Corner of Berkshire & Fairfax Message Board

General Category => Berkshire Hathaway => Topic started by: Mephistopheles on June 22, 2020, 09:21:43 PM

Title: BRK Valuation
Post by: Mephistopheles on June 22, 2020, 09:21:43 PM
BRK Market Cap: $440 B
- Stock Portfolio: $230
- BNSF: $100 (using UNP as a proxy)
- Cash: $130

Call it even at zero.

Utilities, Insurance, everything else = free

How large of a COVID hit to the cash pile are we looking at in terms of insurance and operating losses?

The cash and the utilities serve as a nice hedge in a recession or bear market.

I'm thinking of putting a ton of money into this with leverage... So tempting
Title: Re: BRK Valuation
Post by: LC on June 22, 2020, 09:39:45 PM
I agree it looks enticing but it has done so for months now. WB missed an opportunity back in Mar/Apr. I have added at points under 180 over the last 1-2 months, but for those reasons I am hesitant to commit a lot of capital. Although I do own some LEAPs, but BRK is about a 10-12% position.
Title: Re: BRK Valuation
Post by: bizaro86 on June 22, 2020, 10:48:25 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.

Title: Re: BRK Valuation
Post by: ValueMaven on June 23, 2020, 05:53:22 AM
thank you for starting this topic - this is the cheapest BRK has been in a VERY LONG TIME.  Trading below 1.2x BV.  Operating Biz will likely earn $23-$24B this year as well... also think about Apple... Berk is up $50B+ in Apple -- it is now basically 21% of Berk. 

A simple way to value Berk = Operating Income + Investments + Cash ... throw a below market multiple on the N.I, and you can see how cheap it is here.  You can do things like SOTP etc - but that is a bit more complex and in the weeds IMHO

What is the catalyst to drive value higher?? 
Title: Re: BRK Valuation
Post by: rb on June 23, 2020, 05:56:41 AM
Who gives a shit about the Catalyst? When you're getting something cheap, you're getting something cheap.
Title: Re: BRK Valuation
Post by: Kuhndan on June 23, 2020, 06:28:48 AM
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.

Good point. Buffett himself says that if you include the equities in your intrinsic value calculation, you do not include any value for the insurance companies.
Title: Re: BRK Valuation
Post by: Xerxes on June 23, 2020, 08:00:55 AM
I don’t know who said it some weeks ago.
But a comparison was made with MSFT in Ballmer era and how after ValueAct got in with a more aligned BoD things start to look differently.

I kind of agree with that. To be clear, In no way is Buffet is comparable to Ballmer but I agree that ‘hidden value’ can only by unearthed by the next management. Wether is implementing Precision Scheduling on BNSF or deploy some of the cash.

My investment in BRK is really based on what next management will do and am just buying is close to book now .... while dealing with the pain of going sideways for some more years. And I am ok with whatever Buffet does in the meantime.

I think that a low risk proposition.
Title: Re: BRK Valuation
Post by: navmehta on June 23, 2020, 08:08:19 AM
Thanks bizaro86, I agree you have to subtract the insurance float in the valuation above. These are assets that belong to insurance premium payers.

This is similar to if you were valuing a bank, you wouldn’t count all of depositor’s cash in the valuation. Those are assets held for depositors.

True, Buffet gets to invest these assets similar to how a bank that gets to lend out the deposits. However, if there are big loan losses banks have to still make depositors whole. Also, if Buffett has big investment losses, he has to still make insurance premium payers whole.
Title: Re: BRK Valuation
Post by: Castanza on June 23, 2020, 08:42:56 AM
I don’t know who said it some weeks ago.
But a comparison was made with MSFT in Ballmer era and how after ValueAct got in with a more aligned BoD things start to look differently.

I kind of agree with that. To be clear, In no way is Buffet is comparable to Ballmer but I agree that ‘hidden value’ can only by unearthed by the next management. Wether is implementing Precision Scheduling on BNSF or deploy some of the cash.

My investment in BRK is really based on what next management will do and am just buying is close to book now .... while dealing with the pain of going sideways for some more years. And I am ok with whatever Buffet does in the meantime.

I think that a low risk proposition.

+1 I think WB's involvement is irrelevant moving forward especially if you're relatively young and holding long.
Title: Re: BRK Valuation
Post by: Mephistopheles on June 23, 2020, 08:46:38 AM
Sorry for the dumb mistake. It was late and I was lazy on my phone just doing some basic math. Ok so say the value of the stock portfolio is the value of the insurance operation. You're still getting the utility and everything else ex-bnsf free.

BRK has options that go to 06/2022, 2 years out, and don't have much of a volatility premium. I own some $200s, but this may be a good way to play with leverage.
Title: Re: BRK Valuation
Post by: Xerxes on June 23, 2020, 08:50:31 AM
I don’t know who said it some weeks ago.
But a comparison was made with MSFT in Ballmer era and how after ValueAct got in with a more aligned BoD things start to look differently.

I kind of agree with that. To be clear, In no way is Buffet is comparable to Ballmer but I agree that ‘hidden value’ can only by unearthed by the next management. Wether is implementing Precision Scheduling on BNSF or deploy some of the cash.

My investment in BRK is really based on what next management will do and am just buying is close to book now .... while dealing with the pain of going sideways for some more years. And I am ok with whatever Buffet does in the meantime.

I think that a low risk proposition.

+1 I think WB's involvement is irrelevant moving forward especially if you're relatively young and holding long.

Cheers !
I am very close 40, so not that young.

BRK is one massive call option with no expiry.
Title: Re: BRK Valuation
Post by: AzCactus on June 23, 2020, 08:50:39 AM
My investment in BRK is really based on what next management will do and am just buying is close to book now .... while dealing with the pain of going sideways for some more years. And I am ok with whatever Buffet does in the meantime.


For those holding Berkshire with the above statement in mind---I think this is a little naive.  There has been limited communication that Buffett will step down anytime soon.  I think it's possible he is in charge another 5-7 years. Buffett clearly feels he has earned the right to continue running the show even if he is no longer the best man for the job.  This seems akin to owners giving loyal players big contracts at the end of their career-ala Lakers with Kobe Bryant in 2013.  Except in this case Buffett is both owner and operator. 
Title: Re: BRK Valuation
Post by: Xerxes on June 23, 2020, 09:06:53 AM
I am ok for holding for the next 10 years with Buffet and another 15 years without him. 
That is why I called it one giant call option that one can buy today at fair or below fair price.

And I don’t really care much about any succession communication from Omaha.
When it happens it will be sudden and he won’t telegraph it I think. If he doesn’t telegraph his investments and buybacks, he won’t telegraph anything tangible related to succession.

All I am saying that “juice” wont be extracted in Buffet era
Title: Re: BRK Valuation
Post by: Mephistopheles on June 23, 2020, 09:12:36 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?
Title: Re: BRK Valuation
Post by: Xerxes on June 23, 2020, 09:17:36 AM
It was just an example.
I agree that HQ is probably not that involved and they give lot of room for the operating business to do what they believe best.
Title: Re: BRK Valuation
Post by: Castanza on June 23, 2020, 09:37:27 AM
My investment in BRK is really based on what next management will do and am just buying is close to book now .... while dealing with the pain of going sideways for some more years. And I am ok with whatever Buffet does in the meantime.


For those holding Berkshire with the above statement in mind---I think this is a little naive.  There has been limited communication that Buffett will step down anytime soon.  I think it's possible he is in charge another 5-7 years. Buffett clearly feels he has earned the right to continue running the show even if he is no longer the best man for the job.  This seems akin to owners giving loyal players big contracts at the end of their career-ala Lakers with Kobe Bryant in 2013.  Except in this case Buffett is both owner and operator.

WB is going to be 90 in a few months...I don't think it's naive to think with some degree of certainty that he won't be the head of Berkshire Hathaway sometime in the near future. That being said, I have no problem with him. The man is skilled and has definitely earned his championship rings. I'm just saying (as someone in their late 20's) that I don't really care what WB does in the next few years because 1.) I trust him that if he does anything it will be on the conservative side and is likely to not impair the conglomerate in any significant manner. 2.) like X said above...an under performance in the short term is insignificant to me in the long term. 3.) If one and two are both true then this provides me a few more years to accumulate shares are cheap prices.

So my investment decision in BRK is not built on the back of the Wizard of Omaha's future decision making. It's built on his diligent commitment to value investing in the past, his diligence in establishing a diligent management team which embodies his general principles with perhaps some affluence to the changing climate of the world (perhaps a bit out of WB's circle of competence).

