Author Topic: BRK Valuation  (Read 13580 times)

bizaro86

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Re: BRK Valuation
« Reply #80 on: June 26, 2020, 06:55:56 PM »
I'm not saying it isnt cheap (and I'm long) but if you count the equities you are implicitly including a bunch of the value of the insurance. There were over $160 B in liabilities related to the insurance operation last quarter. I get the concept of float, but I think treating that as equity (vs a long term cheap loan) is an aggressive way to think about it.

If you wanted to sell the insurance cos without their financial assets but with their policy liabilities, you'd be sending a bunch of money out the door to get someone to take them.

bizaro86, not taking a shot at your thoughts on the float liability, but rather want to see if you can poke holes in how I think about it. I'll use a hypothetical company that is 100% capitalized by float as my example. Let's assume we issue a $1.0m policy at the beginning of every year that gets paid out at the end of the year. We take that $1.0m and invest it into Treasury bills at a 10% rate (day-dreaming over here, I know). Well at the end of the year we would have $0.1m in the bank, $1.0m in a Treasury bill, receive cash inflows of $1.0m for the new policy issued, and pay out $1.0m of insurance claims/expense for the beginning of the year policy (assuming cost of float is zero). In this situation, the equity holder would be able to receive a dividend of $0.1m, unencumbered by the float liability. We can have this same situation occur forever into perpetuity, collecting $0.1m every year. My question becomes, why knock something off of the equity value if we never have to truly pay back the float and it doesn't cost anything in interest? That's $0.1m in my pocket every single year, just as if I funded the company 100% with my own money.

The risk of having to give back the float to its owner is more than the risk of having to give back the equity. Maybe that isnt very likely, but the probability is more than zero.

Secondly, BRK doesnt own any theoretical insurance companies. In the real world, they have to hold regulatory capital to write insurance, and some of it is equity. So that $1 MM of float comes with some money as cash earning 0%. That equity could be earning more in non-cash investment.

When Buffett is talking about how they need to keep $50 or $100 B in cash in case they need to cover a bunch of claims when equities do 30 or 40% drop, the opportunity cost of the float becomes pretty real.


wabuffo

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Re: BRK Valuation
« Reply #81 on: June 26, 2020, 07:30:14 PM »
One thing to keep in mind is that if the Democrats sweep the executive and legislative branches of US government in the fall (as seems likely at this time, though that may change), Biden has already indicated that he is raising the federal corporate tax rate to 28% - which he will be able to do if the Democrats have majorities in the House and the Senate.

BRK was a huge beneficiary of the corporate tax rate cut in 2017 and will consequently get hurt if/when it is raised.  It will get hurt two ways - large US subsidiaries like BNSF would see lower operating earnings and cash flows.  But the after-tax values of the equity portfolio would fall as well.   Not as big an effect as it was going from 35% down to 21% - but our partner, Uncle Sam is raising his stake from 21% to 28% without paying us for the larger ownership stake in all future pre-tax earnings.

wabuffo
« Last Edit: June 26, 2020, 07:35:12 PM by wabuffo »

ValueMaven

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Re: BRK Valuation
« Reply #82 on: June 27, 2020, 08:44:37 AM »
The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

He also pegs P/BV at 1.08x


Thoughts?  It's an interesting way to triangulate valuation

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.


how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

longinvestor

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Re: BRK Valuation
« Reply #83 on: June 27, 2020, 10:07:40 AM »
This on Insurance/Float/Goodwill, from the 2016 AR,

Insurance
Let’s now look at Berkshire’s various businesses, starting with our most important sector, insurance. The property/casualty (“P/C”) branch of that industry has been the engine that has propelled our growth since 1967, the year we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Today, National Indemnity is the largest property/casualty company in the world as measured by net worth.
One reason we were attracted to the P/C business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as claims arising from exposure to asbestos, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their own benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume. Consequently, as our business grows, so does our float. And how it has grown, as the following table shows:
Year Float (in millions)
1970 $ 39 1980 237 1990 1,632 2000 27,871 2010 65,832 2016 91,577
We recently wrote a huge policy that increased float to more than $100 billion. Beyond that one-time boost, float at GEICO and several of our specialized operations is almost certain to grow at a good clip. National Indemnity’s reinsurance division, however, is party to a number of large run-off contracts whose float is certain to drift downward.
We may in time experience a decline in float. If so, the decline will be very gradual – at the outside no more than 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate or near-term demands for sums that are of significance to our cash resources. This structure is by design and is a key component in the unequaled financial strength of our insurance companies. It will never be compromised.
If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it.
Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous indeed that it sometimes causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses.
8
This outcome is made more certain by the dramatically lower interest rates that now exist throughout the world. The investment portfolios of almost all P/C companies – though not those of Berkshire – are heavily concentrated in bonds. As these high-yielding legacy investments mature and are replaced by bonds yielding a pittance, earnings from float will steadily fall. For that reason, and others as well, it’s a good bet that industry results over the next ten years will fall short of those recorded in the past decade, particularly in the case of companies that specialize in reinsurance.
Nevertheless, I very much like our own prospects. Berkshire’s unrivaled financial strength allows us far more flexibility in investing than that generally available to P/C companies. The many alternatives available to us are always an advantage; occasionally, they offer us major opportunities. When others are constrained, our choices expand.
Moreover, our P/C companies have an excellent underwriting record. Berkshire has now operated at an underwriting profit for 14 consecutive years, our pre-tax gain for the period having totaled $28 billion. That record is no accident: Disciplined risk evaluation is the daily focus of all of our insurance managers, who know that while float is valuable, its benefits can be drowned by poor underwriting results. All insurers give that message lip service. At Berkshire it is a religion, Old Testament style.
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.

