may remain low for a long time, essentially are not worth much. So we end up valuing the rest of the float or about $50 billion.

Or assume it is going to earn some low rate on the total float and it ends up adding $0.5 to $1 per share.

2) The discount rate.

So you have ROE of about 8.5% which is consistent with the growth rate assumption as well with 100% earnings retention.

If you pick a discount rate of 7%, you have to have to look through 30 years to make it worth 1.5x book value.

The question I have for you is, if you assume a growth rate of 6%, why would it be worth even book value unless your discount rate is less than 6%?

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

rb

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Re: BRK Valuation
« Reply #25 on: June 23, 2020, 12:50:51 PM »
Vinod, instead of worrying about what the float will earn why don't you look at the float as a liability?

Then you can go about valuing the insurance business this way:

Investments + capitalized underwriting profits - PV of float liability - Goodwill.

Thrifty3000

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Re: BRK Valuation
« Reply #26 on: June 23, 2020, 05:21:40 PM »
At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).

Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.

I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).

For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.

Thanks for laying out the assumptions. Without knowing one's estimates of earnings, growth rate of earnings and discount rate, it is difficult to know where there is disagreement if any.

In the base case as of Q1, 2020, I have normalized earnings as $12.5 per share, excluding any earnings from float. Growth rate of 8.5%.

To me, it looks like any differences in IV estimates for BRK really boil down to

1) The value of float. This is harder to assess as it is dependent on interest rates and investment opportunities. One simple and likely very conservative way is to assume that $60-80 billion would always remain in cash and as long term interest rates may remain low for a long time, essentially are not worth much. So we end up valuing the rest of the float or about $50 billion.

Or assume it is going to earn some low rate on the total float and it ends up adding $0.5 to $1 per share.

2) The discount rate.

So you have ROE of about 8.5% which is consistent with the growth rate assumption as well with 100% earnings retention.

If you pick a discount rate of 7%, you have to have to look through 30 years to make it worth 1.5x book value.

The question I have for you is, if you assume a growth rate of 6%, why would it be worth even book value unless your discount rate is less than 6%?

Vinod

For a handful of index funds or index-like investments (aka Berkshire) that I hope to hold for decades I basically just capitalize growth in perpetuity. I know it's inelegant, but one benefit is I can do it in my head.

For Berkshire I do break down the groves in a spreadsheet, and slice and dice assumptions a number of different ways before landing on a look through earnings estimate.

(FWIW, when making an investment I assign a lot more significance to my look through earnings yield estimate than to my ability to forecast growth. Hence, Amazon hasn't made it into the 'ol portfolio just yet.)

I'm definitely comfortable with a long term BRK growth rate over 5%. The ROE, compensation structures, and capital allocation discipline ingrained in the culture give me that confidence.

(As an aside, it also doesn't hurt that:

a) Buffett pledged to give away 5% of his BRK holdings annually to the Gates Foundation
b) he is genetically hardwired to increase his wealth over the long term (with a margin of safety), so if history's greatest investor feels a minimum 5% long term growth rate for his own company is probably a safe bet, I'm more apt to accept that assumption.)

I do have trouble basing a long term growth assumption on a historical 8.5% ROE. They clearly can't reinvest organically at that rate, so it all comes down to acquisition prospects. And,

a) because the universe of sizable investment opportunities in Berkshire's circle of competence is now down to maybe a few dozen companies globally
b) because Buffett spent his entire life teaching/training an army of extremely well capitalized competitors (aka private equity) to do exactly what he does, while they're incentivized to pay higher prices, I can see scenarios where the elephant gun that used to be unloaded every 2 or 3 years, now gets shelved for 5 to 10 (or more) years at a time; leaving the next generation of management no choice but to accept lower growth while buying back shares or paying dividends.

I was comfortable with 7% last year. Now I'm more comfortable with 6%. I really really really hope it turns out to be at least 8.5%.

vinod1

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Re: BRK Valuation
« Reply #27 on: June 23, 2020, 07:05:26 PM »
Vinod, instead of worrying about what the float will earn why don't you look at the float as a liability?