I liken WB to a highly respected surgeon that is now in his 70's. Clearly respectable and renown. But unlikely to learn new methods and approaches. That's not to say he wont complete some miraculous surgeries near the end of his career to the best of his ability. It's simply he isn't likely to view surgeries in a new light with new methods which could potentially give better results maybe in a less invasive, quicker recovery type manner.
Title: Re: BRK Valuation
Post by: AzCactus on June 23, 2020, 09:45:46 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.
Title: Re: BRK Valuation
Post by: ValueMaven on June 23, 2020, 09:50:36 AM
Can we take this back to the specific topic thread of VALUATION

I have Fair Value pegged at $260 - $280 currently.  Would love to know what others think around valuation.  It seems like the Street is giving little credit for the Operating Income at the parent company more broadly. 
Title: Re: BRK Valuation
Post by: AzCactus on June 23, 2020, 10:09:19 AM
I think fair value is around 230-240 per share.  A couple of reasons I don't have a number closer to Value Maven's:
1. Heavy cash balance-This only really helps if recession is much longer than people except.
2. Buffett's inactivity-Heavily covered.  I won't reiterate.
3. Buffett's inability of unwillingness to do buybacks at a bigger scale.  One thing Buffett has said many times is we could move fast or make a deal quickly.  Well he had the opportunity to snatch up shares around 160/170 and didn't.  Now they have spent most of this quarter around 180---we'll see if he did anything. 
Title: Re: BRK Valuation
Post by: longinvestor on June 23, 2020, 10:57:26 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.
Title: Re: BRK Valuation
Post by: Every Banana Counts 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.
Title: Re: BRK Valuation
Post by: villainx 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.
Title: Re: BRK Valuation
Post by: Thrifty3000 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.
Title: Re: BRK Valuation
Post by: bizaro86 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.
Title: Re: BRK Valuation
Post by: vinod1 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
Title: Re: BRK Valuation
Post by: rb 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.
Title: Re: BRK Valuation
Post by: Thrifty3000 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%.
Title: Re: BRK Valuation
Post by: vinod1 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
Title: Re: BRK Valuation
Post by: vinod1 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
Title: Re: BRK Valuation
Post by: Thrifty3000 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%.
Title: Re: BRK Valuation
Post by: Munger_Disciple on June 23, 2020, 09:04:15 PM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 23, 2020, 09:36:59 PM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward.
Title: Re: BRK Valuation
Post by: Munger_Disciple on June 23, 2020, 09:42:10 PM
In 24 years, for example, it will be earning $40 per share according to the model.

Ok, what is your estimate of intrinsic value then? Please show the steps you use to arrive at it. You cannot use the standard DCF model because there are no cash flows that accrue to the owner during the 24 years; they are reinvested back in the company.
Title: Re: BRK Valuation
Post by: Poor Charlie on June 24, 2020, 01:59:48 AM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward.

Your’re capitalizing retained earnings rather than distributed earnings.  The value of $10 in earnings growing by 6% a year depends on how much has to be reinvested to produce the 6% growth.  Your economic assumptions ($10 initial earnings, 100% retention, 6% growth) and your valuation assumptions ($10 initial earnings, 0% retention, 6% growth) are not the same thing.  Using your 10% discount rate, you get the following present values for Berkshire’s operating earnings (i.e., the value of Berkshire excluding cash and securities):


(a) $10 earnings, 100% retention, 6% growth (using your terminal year of 24): ($40.49/.10) / 1.10^24 = $41.11

(b) $10 earnings, 0% retention, 6% growth (in perpetuity): $10 / (.10-.06) = $250


Under your economic assumptions of 100% retention, 6% growth and a 10% discount rate, Berkshire would be destroying value.  In fact, each dollar retained would be worth only 60 cents. 

Here’s another way to look at it: If Berkshire needs to retain 100% of its earnings to grow by 6% a year, they’re earning 6% on equity.  Berkshire is levered 2:1 and the liabilities cost zero (roughly).  You’re therefore assuming Berkshire will earn just 3% on the asset side.  Of course, assets that produce operating earnings only make up half the balance sheet, but you get the idea.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 07:55:52 AM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward.

Your’re capitalizing retained earnings rather than distributed earnings.  The value of $10 in earnings growing by 6% a year depends on how much has to be reinvested to produce the 6% growth.  Your economic assumptions ($10 initial earnings, 100% retention, 6% growth) and your valuation assumptions ($10 initial earnings, 0% retention, 6% growth) are not the same thing.  Using your 10% discount rate, you get the following present values for Berkshire’s operating earnings (i.e., the value of Berkshire excluding cash and securities):


(a) $10 earnings, 100% retention, 6% growth (using your terminal year of 24): ($40.49/.10) / 1.10^24 = $41.11

(b) $10 earnings, 0% retention, 6% growth (in perpetuity): $10 / (.10-.06) = $250


Under your economic assumptions of 100% retention, 6% growth and a 10% discount rate, Berkshire would be destroying value.  In fact, each dollar retained would be worth only 60 cents. 

Here’s another way to look at it: If Berkshire needs to retain 100% of its earnings to grow by 6% a year, they’re earning 6% on equity.  Berkshire is levered 2:1 and the liabilities cost zero (roughly).  You’re therefore assuming Berkshire will earn just 3% on the asset side.  Of course, assets that produce operating earnings only make up half the balance sheet, but you get the idea.

For an investment that doesn’t pay dividends the cash flows consist of

a) the initial investment
b) the amount received upon exit.

The ROI is a function of

a) earnings growth
b) earnings multiple at entry vs earnings multiple at exit

^that’s Jack Bogle 101

The longer you hold the investment the less of a factor multiple expansion/compression becomes, while the ROI gravitates toward the earnings growth rate (there is a nuanced relationship between ROE and ROI). It’s why paying a fair price for a great business over the long term works out better than paying a great price for a fair business.

^that’s Chuck Munger 101

I said I can quickly estimate the intrinsic value of a long term index-like investment by using a perpetual growth formula in my head. I didn’t say the result is what I would pay for the investment. I did mention I would get excited about buying at prices below $160 per share - or 16 times my estimated look through earnings (my opinion of a fair price for a good business).

If I buy and hold for several decades I would expect my ROI to equate to the long term growth rate.

In looking ahead over the next 2 to 6 decades I’m not giving Berkshire any benefits of the doubt regarding a future performance anywhere near past performance - even the recent past.

The company is gigantic, it has limited investment opportunities of scale, extreme competition for those investment opportunities, and its leadership is in transition.

Personally, I’m concerned the company isn’t being handed over to “leaders.” I think it’s being handed off to managers. There’s a big difference.

On the positive front you have Ajit and Todd. Ajit is the real deal when it comes to insurance. And, I’m generally excited about the prospects of capital being deployed by Todd Combs, as I get a sense he can learn to be as shrewd as Buffett.

I think Ted and Greg, however, are faking it until they don’t make it.

No manager will grasp Berkshire or the investment world the way Buffett did in his prime - when it was easier to grow. And, none of the next generation of senior management has shown any ability to communicate like a leader (David Sokol was the closest - but awkwardly arrogant). I suspect they will communicate like operators not wanting to screw up. And, thus begin the journey toward bigness and dumbness.

As far as the 2 to 1 leverage goes, Buffett has set an expectation for float to peak, and even decline, though slowly, in the not too distant future. Markets do saturate. I don’t necessarily believe it will decline, I certainly don’t model for it, but declining leverage would create a drag.

Estimating earnings growth of 6% and discounting those earnings at 10% is not destroying value. It’s producing an estimate of what I would pay for a 10% return on an earnings stream growing at 6%.

Retaining $10 to earn $.60 in perpetuity only destroys value if the multiple others are willing to pay for that $.60 is less than 16.67.
Title: Re: BRK Valuation
Post by: Munger_Disciple on June 24, 2020, 11:44:04 AM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward.

Your’re capitalizing retained earnings rather than distributed earnings.  The value of $10 in earnings growing by 6% a year depends on how much has to be reinvested to produce the 6% growth.  Your economic assumptions ($10 initial earnings, 100% retention, 6% growth) and your valuation assumptions ($10 initial earnings, 0% retention, 6% growth) are not the same thing.  Using your 10% discount rate, you get the following present values for Berkshire’s operating earnings (i.e., the value of Berkshire excluding cash and securities):


(a) $10 earnings, 100% retention, 6% growth (using your terminal year of 24): ($40.49/.10) / 1.10^24 = $41.11

(b) $10 earnings, 0% retention, 6% growth (in perpetuity): $10 / (.10-.06) = $250


Under your economic assumptions of 100% retention, 6% growth and a 10% discount rate, Berkshire would be destroying value.  In fact, each dollar retained would be worth only 60 cents. 

Here’s another way to look at it: If Berkshire needs to retain 100% of its earnings to grow by 6% a year, they’re earning 6% on equity.  Berkshire is levered 2:1 and the liabilities cost zero (roughly).  You’re therefore assuming Berkshire will earn just 3% on the asset side.  Of course, assets that produce operating earnings only make up half the balance sheet, but you get the idea.

+1

It is really dumb for a company to retain 100% of earnings and grow at a lower rate than its discount rate (alternately, the opportunity cost for shareholders). Such a management action destroys shareholder wealth. This is the main reason Buffett said the condition for earnings retention is to be able produce more than $1 of market value for each dollar retained.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 12:26:08 PM
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%.

The $10 of current earnings are not distributable earnings, but retained earnings. In other words, the only way Berkshire can achieve growth rate of 6% in your model is by retaining the earnings. So you should re-work your model to come up with an intrinsic value estimate that incorporates this fact. It is not equal to $10/(10%-6%) = $250 per B share as you seem to be implying.

The company earns $10 in year 1. It retains and reinvests that $10 earned in year 1, and as a result, it earns an additional $.60 in year 2, for total year 2 earnings of $10.60. It does the same in year 3. It reinvests the $10.60 it retained in year 2, and earns $11.24. That pattern continues in perpetuity. In 24 years, for example, it will be earning $40 per share according to the model. Why does that need to be reworked? Seems straightforward.