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« Last Edit: June 27, 2020, 10:09:18 AM by longinvestor »

Thrifty3000

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Re: BRK Valuation
« Reply #84 on: June 27, 2020, 01:04:20 PM »
How I derive Berkshire’s Look Through Earnings

Based on 2019 Earnings (In Billions USD except per share info)

Non-Insurance Business Earnings: $17.7

Less CapEx Adjustment (Maintenance CapEx less Depreciation): $3
Plus Acquisition-related Amortization: $1.3

TOTAL ADJUSTED NON-INSURANCE BUSINESS EARNINGS: $16
—————————————————————————————————

Equities

Dividends: $4
Estimated Equity Retained Earnings: $9

TOTAL EQUITIES LOOK THROUGH EARNINGS: $13
—————————————————————————————————

TOTAL SHARED HOLDINGS EARNINGS (Kraft-Heinz, Berkadia, Flying J): $1

EARNINGS FROM TREASURIES & CASH EQUIVS (Assume 1% yield. #lazy): $1.25

INSURANCE COMPANIES (After tax operating profit - I think Buffett ignores this): $.325

TOTAL LOOK THROUGH EARNINGS: $32 BILLION

Average Equivalent B Shares Outstanding (3/31/2020): 2,434,333,367

LOOK THROUGH EARNINGS PER B SHARE: $12.97

Post-Covid New World Order 20% Impairment (#reallyLazy): $10.37 per B share

So, above we have the breakdown of 2019 look through earnings. Now let's take a look at 2018 look through earnings laid out in the same form. But, first try to guess the look through earnings growth rate for the final year of the longest economic expansion in history. Was it 8.5%? 6%? Less than 6%? Drum roll please...

Based on 2018 Earnings (In Billions USD except per share info)

Non-Insurance Business Earnings: $16.8

Less CapEx Adjustment (Maintenance CapEx less Depreciation): $3
Plus Acquisition-related Amortization: $1.4

TOTAL ADJUSTED NON-INSURANCE BUSINESS EARNINGS: $15.2
—————————————————————————————————

Equities

Dividends: $3.8
Estimated Equity Retained Earnings: $8

TOTAL EQUITIES LOOK THROUGH EARNINGS: $11.8
—————————————————————————————————

TOTAL SHARED HOLDINGS EARNINGS (Kraft-Heinz, Berkadia, Flying J): $1.3

EARNINGS FROM TREASURIES & CASH EQUIVS (Assume 1% yield. #lazy): $1.32

INSURANCE COMPANIES (After tax operating profit - I think Buffett ignores this): $1.58

TOTAL LOOK THROUGH EARNINGS: $31 BILLION

Average Equivalent B Shares Outstanding (3/31/2020): 2,434,333,367

LOOK THROUGH EARNINGS PER B SHARE: $12.82

So, what was the year over year look through earnings growth rate? A spectacular, breathtaking, hair raising, jaw dropping, 1.2%!

Are we going to set a new look through earnings record this year? Spoiler alert... nope. Next year? Maaaaybe, IF we get a vaccine AND if BRK converts $50 to $80 billion of cash/treasuries into something that actually earns money.

(WARNING: When I did this analysis after the annual report was published I did it quickly with zero expectation of voluntarily sharing it with hundreds or thousands of people. It's probably flawed (I'd love to know where - preferably without insult). And, don't forget you get what you pay for.)

Thrifty3000

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Re: BRK Valuation
« Reply #85 on: June 27, 2020, 01:40:37 PM »
The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

He also pegs P/BV at 1.08x


Thoughts?  It's an interesting way to triangulate valuation

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.


how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

I think the value of BRK will ultimately correlate with earnings potential.

steph

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Re: BRK Valuation
« Reply #86 on: June 27, 2020, 02:07:44 PM »
The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

He also pegs P/BV at 1.08x


Thoughts?  It's an interesting way to triangulate valuation

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.


how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

I think the value of BRK will ultimately correlate with earnings potential.

Putting a multiple on earnings on the cash is a bit strange, no?

Top equity position by miles at year end was Apple, which is up 21%. 

Thrifty3000

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Re: BRK Valuation
« Reply #87 on: June 27, 2020, 02:27:47 PM »
The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

He also pegs P/BV at 1.08x


Thoughts?  It's an interesting way to triangulate valuation

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.


how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

I think the value of BRK will ultimately correlate with earnings potential.

Putting a multiple on earnings on the cash is a bit strange, no?

Top equity position by miles at year end was Apple, which is up 21%.

Apple Diluted Earnings Per Share 2018: $11.91
Apple Diluted Earnings Per Share 2019: $11.89
Growth: Negative
Apple Share Price: $353.63
Multiple of 2019 Earnings: 29.74

FWIW Morningstar puts Apple's fair value at $240 per share. No matter how you swing it $353 feels a bit sporty.
« Last Edit: June 27, 2020, 02:31:06 PM by Thrifty3000 »

aws

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Re: BRK Valuation
« Reply #88 on: June 27, 2020, 10:30:24 PM »
I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

bizaro86

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Re: BRK Valuation
« Reply #89 on: June 28, 2020, 09:52:34 AM »
I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

The consensus seems to be that the value of the float liability is less than dollar for dollar because maybe it never needs to be paid back.

If you invert that, what's the value of a cash asset that earns ~0 and may never be put to productive use? Possibly less than dollar for dollar is appropriate there as well.