Then you can go about valuing the insurance business this way:

Investments + capitalized underwriting profits - PV of float liability - Goodwill.

rb,

We can do BRK valuation different ways and I do that too. However, the only valuation approach on which I have confidence  is one based on owners earnings. When shit hits the fan, it is the only thing that gives me enough conviction on an investment. Nearly every investment mistake I made is because I misjudged earnings. I see that pattern among Buffett and other greats as well.

So my strong bias is to look at the earnings an investment can generate. Above, I am basically looking at all the earnings that BRK can generate (even though some are just look through) that accrue to the owners.

Coming back to float, you need to make some assumptions about it. Almost all the other parts of BRK are pretty simple to value. We can nit pick about the multiples a bit here and there, but there is not much ambiguity in most of the business. The thing that drives uncertainty in BRK valuation is float and its reinvestment opportunity. Even if you do not explicitly value float, you are basically making some assumption implicitly about its value. Better separate it out, that way you can change its value if something changes related to it.

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

vinod1

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Re: BRK Valuation
« Reply #28 on: June 23, 2020, 07:10:58 PM »
At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).

Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.

I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).

For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.

Thanks for laying out the assumptions. Without knowing one's estimates of earnings, growth rate of earnings and discount rate, it is difficult to know where there is disagreement if any.

In the base case as of Q1, 2020, I have normalized earnings as $12.5 per share, excluding any earnings from float. Growth rate of 8.5%.

To me, it looks like any differences in IV estimates for BRK really boil down to

1) The value of float. This is harder to assess as it is dependent on interest rates and investment opportunities. One simple and likely very conservative way is to assume that $60-80 billion would always remain in cash and as long term interest rates may remain low for a long time, essentially are not worth much. So we end up valuing the rest of the float or about $50 billion.

Or assume it is going to earn some low rate on the total float and it ends up adding $0.5 to $1 per share.

2) The discount rate.

So you have ROE of about 8.5% which is consistent with the growth rate assumption as well with 100% earnings retention.

If you pick a discount rate of 7%, you have to have to look through 30 years to make it worth 1.5x book value.

The question I have for you is, if you assume a growth rate of 6%, why would it be worth even book value unless your discount rate is less than 6%?

Vinod

For a handful of index funds or index-like investments (aka Berkshire) that I hope to hold for decades I basically just capitalize growth in perpetuity. I know it's inelegant, but one benefit is I can do it in my head.

For Berkshire I do break down the groves in a spreadsheet, and slice and dice assumptions a number of different ways before landing on a look through earnings estimate.

(FWIW, when making an investment I assign a lot more significance to my look through earnings yield estimate than to my ability to forecast growth. Hence, Amazon hasn't made it into the 'ol portfolio just yet.)

I'm definitely comfortable with a long term BRK growth rate over 5%. The ROE, compensation structures, and capital allocation discipline ingrained in the culture give me that confidence.

(As an aside, it also doesn't hurt that:

a) Buffett pledged to give away 5% of his BRK holdings annually to the Gates Foundation
b) he is genetically hardwired to increase his wealth over the long term (with a margin of safety), so if history's greatest investor feels a minimum 5% long term growth rate for his own company is probably a safe bet, I'm more apt to accept that assumption.)

I do have trouble basing a long term growth assumption on a historical 8.5% ROE. They clearly can't reinvest organically at that rate, so it all comes down to acquisition prospects. And,

a) because the universe of sizable investment opportunities in Berkshire's circle of competence is now down to maybe a few dozen companies globally
b) because Buffett spent his entire life teaching/training an army of extremely well capitalized competitors (aka private equity) to do exactly what he does, while they're incentivized to pay higher prices, I can see scenarios where the elephant gun that used to be unloaded every 2 or 3 years, now gets shelved for 5 to 10 (or more) years at a time; leaving the next generation of management no choice but to accept lower growth while buying back shares or paying dividends.

I was comfortable with 7% last year. Now I'm more comfortable with 6%. I really really really hope it turns out to be at least 8.5%.

Thanks for the detailed response. Lots of good points.