Your’re capitalizing retained earnings rather than distributed earnings.  The value of $10 in earnings growing by 6% a year depends on how much has to be reinvested to produce the 6% growth.  Your economic assumptions ($10 initial earnings, 100% retention, 6% growth) and your valuation assumptions ($10 initial earnings, 0% retention, 6% growth) are not the same thing.  Using your 10% discount rate, you get the following present values for Berkshire’s operating earnings (i.e., the value of Berkshire excluding cash and securities):


(a) $10 earnings, 100% retention, 6% growth (using your terminal year of 24): ($40.49/.10) / 1.10^24 = $41.11

(b) $10 earnings, 0% retention, 6% growth (in perpetuity): $10 / (.10-.06) = $250


Under your economic assumptions of 100% retention, 6% growth and a 10% discount rate, Berkshire would be destroying value.  In fact, each dollar retained would be worth only 60 cents. 

Here’s another way to look at it: If Berkshire needs to retain 100% of its earnings to grow by 6% a year, they’re earning 6% on equity.  Berkshire is levered 2:1 and the liabilities cost zero (roughly).  You’re therefore assuming Berkshire will earn just 3% on the asset side.  Of course, assets that produce operating earnings only make up half the balance sheet, but you get the idea.

+1

It is really dumb for a company to retain 100% of earnings and grow at a lower rate than its discount rate (alternately, the opportunity cost for shareholders). Such a management action destroys shareholder wealth. This is the main reason Buffett said the condition for earnings retention is to be able produce more than $1 of market value for each dollar retained.

Seriously? It's not ITS discount rate it's MY discount rate!

I think you might be confusing discount rate with cost of capital.

PS. -1
Title: Re: BRK Valuation
Post by: Poor Charlie on June 24, 2020, 12:35:45 PM
For an investment that doesn’t pay dividends the cash flows consist of

a) the initial investment
b) the amount received upon exit.

The ROI is a function of

a) earnings growth
b) earnings multiple at entry vs earnings multiple at exit

^that’s Jack Bogle 101

If the only cash you get is when you sell the investment (the terminal year), then why are you capitalizing the yearly earnings [$10 / (.10 - .06) = $250]?  You wouldn’t capitalize the reinvested interest when valuing a zero-coupon bond, so why would you capitalize the reinvested earnings when valuing an equity investment?

The longer you hold the investment the less of a factor multiple expansion/compression becomes, while the ROI gravitates toward the earnings growth rate (there is a nuanced relationship between ROE and ROI). It’s why paying a fair price for a great business over the long term works out better than paying a great price for a fair business.

^that’s Chuck Munger 101

I said I can quickly estimate the intrinsic value of a long term index-like investment by using a perpetual growth formula in my head. I didn’t say the result is what I would pay for the investment. I did mention I would get excited about buying at prices below $160 per share - or 16 times my estimated look through earnings (my opinion of a fair price for a good business).

If I buy and hold for several decades I would expect my ROI to equate to the long term growth rate.

In looking ahead over the next 2 to 6 decades I’m not giving Berkshire any benefits of the doubt regarding a future performance anywhere near past performance - even the recent past.

The company is gigantic, it has limited investment opportunities of scale, extreme competition for those investment opportunities, and its leadership is in transition.

Personally, I’m concerned the company isn’t being handed over to “leaders.” I think it’s being handed off to managers. There’s a big difference.

On the positive front you have Ajit and Todd. Ajit is the real deal when it comes to insurance. And, I’m generally excited about the prospects of capital being deployed by Todd Combs, as I get a sense he can learn to be as shrewd as Buffett.

I think Ted and Greg, however, are faking it until they don’t make it.

No manager will grasp Berkshire or the investment world the way Buffett did in his prime - when it was easier to grow. And, none of the next generation of senior management has shown any ability to communicate like a leader (David Sokol was the closest - but awkwardly arrogant). I suspect they will communicate like operators not wanting to screw up. And, thus begin the journey toward bigness and dumbness.

As far as the 2 to 1 leverage goes, Buffett has set an expectation for float to peak, and even decline, though slowly, in the not too distant future. Markets do saturate. I don’t necessarily believe it will decline, I certainly don’t model for it, but declining leverage would create a drag.

Not worth commenting on.

Estimating earnings growth of 6% and discounting those earnings at 10% is not destroying value. It’s producing an estimate of what I would pay for a 10% return on an earnings stream growing at 6%.

Retaining $10 to earn $.60 in perpetuity only destroys value if the multiple others are willing to pay for that $.60 is less than 16.67.

If Berkshire is earning 6% on incremental retained earnings, which is what you’re implying (6% growth * 100% retention = 6% ROEs), and you assume the market will discount cash flows at 10%, which is also what you’re implying [$10 earnings / (10% discount rate – 4% growth rate)], each dollar retained is indeed worth 60 cents.  For example, retained earnings at the end of year 24 for would increase by $508.16 [($40.49 ending earnings – $10 beginning earnings) / 6% ROE] but the market value would only increase by $304.89 [($40.49 ending earnings – $10 beginning earnings) / 10% discount rate].  This means that each dollar retained is worth 60 cents ($304.89 increase in market value / $508.16 increase in retained earnings).

Part of the problem is you’re conflating the market’s discount rate with your discount rate (or more specifically, your required rate of return).  Rather than plugging the wrong numbers into a formula it seems you don’t fully understand, try thinking about it without using a formula at all.  For instance, “I get $40.49 in cash flow every year after year 24.  The market will capitalize cash flows at 6.25% (using the 16x you used above, but pick whatever multiple you want), which means I can exchange my $40.49 cash flow stream for an upfront payment of $647.83 at the end of year 24.  I want a 10% compounded return (what you say you’d pay for an “earnings cash flow stream growing at 6%”), so I’d be willing to pay anything less than $65.77 for this now ($647.84 / 1.10^24).”


Title: Re: BRK Valuation
Post by: Jurgis on June 24, 2020, 12:44:21 PM
It is really dumb for a company to retain 100% of earnings and grow at a lower rate than its discount rate (alternately, the opportunity cost for shareholders). Such a management action destroys shareholder wealth. This is the main reason Buffett said the condition for earnings retention is to be able produce more than $1 of market value for each dollar retained.

OT? Something useful out of this discussion.  8) ./bow

Let me see if I understood this correctly in a broader context. Let's take a company that produces FCF. But it does not pay it out some way. Instead it keeps it and does not invest it (at high/reasonable ROI). Then really we cannot just DCF that FCF at the time it was produced since we are not really getting it. We'd have to assume it's only paid out later (if ever) and add additional time periods (and discounts) to DCF model to estimate when it is paid out.

Of course, we could still assume that if we owned the whole business then we'd be able to use the FCF as we wish. And we can do the basic DCF based on that "wholly owned" assumption. It's just that in reality the business won't be worth as much as our basic DCF indicates.

Pretty interesting, n'est-ce pas?  8)

I agree that Thrifty3000 is confused, but I'm not sure how to explain to them why their calculations are incorrect.
Title: Re: BRK Valuation
Post by: Munger_Disciple on June 24, 2020, 12:54:37 PM
Thrifty3000,

It is clear to me that you don't understand (and perhaps don't want to understand) how to think about retained earnings that enable future growth and free cash flow that can be distributed to shareholders. I belatedly realize that there is no point in replying to your posts and I am sure the feeling is mutual. So let's leave it at that.

-MD
Title: Re: BRK Valuation
Post by: Poor Charlie on June 24, 2020, 01:11:30 PM
Thrifty3000,

It is clear to me that you don't understand (and perhaps don't want to understand) how to think about retained earnings that enable future growth and free cash flow that can be distributed to shareholders. I belatedly realize that there is no point in replying to your posts and I am sure the feeling is mutual. So let's leave it at that.

-MD

I actually enjoy conversations on valuation math.  I’m always looking to improve my understanding, so I welcome people poking holes in my posts.  I just ask that you put forth coherent arguments, which we don’t seem to be getting from Thrifty.   
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 03:14:46 PM
Thrifty3000,

It is clear to me that you don't understand (and perhaps don't want to understand) how to think about retained earnings that enable future growth and free cash flow that can be distributed to shareholders. I belatedly realize that there is no point in replying to your posts and I am sure the feeling is mutual. So let's leave it at that.

-MD

I actually enjoy conversations on valuation math.  I’m always looking to improve my understanding, so I welcome people poking holes in my posts.  I just ask that you put forth coherent arguments, which we don’t seem to be getting from Thrifty.   

As soon as I sober up I'll see if I can clarify. Haha. Geez, I feel like I'm being baited.

But, fine, if it makes you trolls happy...

Normalized Per-Share Look Through Earnings - Year 0: $10.31

Projected Earnings:

Year 1: $10.93
Year 2: $11.58
Year 3: $12.28
Year 4: $13.02
Year 5: $13.80

Present Value of Projected Earnings - Years 1 Through 5 (10% Discount Rate): $46.19

Residual Value:
Residual Earnings (Year 5 Earnings x 1.06): $14.62
Capitalization Rate: 6%
Capitalized Residual Value: $243.75

Present Value of Capitalized Residual Value (10% Discount Rate): $151.35

Total Present Value of Projected Look Through Earnings: $46.19 + $151.35 = $197.54

And there you have it. $197.54 is the precise intrinsic value of a Berkshire Hathaway B share down to the penny. I can carry it out to more decimals if you like. Haha.

Obviously, you can model it out for more than 5 years, play with all the variables, add more inputs and variables, and derive pretty much whatever intrinsic value you want (why Warren Buffett has never wasted time on a DCF model, and why I feel slightly disgusted for wasting my own time).

For me, the most important inputs are the normal earnings estimate and growth estimate. Naturally, those are the two numbers I originally shared, and are the two items I wish others would share and intelligently discuss (that goes for all investments on COBF), especially if they aren't just pulled out of the air, and are the result of quality research and personal experience.

If you want to add value while attacking my (or anyone's) work, personally I'd prefer you challenge me to defend the effort and assumptions that went into deriving the look through earnings and growth estimates.

Another way to be a hero would be to post your own estimates, and subject yourself to a little scrutiny.

Bring it on!



Title: Re: BRK Valuation
Post by: Poor Charlie on June 24, 2020, 04:14:38 PM
Thrifty3000,

It is clear to me that you don't understand (and perhaps don't want to understand) how to think about retained earnings that enable future growth and free cash flow that can be distributed to shareholders. I belatedly realize that there is no point in replying to your posts and I am sure the feeling is mutual. So let's leave it at that.

-MD

I actually enjoy conversations on valuation math.  I’m always looking to improve my understanding, so I welcome people poking holes in my posts.  I just ask that you put forth coherent arguments, which we don’t seem to be getting from Thrifty.   

As soon as I sober up I'll see if I can clarify. Haha. Geez, I feel like I'm being baited.

But, fine, if it makes you trolls happy...

Normalized Per-Share Look Through Earnings - Year 0: $10.31

Projected Earnings:

Year 1: $10.93
Year 2: $11.58
Year 3: $12.28
Year 4: $13.02
Year 5: $13.80

Present Value of Projected Earnings - Years 1 Through 5 (10% Discount Rate): $46.19

Residual Value:
Residual Earnings (Year 5 Earnings x 1.06): $14.62
Capitalization Rate: 6%
Capitalized Residual Value: $243.75

Present Value of Capitalized Residual Value (10% Discount Rate): $151.35

Total Present Value of Projected Look Through Earnings: $46.19 + $151.35 = $197.54

And there you have it. $197.54 is the precise intrinsic value of a Berkshire Hathaway B share down to the penny. I can carry it out to more decimals if you like. Haha.

Obviously, you can model it out for more than 5 years, play with all the variables, add more inputs and variables, and derive pretty much whatever intrinsic value you want (why Warren Buffett has never wasted time on a DCF model, and why I feel slightly disgusted for wasting my own time).

For me, the most important inputs are the normal earnings estimate and growth estimate. Naturally, those are the two numbers I originally shared, and are the two items I wish others would share and intelligently discuss (that goes for all investments on COBF), especially if they aren't just pulled out of the air, and are the result of quality research and personal experience.

If you want to add value while attacking my (or anyone's) work, personally I'd prefer you challenge me to defend the effort and assumptions that went into deriving the look through earnings and growth estimates.

Another way to be a hero would be to post your own estimates, and subject yourself to a little scrutiny.

Bring it on!

My posts had nothing to do with what I think Berkshire is worth.  I was simply trying to point out that $10 in retained earnings aren’t the same thing as $10 in distributed earnings.   You can’t capitalize earnings like you did (and continue to do) unless those earnings are distributed.   Would you capitalize the reinvested interest when valuing a zero-coupon bond?  If not, then why would you capitalize the retained earnings of Berkshire (Berkshire, which retains all its capital, is effectively a zero-coupon equity)?  Aren’t they the same thing?

If we can’t agree retained earnings ≠ distributed earnings, then I’m sorry for wasting your time.  I was just looking to join a conversation about something I find interesting. 

All the best
Title: Re: BRK Valuation
Post by: mcliu on June 24, 2020, 04:54:41 PM
He doesn't get it. But it's a nice demonstration of commitment bias.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 04:55:42 PM
Thrifty3000,

It is clear to me that you don't understand (and perhaps don't want to understand) how to think about retained earnings that enable future growth and free cash flow that can be distributed to shareholders. I belatedly realize that there is no point in replying to your posts and I am sure the feeling is mutual. So let's leave it at that.

-MD

I actually enjoy conversations on valuation math.  I’m always looking to improve my understanding, so I welcome people poking holes in my posts.  I just ask that you put forth coherent arguments, which we don’t seem to be getting from Thrifty.   

As soon as I sober up I'll see if I can clarify. Haha. Geez, I feel like I'm being baited.

But, fine, if it makes you trolls happy...

Normalized Per-Share Look Through Earnings - Year 0: $10.31

Projected Earnings:

Year 1: $10.93
Year 2: $11.58
Year 3: $12.28
Year 4: $13.02
Year 5: $13.80

Present Value of Projected Earnings - Years 1 Through 5 (10% Discount Rate): $46.19

Residual Value:
Residual Earnings (Year 5 Earnings x 1.06): $14.62
Capitalization Rate: 6%
Capitalized Residual Value: $243.75

Present Value of Capitalized Residual Value (10% Discount Rate): $151.35

Total Present Value of Projected Look Through Earnings: $46.19 + $151.35 = $197.54

And there you have it. $197.54 is the precise intrinsic value of a Berkshire Hathaway B share down to the penny. I can carry it out to more decimals if you like. Haha.

Obviously, you can model it out for more than 5 years, play with all the variables, add more inputs and variables, and derive pretty much whatever intrinsic value you want (why Warren Buffett has never wasted time on a DCF model, and why I feel slightly disgusted for wasting my own time).

For me, the most important inputs are the normal earnings estimate and growth estimate. Naturally, those are the two numbers I originally shared, and are the two items I wish others would share and intelligently discuss (that goes for all investments on COBF), especially if they aren't just pulled out of the air, and are the result of quality research and personal experience.

If you want to add value while attacking my (or anyone's) work, personally I'd prefer you challenge me to defend the effort and assumptions that went into deriving the look through earnings and growth estimates.

Another way to be a hero would be to post your own estimates, and subject yourself to a little scrutiny.

Bring it on!

My posts had nothing to do with what I think Berkshire is worth.  I was simply trying to point out that $10 in retained earnings aren’t the same thing as $10 in distributed earnings.   You can’t capitalize earnings like you did (and continue to do) unless those earnings are distributed.   Would you capitalize the reinvested interest when valuing a zero-coupon bond?  If not, then why would you capitalize the retained earnings of Berkshire (Berkshire, which retains all its capital, is effectively a zero-coupon equity)?  Aren’t they the same thing?

If we can’t agree retained earnings ≠ distributed earnings, then I’m sorry for wasting your time.  I was just looking to join a conversation about something I find interesting. 

All the best

If you can’t understand your mom ≠ a girlfriend then I cant help you. Haha

Everyone on this forum understands earnings retained by a company aren’t distributed. I’m dying to hear what other brilliant insights you have.

I recommend taking your ample free time to read some of Buffett’s annual letters about how to consider retained / look through / owner earnings.
Title: Re: BRK Valuation
Post by: LC on June 24, 2020, 05:00:24 PM
Put it this way.

CashCo dividends out $50 this year and $50 next year, then immediately goes BK.

InvestCo retains $50 this year and dividends out $100 next year, then also goes BK.

What is each worth.
Title: Re: BRK Valuation
Post by: mcliu on June 24, 2020, 05:02:45 PM
If you can’t understand your mom ≠ a girlfriend then I cant help you. Haha

Everyone on this forum understands earnings retained by a company aren’t distributed. I’m dying to hear what other brilliant insights you have.

I recommend taking your ample free time to read some of Buffett’s annual letters about how to consider retained / look through / owner earnings.
You are double counting the earnings without considering how growth is generated.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 05:21:42 PM
Put it this way.

CashCo dividends out $50 this year and $50 next year, then immediately goes BK.

InvestCo retains $50 this year and dividends out $100 next year, then also goes BK.

What is each worth.

Let’s assume a 10% discount rate...

CashCo: Pre-tax PV of year 1 dividend = $45; year 2 = $40.5. Sum = $85.5

InvesCo: Pre-tax PV of year 2 dividend = $81

Am I getting the hang of it?

Now, my question for you. How come the retained earnings didn’t generate additional value in year 2?
Title: Re: BRK Valuation
Post by: LC on June 24, 2020, 05:31:31 PM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 05:37:08 PM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.

Ok, I totally agree with you there. I feel like that’s where my 6% growth assumption comes into play. I’ve seen growth assumptions from others as high as 8.5%.

But, I’m pretty sure Buffett would not have stopped buying back shares in Q1 if he thought long term growth of 8.5% was feasible.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 05:41:55 PM
He doesn't get it. But it's a nice demonstration of commitment bias.

^This is why you have no friends. No no, your grandpa doesn’t count.

I think you meant confirmation bias, which Munger shorthands as commitment/consistency.
Title: Re: BRK Valuation
Post by: jfan on June 24, 2020, 07:43:21 PM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.

It's taken me a while but I finally got my head around this concept. I've read through the Stephen Penman accounting textbook and his use the residual earnings model. I think this model hides the exact issue that others have been raised up,  freely distributable earnings (today) that don't need to be reinvested for growth (aka FCF, owner's earnings, cash from operations less maintenance capex, etc) is very different than earnings that need to be retained in the business for future growth (eg expansion of inventory and accounts receivables, PPE, etc).