What I am asking is what is your expected long term expected return on BRK? This is what people would call "required return".  If I understand it correctly, you seem to be saying you would be happy with 5%.

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

Thrifty3000

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Re: BRK Valuation
« Reply #29 on: June 23, 2020, 07:34:56 PM »
At the end of 2019 my model assumed "normal" BRK.B look through earnings of $12 to $16 per share, and a growth rate of 6% to 8% (a base case of $14 per share look through earnings and 7% growth).

Since then I've impaired my estimates to incorporate post-covid margin compression for financials, and more modest growth expectations.

I now model for look through earnings of $8 to $12 per share, and growth of 5% to 7% (a base case of $10 per share and 6% growth).

For me, intrinsic value falls somewhere in the neighborhood of $240 per B share. I'm perfectly comfortable owning the stock at the current price, and would happily buy more below $160 per share.

Thanks for laying out the assumptions. Without knowing one's estimates of earnings, growth rate of earnings and discount rate, it is difficult to know where there is disagreement if any.

In the base case as of Q1, 2020, I have normalized earnings as $12.5 per share, excluding any earnings from float. Growth rate of 8.5%.

To me, it looks like any differences in IV estimates for BRK really boil down to

1) The value of float. This is harder to assess as it is dependent on interest rates and investment opportunities. One simple and likely very conservative way is to assume that $60-80 billion would always remain in cash and as long term interest rates may remain low for a long time, essentially are not worth much. So we end up valuing the rest of the float or about $50 billion.

Or assume it is going to earn some low rate on the total float and it ends up adding $0.5 to $1 per share.

2) The discount rate.

So you have ROE of about 8.5% which is consistent with the growth rate assumption as well with 100% earnings retention.

If you pick a discount rate of 7%, you have to have to look through 30 years to make it worth 1.5x book value.

The question I have for you is, if you assume a growth rate of 6%, why would it be worth even book value unless your discount rate is less than 6%?

Vinod

For a handful of index funds or index-like investments (aka Berkshire) that I hope to hold for decades I basically just capitalize growth in perpetuity. I know it's inelegant, but one benefit is I can do it in my head.

For Berkshire I do break down the groves in a spreadsheet, and slice and dice assumptions a number of different ways before landing on a look through earnings estimate.

(FWIW, when making an investment I assign a lot more significance to my look through earnings yield estimate than to my ability to forecast growth. Hence, Amazon hasn't made it into the 'ol portfolio just yet.)

I'm definitely comfortable with a long term BRK growth rate over 5%. The ROE, compensation structures, and capital allocation discipline ingrained in the culture give me that confidence.

(As an aside, it also doesn't hurt that:

a) Buffett pledged to give away 5% of his BRK holdings annually to the Gates Foundation
b) he is genetically hardwired to increase his wealth over the long term (with a margin of safety), so if history's greatest investor feels a minimum 5% long term growth rate for his own company is probably a safe bet, I'm more apt to accept that assumption.)

I do have trouble basing a long term growth assumption on a historical 8.5% ROE. They clearly can't reinvest organically at that rate, so it all comes down to acquisition prospects. And,

a) because the universe of sizable investment opportunities in Berkshire's circle of competence is now down to maybe a few dozen companies globally
b) because Buffett spent his entire life teaching/training an army of extremely well capitalized competitors (aka private equity) to do exactly what he does, while they're incentivized to pay higher prices, I can see scenarios where the elephant gun that used to be unloaded every 2 or 3 years, now gets shelved for 5 to 10 (or more) years at a time; leaving the next generation of management no choice but to accept lower growth while buying back shares or paying dividends.

I was comfortable with 7% last year. Now I'm more comfortable with 6%. I really really really hope it turns out to be at least 8.5%.

Thanks for the detailed response. Lots of good points.

What I am asking is what is your expected long term expected return on BRK? This is what people would call "required return".  If I understand it correctly, you seem to be saying you would be happy with 5%.

Vinod

My current “normalized” look through earnings estimate is $10 per B share. My long term expected growth rate is 6%. I usually use a discount rate of 9% or 10%.