I'll share with everyone my mistakes and what the lessons were:
1) Linamar - The net income of the business was growing year over year 10-15%, with an ROE of 15-20% before all the trade war stuff. However, what I failed to realize was that while it look quite good using a Penman's residual earnings model, it failed to account for the fact that in order for it to grow, it would need to take those cash earnings and reinvest all of it to working capital and capex in order to grow the next year, leaving very little free cash flow to could be distributed to me. I was not until the business started shrinking, that free cash flow (owner's earnings) was then able to be distributed via share buybacks, its meager dividend, and paying back debt.

2) Missing out on Amazon (or substitute a SAAS business, advertising agencies, insurance companies, Costco (to some degree)  etc). I remember telling a colleague that Amazon is not profitable. It's net income margins are so slim, so what if it is growing revenues, it's too pricey. What I failed to realize was that by creating a marketplace with a feedback loop on supplier and buyer dynamics, it was able to receive payments from buyers before having to pay suppliers and able to grow on the backs of the supplier's money without having to put up its own capital. Then layer  on the prime membership, and now it was receiving prepayment of customer's money even before providing any service. So in essence, Amazon was able to grow by using other people's money and as a result generating massive amounts of distributable cash. This potentially distributable cash was reinvested for more growth in other areas but it could have been easily paid out as a dividend or share buybacks.

So it only makes sense that Amazon is much more valuable than Linamar.

I guess if you can make an argument that BRK could grow 6% per year WITHOUT needing to retain its cash earnings, then BRK could be creating value for shareholder. If BRK needs alot of its cash earnings to reinvest in working capital and PPE in order to grow the cash earnings the year after by 6%, then BRK would be destroying value for shareholders.

I think the nuance is in the definition of what you exactly mean by owner's earnings and how you parse out growth expenditures.


Title: Re: BRK Valuation
Post by: DooDiligence on June 24, 2020, 08:14:06 PM
He doesn't get it. But it's a nice demonstration of commitment bias.

Textbook example.

I like the way he escalates the commitment & projects his own friendlessness on you.
Title: Re: BRK Valuation
Post by: LC on June 24, 2020, 08:19:48 PM
Right- and this is one of the big benefits of pricing power. Cigarettes are a prime example of this but there are certainly others.

In fact this is where Thrifty is actually somewhat on point - not many companies have tons of opportunities to re-invest lots of capital for growth. The utilities, the railroad, even the insurance ops provide built-in reinvestment opportunities. And (at least for the first two) the return is relatively stable. Actually it provides WB with an option: If he can't find super attractive uses for $$, he can always dump some into the heavy businesses. What is the value of a perpetuity-like reinvestment option?

To the other point, I don't think Berkshire is investing below its cost of capital i.e. engaging in value destruction. If your personal hurdle rate is 25% for example then BRK is probably not where you want to put your money.  ;D
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 08:27:33 PM
Right- and this is one of the big benefits of pricing power. Cigarettes are a prime example of this but there are certainly others.

In fact this is where Thrifty is actually somewhat on point - not many companies have tons of opportunities to re-invest lots of capital for growth. The utilities, the railroad, even the insurance ops provide built-in reinvestment opportunities. And (at least for the first two) the return is relatively stable. Actually it provides WB with an option: If he can't find super attractive uses for $$, he can always dump some into the heavy businesses. What is the value of a perpetuity-like reinvestment option?

To the other point, I don't think Berkshire is investing below its cost of capital i.e. engaging in value destruction. If your personal hurdle rate is 25% for example then BRK is probably not where you want to put your money.  ;D

I feel like I’m in bizarro world. If your hurdle rate is 25% then buy Berkshire at a low enough price to yield 25%. (Spoiler alert, that won’t happen since company buybacks set a floor well above said price.)
Title: Re: BRK Valuation
Post by: LC on June 24, 2020, 08:41:05 PM
Yes, obviously. And if Brk-A trades at $1/share you should also purchase it.

In reality it trades at a 6% yield which is why I said, "if your hurdle rate is 25% then you should be looking elsewhere."
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 24, 2020, 08:41:16 PM
Sadly, nobody is offering opinions of Berkshire’s valuation.

Further, we seem to be having some sort of a debate over whether the retained earnings of Berkshire’s operating companies and equity investments are valuable and growing. (I’m of the opinion they are both valuable and growing.)

And, there seems to be some degree of general disdain over a private investor’s desire to discount those earnings at a rate greater than the rate he estimates those earnings will grow when he is establishing his own desired purchase price.
Title: Re: BRK Valuation
Post by: longterminvestor on June 25, 2020, 03:44:46 AM
Personally, I’m concerned the company isn’t being handed over to “leaders.” I think it’s being handed off to managers. There’s a big difference.

On the positive front you have Ajit and Todd. Ajit is the real deal when it comes to insurance. And, I’m generally excited about the prospects of capital being deployed by Todd Combs, as I get a sense he can learn to be as shrewd as Buffett.

I think Ted and Greg, however, are faking it until they don’t make it.

No manager will grasp Berkshire or the investment world the way Buffett did in his prime - when it was easier to grow. And, none of the next generation of senior management has shown any ability to communicate like a leader (David Sokol was the closest - but awkwardly arrogant). I suspect they will communicate like operators not wanting to screw up. And, thus begin the journey toward bigness and dumbness.

Thrifty3000 - thanks for sharing.  All opinions/thoughts are welcome even if some are not well received.  I am curious on your comment above regarding Ajit/Todd and Gregg/Ted.  Ajit is hands down wonderful insurance man however he may not be as long lived as we all want.  Pray he is grooming a deep bench.  Todd is doing just fine.  Don't agree with comment on Gregg - you believe he does not have "the right stuff"?  Please expand.  I was very impressed with his tone/candor during meeting and believe he can allocate capital very well.   Ted is gonna do just fine as well.

With regards to management taking over, I think its easier than people think.  I believe new management's charge from BOD will be to "not make a big mistake" rather than "grow earnings at XX%/yr".  Basically Gregg will sit in the Ivory tower with Tedd/Todd (or Gregg has his own lieutenants) and WAIT for 10-12% year 1 return to deploy significant capital.  WAITING is the discipline.  Only difference will be Gregg is gonna have a spreadsheet to do calculations where Mr. Buffett calculates in his head real time. And Mr. Buffett is leaving Gregg/Tedd/Todd 2 ACES to play when no opportunity is available: #1 Buybacks & #2 Dividend. 

The tone of Thrifty3000 post is assuming WAITING = DUMBNESS.  I very much disagree, waiting is the ENTIRE GAME!!!  No one else waits, they all scour the earth for 10%-12% returns and when they see nothing is available they reduce expectations to 6%/8% or even 3%/5% and say "well, if we lever that - we will get 10%/12%".  I mean, VC's and PE Groups are now investing in Copywrite Vehicles that own music to license to for commercial use - wow have we reached a new level of creativity looking for yield.  Could be a wonderful business, I have no opinion however the point is "Helpers" will find or manufacture vehicles for investment to give the yield market needs to feed itself.  Idiots, all of them!  and ssssshhhhhhh - dont tell them.  BRK will pick the bones of their dead carcasses and now the return will be 15%/17%!!!

 
Title: Re: BRK Valuation
Post by: vinod1 on June 25, 2020, 05:23:34 AM
Sadly, nobody is offering opinions of Berkshire’s valuation.

Further, we seem to be having some sort of a debate over whether the retained earnings of Berkshire’s operating companies and equity investments are valuable and growing. (I’m of the opinion they are both valuable and growing.)

And, there seems to be some degree of general disdain over a private investor’s desire to discount those earnings at a rate greater than the rate he estimates those earnings will grow when he is establishing his own desired purchase price.

Hi Thrifty3000,

You mentioned a lot of good points and obviously very smart and knowledgeable.

A lot of the board members are providing you with good advice. I made a very similar mistake in the past until I realized why there is no earnings discount model. I wish I wrote something that caused fellow board members to point out my mistake. Then I would have corrected it earlier.

You are lucky!

Here we are disagreeing with some very basic financial math. There is not much to disagree on if one understands it. I say it with nothing but goodwill and regards for you.

Vinod
Title: Re: BRK Valuation
Post by: vinod1 on June 25, 2020, 05:37:54 AM
I will try one simple exercise to see if it conveys the point. Forget all the earnings models.

Assume BRK has $10 normalized earnings last year. Retains all earnings and does not pay dividends.

It grows at 5% for 50 years to $115 EPS in 2070.

It sells at a PE of 25 or $2875 in 2070.

So if you buy BRK today at $160 (a PE of 16), you would end up earning 6% total return.

The PE increase contributed adding only 1% to the return. Earnings growth per share drives the return. You cannot have vastly different earnings growth and share price growth without PE blowing out to an extreme.

If you want 10% returns from BRK assuming above, you need to buy it at $25 per share. A PE of 2.5.

Vinod
Title: Re: BRK Valuation
Post by: vinod1 on June 25, 2020, 05:55:20 AM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.

Ok, I totally agree with you there. I feel like that’s where my 6% growth assumption comes into play. I’ve seen growth assumptions from others as high as 8.5%.

But, I’m pretty sure Buffett would not have stopped buying back shares in Q1 if he thought long term growth of 8.5% was feasible.

I model out for 7 years. So my forecast is over the next 7 years starting from end of March 31. BRK portfolio had slightly higher expected returns from the prices on March 31 and it providing a bit of tailwind from re-rating over 7 years.

The 8.5% is not from here to eternity.

I did a valuation for YE 2009 and my estimates for 10 year, BV and price. See below. I then reconcile every 5 years to see why it differed. I had not put up the reconciliation on my website. But the main book value growth difference is from (1) tax cut changes (2) portfolio returns.

http://vinodp.com/documents/investing/BerkshireHathaway.pdf

Vinod
Title: Re: BRK Valuation
Post by: sleepydragon on June 25, 2020, 05:58:42 AM
What is a good book to read on this subject?
Thanks!
Title: Re: BRK Valuation
Post by: vinod1 on June 25, 2020, 06:15:48 AM
What is a good book to read on this subject?
Thanks!

Hands down Investment Valuation: Tools and Techniques for Determining the Value of any Asset by Aswath Damodaran. Spent several months on this. This is after I passed all the CFA exams. It just goes into all the nitty gritty that is not covered well elsewhere. Some prefer McKinsey's Valuation book.

https://www.amazon.com/dp/1118130731/ref=pd_bxgy_3/137-5938580-2840858?_encoding=UTF8&pd_rd_i=1118130731&pd_rd_r=5dc816ca-cf6a-4875-869b-211f186b1995&pd_rd_w=jTwQ7&pd_rd_wg=igTPH&pf_rd_p=4e3f7fc3-00c8-46a6-a4db-8457e6319578&pf_rd_r=NCA2HZFBPWA29D8W148Y&psc=1&refRID=NCA2HZFBPWA29D8W148Y
Title: Re: BRK Valuation
Post by: sleepydragon on June 25, 2020, 06:46:00 AM
What is a good book to read on this subject?
Thanks!

Hands down Investment Valuation: Tools and Techniques for Determining the Value of any Asset by Aswath Damodaran. Spent several months on this. This is after I passed all the CFA exams. It just goes into all the nitty gritty that is not covered well elsewhere. Some prefer McKinsey's Valuation book.

https://www.amazon.com/dp/1118130731/ref=pd_bxgy_3/137-5938580-2840858?_encoding=UTF8&pd_rd_i=1118130731&pd_rd_r=5dc816ca-cf6a-4875-869b-211f186b1995&pd_rd_w=jTwQ7&pd_rd_wg=igTPH&pf_rd_p=4e3f7fc3-00c8-46a6-a4db-8457e6319578&pf_rd_r=NCA2HZFBPWA29D8W148Y&psc=1&refRID=NCA2HZFBPWA29D8W148Y

Vinod, thank you very much!
I read a smaller book by him before and it was pretty good.
Title: Re: BRK Valuation
Post by: aryadhana on June 25, 2020, 07:31:42 AM
You may also want to check out John Burr Williams' (https://en.wikipedia.org/wiki/John_Burr_Williams) "Theory of Investment Value" (1938, Amazon (https://www.amazon.com/Theory-Investment-Contrary-Opinion-Library/dp/087034126X)).  There's a cogency to the way he writes, and I'm not sure we've substantively advanced our conceptual understanding of valuation by much since then. 

I'm not sure what the argument against initiating dividends paying out even just a fifth of earnings really is.  I'm not even really sure that "taxes" is the right answer.  We can all hold stock and treasuries on our person without paying any corporate tax.  A dividend would also enable them to methodically reason about share repurchases: how much in future dividend payouts are saved by repurchasing at this price or, similarly, by how much more can we accelerate dividends paid per share given this repurchase? 

Should they even have a sizable investment portfolio? 
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 25, 2020, 07:33:11 AM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.

Ok, I totally agree with you there. I feel like that’s where my 6% growth assumption comes into play. I’ve seen growth assumptions from others as high as 8.5%.

But, I’m pretty sure Buffett would not have stopped buying back shares in Q1 if he thought long term growth of 8.5% was feasible.

I model out for 7 years. So my forecast is over the next 7 years starting from end of March 31. BRK portfolio had slightly higher expected returns from the prices on March 31 and it providing a bit of tailwind from re-rating over 7 years.

The 8.5% is not from here to eternity.

I did a valuation for YE 2009 and my estimates for 10 year, BV and price. See below. I then reconcile every 5 years to see why it differed. I had not put up the reconciliation on my website. But the main book value growth difference is from (1) tax cut changes (2) portfolio returns.

http://vinodp.com/documents/investing/BerkshireHathaway.pdf

Vinod

Vinod, I sincerely appreciate your generous advice and look forward to reviewing your valuation. Thank you.
Title: Re: BRK Valuation
Post by: sleepydragon on June 25, 2020, 08:17:53 AM
Thrifty,
I think when you use ROE, people get to valuation represented by a multiple of the book value. The higher roe the higher multiple.
If you mix roe and DCF model, you need to make sure you separate the FCF from earning to do DCF. So in your spreadsheet, you use ROE to get the earnings, you then deduct capex (and dividends), and then DCF on the FCF/retained earning.

Actually I think a better way for valuations is do comparables.
For BRKb, we can compare BRK against UNP, XLU, progressive and then just take the market value of the portfolio. I believe if we take brk’s revenue segmentation weighted YTD market price returns of the peer companies of BRK’s biggest component’s, we will find BRK is lagging by at least 20% YTD.
Title: Re: BRK Valuation
Post by: sleepydragon on June 25, 2020, 09:51:00 AM
You may also want to check out John Burr Williams' (https://en.wikipedia.org/wiki/John_Burr_Williams) "Theory of Investment Value" (1938, Amazon (https://www.amazon.com/Theory-Investment-Contrary-Opinion-Library/dp/087034126X)).  There's a cogency to the way he writes, and I'm not sure we've substantively advanced our conceptual understanding of valuation by much since then. 

I'm not sure what the argument against initiating dividends paying out even just a fifth of earnings really is.  I'm not even really sure that "taxes" is the right answer.  We can all hold stock and treasuries on our person without paying any corporate tax.  A dividend would also enable them to methodically reason about share repurchases: how much in future dividend payouts are saved by repurchasing at this price or, similarly, by how much more can we accelerate dividends paid per share given this repurchase? 

Should they even have a sizable investment portfolio?

Thanks! I will check it out
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 25, 2020, 10:48:02 AM
You can play with the #s however you like, the point is that companies which can grow earnings without reinvesting capital (and therefore can distribute it to owners) are much more valuable.

Ok, I totally agree with you there. I feel like that’s where my 6% growth assumption comes into play. I’ve seen growth assumptions from others as high as 8.5%.

But, I’m pretty sure Buffett would not have stopped buying back shares in Q1 if he thought long term growth of 8.5% was feasible.

I model out for 7 years. So my forecast is over the next 7 years starting from end of March 31. BRK portfolio had slightly higher expected returns from the prices on March 31 and it providing a bit of tailwind from re-rating over 7 years.

The 8.5% is not from here to eternity.

I did a valuation for YE 2009 and my estimates for 10 year, BV and price. See below. I then reconcile every 5 years to see why it differed. I had not put up the reconciliation on my website. But the main book value growth difference is from (1) tax cut changes (2) portfolio returns.

http://vinodp.com/documents/investing/BerkshireHathaway.pdf

Vinod

Awesome analysis, Vinod. It looks like your valuation and advice were spot on. I liked how you segmented your intrinsic valuation into investment value vs speculative value.

I did notice something interesting when I compared the output of your approach to mine.

Your approach resulted in a total intrinsic valuation of $110 per B share (in 2009).
You advised that investors would earn a 9% to 10% return if they purchased B shares at a price of $84 per share.
You advised that aggressive investors should invest at $67 per share.
And, you estimated look through earnings of $4.90 per B share.

Now, the funny thing is that when I plug $4.90 earnings and 9% growth into my humble little discount-based model it spits out the following:

Intrinsic value per B share: $108.88 (Difference from Vinod's model = $1.12 or 1%)
Recommended purchase price at 40% discount to Intrinsic Value: $65.33 (Difference from Vinod's model = $1.67 or 2.49%)
And, if I had purchased shares in 2009 at $65.33 per share I would have experienced compound growth of approx. 10%. Not too bad.

(Side note: Uh Oh! Thrifty3k might be on to something!)

It still feels like getting the look through earnings and growth estimates right are the most important factors. Oh yeah, and purchase price. I'll post how I arrive at look through earnings in a bit.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 25, 2020, 11:16:17 AM
Thrifty,
I think when you use ROE, people get to valuation represented by a multiple of the book value. The higher roe the higher multiple.
If you mix roe and DCF model, you need to make sure you separate the FCF from earning to do DCF. So in your spreadsheet, you use ROE to get the earnings, you then deduct capex (and dividends), and then DCF on the FCF/retained earning.

Actually I think a better way for valuations is do comparables.
For BRKb, we can compare BRK against UNP, XLU, progressive and then just take the market value of the portfolio. I believe if we take brk’s revenue segmentation weighted YTD market price returns of the peer companies of BRK’s biggest component’s, we will find BRK is lagging by at least 20% YTD.

I use Look Through Earnings, which are the earnings that would be available to owners if all free cash flow generated by the operating companies and equity holdings were distributed instead of retained.

I assume every dollar retained will lead to at least a dollar of market value over time.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 25, 2020, 04:35:46 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
Title: Re: BRK Valuation
Post by: handycap5 on June 26, 2020, 01:21:23 PM
Chris Bloomstran on a recent interview put the normalized earnings power at $40 billion. Any idea of where he gets that figure?

Title: Re: BRK Valuation
Post by: Cigarbutt on June 26, 2020, 02:26:43 PM
You may also want to check out John Burr Williams' (https://en.wikipedia.org/wiki/John_Burr_Williams) "Theory of Investment Value" (1938, Amazon (https://www.amazon.com/Theory-Investment-Contrary-Opinion-Library/dp/087034126X)).  There's a cogency to the way he writes, and I'm not sure we've substantively advanced our conceptual understanding of valuation by much since then. 

I'm not sure what the argument against initiating dividends paying out even just a fifth of earnings really is.  I'm not even really sure that "taxes" is the right answer.  We can all hold stock and treasuries on our person without paying any corporate tax.  A dividend would also enable them to methodically reason about share repurchases: how much in future dividend payouts are saved by repurchasing at this price or, similarly, by how much more can we accelerate dividends paid per share given this repurchase? 

Should they even have a sizable investment portfolio?
The book is available here:
https://archive.org/details/in.ernet.dli.2015.225177/page/n1/mode/2up
If anything, the book is interesting for historical reasons and investing work still basically comes down to somehow imagining future cashflows and using an appropriate discount factor. The emphasis on dividends has changed and Mr. Burr Williams hoped that investment analysis may eventually help to reduce the damage done by the cycle. i wouldn't bet on that.

Chris Bloomstran on a recent interview put the normalized earnings power at $40 billion. Any idea of where he gets that figure?
i haven't heard (or read) Mr. Bloomstran lately but it may be related to what he wrote in his last annual letter (p113, adjusted net income,economic earnings)
https://static.fmgsuite.com/media/documents/c388840b-3dda-41da-a062-077bf785255b.pdf
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 26, 2020, 02:34:53 PM
Yes. He lays everything out in great detail in his annual letters/novellas. He makes several more accounting adjustments than Vinod and I do for things like pension liabilities, etc.

He makes assumptions that a large percentage of the cash will be invested at higher rates of return over time (a safe bet), and incorporates the higher projected earning power into “normalized” earnings.

Due to his accounting adjustments and assumptions his pre-covid normalized earnings came in about $8 billion higher than my pre-covid estimate. If you assume $100 billion of cash will eventually be invested at an 8% to 10% return, and discount it a bit to account for the wait time to deploy, it accounts for much of the difference between his estimate and mine. I'm a wuss when it comes to optimistic forecasts, so I prefer to assume more cash will pile up at the same rate existing cash will be deployed (see next paragraph).

If I recall correctly he also assumes a higher growth rate than I do. I believe his pre-covid estimate gravitated towards 8%. I’m trying to talk myself into using a 7% rate, but I’m not there yet. The cash will be a huge drag. They have to invest $30 billion and growing annually in expensive large cap equities, expensive private companies, or their own fairly priced shares. Remember, BNSF “only” cost $26 billion. I just can’t be optimistic about BRK being able to make a BNSF sized acquisition at a decent price every single year going forward, which is pretty much what it will take to sop up the free cash pouring in (cry me a river). (Buffett says his circle of competence encompasses about 5% of businesses. If you assume he’s comfortable evaluating/purchasing 5% of the businesses in the world, which are at least as big as BNSF, that doesn’t leave many.)

I do look forward to Bloomstran’s analysis of covid’s impact on the various segments, if for no other reason than trying to forecast how things like negative interest rates will impact every insurance and banking operation; how less travel will impact airline and auto related businesses, etc, etc, etc - a gargantuan undertaking, and WAY above my pay grade (probably above Bloomstran’s pay grade, and maaaybe above Buffett’s, seeing as he went to DEFCON 1 in March). That’s why I just lop 20% off my pre-covid estimate (#lazy #tooHardPile).

Title: Re: BRK Valuation
Post by: widenthemoat on June 26, 2020, 04:32:16 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.
Title: Re: BRK Valuation
Post by: Mephistopheles on June 26, 2020, 05:16:18 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.


Well, good way to think of it is-

would you rather have $1 m in equity or $1 m in float, all else being equal?
The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.
Title: Re: BRK Valuation
Post by: widenthemoat on June 26, 2020, 05:31:11 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.


Well, good way to think of it is-

would you rather have $1 m in equity or $1 m in float, all else being equal?
The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.

Personally, I think I would prefer $1.0m in float. I don't have to lay out a dime of my own money to earn $0.1m per year. If I'm laying out my own money to purchase the business from someone else, I would certainly prefer float if I wanted to grow the business - I would be able to distribute all earnings and grow them by using float instead of my own equity. I would also prefer float if it was profitable (i.e. essentially borrowing at a negative rate).
Title: Re: BRK Valuation
Post by: ValueMaven on June 26, 2020, 06:29:18 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
Title: Re: BRK Valuation
Post by: Cigarbutt on June 26, 2020, 06:50:08 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.
Well, good way to think of it is-
would you rather have $1 m in equity or $1 m in float, all else being equal?
The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.
Personally, I think I would prefer $1.0m in float. I don't have to lay out a dime of my own money to earn $0.1m per year. If I'm laying out my own money to purchase the business from someone else, I would certainly prefer float if I wanted to grow the business - I would be able to distribute all earnings and grow them by using float instead of my own equity. I would also prefer float if it was profitable (i.e. essentially borrowing at a negative rate).
Waiting for bizaro's more sensible and practical answer but here's a perspective.
Float can be free or can even have negative cost but it's conditional on a cushion of equity. One way to see it is if the characteristics of the insurance business allow you to discount the insurance reserve liabilities.
Take the following (simplified) and consider the ends of the spectrum:
Assets (float)=240, Liabilities (reserves)=160, equity=80
Scenario #1, poor business
You buy the business to put in runoff and pay about book value or a slight discount to BV (say 0.9 BV). So you pay 72 and record 8 as negative goodwill. A way to appraise the negative goodwill (as an equivalent) is to augment the value of the reserves (often done post-acquisition with a hit to acquired equity when such a business is acquired).
Scenario #2, great business, expect underwriting profit and growth (other end of the spectrum)
You buy the business, pay a premium to book value (say 2 BV). So you pay 160 and record 80 as goodwill. A way to appraise the goodwill (as an equivalent) is a contra-account to decrease the value of the reserves.

When you look at float as a source of financing (from policy holders), you can't choose it above other sources of financing but its value can be modified by the type of business you're running or acquiring.
Historically, insurance companies have behaved closer to scenario #1, which is a reason why reserves are not typically discounted and high premiums to BV are not the norm.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 26, 2020, 06:54:31 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.
Title: Re: BRK Valuation
Post by: bizaro86 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.
Title: Re: BRK Valuation
Post by: wabuffo 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
Title: Re: BRK Valuation
Post by: ValueMaven 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
Title: Re: BRK Valuation
Post by: longinvestor 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.

************
Title: Re: BRK Valuation
Post by: Thrifty3000 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.)
Title: Re: BRK Valuation
Post by: Thrifty3000 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.
Title: Re: BRK Valuation
Post by: steph 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%. 
Title: Re: BRK Valuation
Post by: Thrifty3000 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.
Title: Re: BRK Valuation
Post by: aws 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.
Title: Re: BRK Valuation
Post by: bizaro86 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.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 28, 2020, 11:20:07 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.

I agree. Lumping together cash and investments is a gummed up way of evaluating BRK. I only pointed out the high PE of those two items because another poster mentioned the Rational Walk's grouping of cash and investments when making their point that the rest of BRK is cheap.

I personally Love investments with multiple earnings streams, and I feel like I run into the argument that "you get the rest for free" All The Time. In fact, I've been plenty guilty of wanting to use that phrase when evaluating things like Altius, or FFH, or FFH Africa/India, or even something like St. Joe back in the day.

IMHO (and talking to myself too) it's probably best if that phrase is deleted from the value investor lexicon. 9 times out of 10, if I keep pushing myself to uncover what the true look through earnings potential of each earnings stream is, I come to find that if you're getting "part of an investment for free" in a highly liquid, highly informed, free market system it's because you're paying too much for the other parts.

In the case of Berkshire, we know we're paying too much for Apple, etc. In fact, another COBF thread is currently discussing the merits of shorting Apple if you hold BRK. (Maybe worth exploring if you'd normally sell an equity for a 40% premium to fair value.)

For me, the biggest curve balls in recent months are how to think about Covid and the deployment of cash. And, one of the biggest surprises of my investing life is that Buffett was fearful when all others were fearful. I'm sure for very good reason, which only time will tell, but that wasn't supposed to be in his DNA (especially with $100+ billion of cash).

I'm confident that if Berkshire deploys cash into equities - including share buybacks - it is with an expectation of high single digit or low double digit returns over time (see Buffett's recent commentary on airline investment justification - there was a double digit return expectation). For that reason I don't think you look at the value of cash as worth less than $1 for each $1 of cash held (despite any inflation-induced decline in near-term purchasing power).

Theoretically, $100 billion of cash could be deployed tomorrow at a 10% after tax return. Or, more likely, it could be deployed in chunks over several years (while more cash is piling up). So, you can do what Semper Augustus does and pick the "normalized" long term earnings power you're comfortable with for the $100 billion, and tack it on to your "normal" look through earnings estimate. It's probably not conservative enough to say the $100 billion represents $10 billion of after tax earnings potential, but it's probably perfectly safe to estimate $4 to $6 billion.

If look through earnings in 2018 and 2019 were around $31 billion, then after whatever covid impairments you choose to make, you could reasonably add $4 to $6 billion to represent the normal long-term earnings potential of the cash.

I already own plenty of BRK, so I'm not currently making an upward earnings adjustment for the cash. But, I have in the past, I probably would now if I had seen at least a few billion deployed in March, and who knows, I could change my mind tomorrow.
Title: Re: BRK Valuation
Post by: StevieV on June 28, 2020, 12:35:26 PM
I also don't like - "you get the rest for free" analysis.  How big is the "Free" part?  How sure are you of the valuation of the "fairly valued" part?  If you change the multiple of the "not free" part maybe you aren't getting anything for free or the "free" part only represents a small discount.

Quote
Theoretically, $100 billion of cash could be deployed tomorrow at a 10% after tax return. Or, more likely, it could be deployed in chunks over several years (while more cash is piling up). So, you can do what Semper Augustus does and pick the "normalized" long term earnings power you're comfortable with for the $100 billion, and tack it on to your "normal" look through earnings estimate. It's probably not conservative enough to say the $100 billion represents $10 billion of after tax earnings potential, but it's probably perfectly safe to estimate $4 to $6 billion.

I'm concerned about the value of this $100 B, the ability to deploy it at high rates and the timing of doing so.

Title: Re: BRK Valuation
Post by: Mephistopheles on June 28, 2020, 12:49:55 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.

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.

I agree with this line of thought. Maybe the best way to discount the float liability for the IV calculation is just take out the amount in cash that we are never going to see. Buffett talks about $20 billion minimum, it's probably more realistically $40 billion. 20 minimum he refuses to spend and add another 20 that will never be spent fast enough as it is made. Add another $10 billion to be safe. So that is $50 billion cash that for shareholder purposes, we will never see.

So out of $130 billion float, we can consider as free money approx (130-50) = 80 billion of it.

The stock is still insanely cheap with these numbers.

People tend to weigh recent trends too heavily. Would we be talking about discounting the cash balance if we didn't see this massive upswing in stock prices? Would people be questioning Buffett's judgment for not repurchasing in March if S&P was even lower today?

BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

That cash pile will quickly look heroic if/when we have another downswing. For that reason by buying BRK you are naturally hedging against the downside.

The expectations are so low right now that any sort of good news will cause a huge jump. Imagine next Q we see $10 billion in repurchase activity?
Title: Re: BRK Valuation
Post by: bizaro86 on June 28, 2020, 01:40:42 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.

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.


BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

I agree with this entire post, but especially the part about sentiment. I converted a big chunk of my BRK position from shares to LEAPs on Friday. 2:1 ratio of deep ITM calls to shares. If it continues to drop I'll do more. Biggest reasoning is I think risk of permanent impairment at the current price is very low.
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 28, 2020, 04:57:11 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.

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.


BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

I agree with this entire post, but especially the part about sentiment. I converted a big chunk of my BRK position from shares to LEAPs on Friday. 2:1 ratio of deep ITM calls to shares. If it continues to drop I'll do more. Biggest reasoning is I think risk of permanent impairment at the current price is very low.

Man, I hope you guys are right. I invested a small fortune in March thanks to trade triggers that were based on a pre-covid view of the world.

If you take the pre-covid look through earnings of $31 billion, and then add a $5 billion upward adjustment for the cash holdings, you get normal earnings of $36 billion, or $15 per B share (close to the Semper Augustus expectation of normal earnings). If you slap an 18 multiple on it you get a fair value of $270 per B share. If the value doubles over the next 7 to 10 years and you pay today's price of $175 then you'll earn your spot in value investor heaven. Hopefully investing turns out to be that easy.

But why did one of the greatest investment minds in history... who knows the salient financial details of thousands of businesses, the interworking of global supply chains, the price history of commodities and their impact on the raw material costs of his dozens of investments (including the price of sugar's impact on the profitability of an 8 ounce serving of coke), whose best friend Bill Gates is also a founder of one of the most valuable companies on the planet and who predicted the enormous global economic pain of a pandemic years before it happened, who together with Gates jointly funds a foundation with its finger on the pulse of the highest probability solutions to covid, who has any world leader and several of the world's greatest risk handicappers - like Ajit Jain - on speed dial... stop buying back shares in March?

It wasn't because he's ill-informed.
Title: Re: BRK Valuation
Post by: steph on June 29, 2020, 12:07:58 AM
He probably was too well informed. Bill Gates scared him and he got very little time to buy at prices he really found attractive.

Never forget that in 2008 he didn't buy anything meaningful in the stockmarket.  He responded to very attractive offers made to him with preferreds,etc....

Title: Re: BRK Valuation
Post by: JPerez on June 29, 2020, 05:13:33 AM
I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.
He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.
This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.
The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.
He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.
That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.
What is the upside of going all in in the march low? A few extra points of performance for the next few years?
What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?
Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.
What if the vaccines don't work, what if the government reduce the stimulus?
Both are unlikely but there isn't a zero chance of them
On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.
Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.
At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.
How is that a bad outcome?
We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.
By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.
Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.
The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense
Title: Re: BRK Valuation
Post by: longinvestor on June 29, 2020, 07:08:41 AM
I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.
He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.
This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.
The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.
He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.
That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.
What is the upside of going all in in the march low? A few extra points of performance for the next few years?
What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?
Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.
What if the vaccines don't work, what if the government reduce the stimulus?
Both are unlikely but there isn't a zero chance of them
On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.
Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.
At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.
How is that a bad outcome?
We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.
By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.
Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.
The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense
[/b]
+1

Agree wholeheartedly that he’s not terribly excited about buying back. That said, he’s acutely aware that the next guy needs buybacks in his toolkit. Likely the main tool. The longer the  undervalued situation can continue the easier it is for the next guy. “You all have to endure us” Munger!
Title: Re: BRK Valuation
Post by: ValueMaven on June 29, 2020, 10:12:49 AM
Chris Bloomstrain from the Manual of Ideas on 3/26

'Berkshire is a big position for us, and I think they’re in pretty good shape. That’s the proper
way to think about it. When I think about Berkshire — I said it at the year end — they had
about $42 billion in economic earnings. That includes $3 billion for the optionality of the
cash, and everybody can make their own decision about that, so $40 billion. It won’t be $40
billion this year, but discounting 2021 and beyond, I think $40 billion is right. When the
stock traded at a market cap of less than $400 billion, I don’t recall a time that Berkshire
has traded at 10x what I would call normalized earnings. It’s got a fortress balance sheet,
and it’s got a lot of businesses inside it that are about as well protected against the
downturn as you can have. It made no sense to me that the stock traded at 160.'
Title: Re: BRK Valuation
Post by: Thrifty3000 on June 29, 2020, 11:54:14 AM
I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.
He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.
This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.
The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.
He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.
That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.
What is the upside of going all in in the march low? A few extra points of performance for the next few years?
What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?
Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.
What if the vaccines don't work, what if the government reduce the stimulus?
Both are unlikely but there isn't a zero chance of them
On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.
Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.
At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.
How is that a bad outcome?
We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.
By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.
Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.
The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense

Yeah, I think you're on to something with the recession mental model point...

Imagine being Buffett in March. His operations and suppliers in China have already gone dark. The US is just starting to work through a shutdown - averting what was already happening in Italy. He already sees the cash drain on Dairy Queen China, suppliers delaying deliveries, orders being canceled, plummeting rail car loads, a massive drop in daily auto insurance claims, planes not flying, assembly lines halting, and employees being furloughed.

His buddy Billy G. advised a vaccine is 18 months away at best, and that the first iterations may not protect the at-risk population (so buckle up for prolonged behavior changes). He's surely talked to his top managers about downside risk scenarios, and about the parental support potentially needed to survive 18, 24, or even 36 months. He's likely urged them to look out for good competitors in financial trouble. In other words he's handicapped Berkshire's risk, so he can more fully focus on opportunity.

He knows there's an unprecedented amount of corporate debt sitting one notch above junk. He knows financial markets are gumming up, and companies like AIG are at the mercy of commercial paper. He knows full well the lock down can only subsist about 45 days before businesses globally start dropping like flies. There could soon be opportunities aplenty.

He has no idea how the government will respond to this crisis, or how the economy will respond to the government. (The CARES act was introduced to the Senate floor on March 19, at least 9 days after Buffett's last Q1 share repurchase - for $214 per B share.)

He does know the Warren Buffett help line is starting to ring...

My conclusion:

It makes perfect sense for those events to trigger a "recession mental model." Therefore, it makes perfect sense for Buffett to halt repurchases at that time, as the option value of cash was potentially worth FAR more than a moderately discounted share of Berkshire Hathaway. In fact, now that we've talked it out, I'd be scratching my head a bit if he HAD kept buying back shares. So, to that I say well played, Buffett.
Title: Re: BRK Valuation
Post by: bizaro86 on June 29, 2020, 12:12:07 PM

What is the upside of going all in in the march low? A few extra points of performance for the next few years?
What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?
Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.
 sense

There is a difference between going all in and adding a few extra percentage points of long exposure after a 30% drop. Especially when  you have a big cash position.

The reason the market has been negative on BRK is that the "story" in the stock was that the big cash position would provide huge upside after buying low during the next drop. And then I believe WEB was a net seller during the worst of the draw down.

If there is a second wave drop and he ends up deploying a big chunk of the cash that will be a double win - the profits on the investment plus the reputation gains (which flow to the multiple).
Title: Re: BRK Valuation
Post by: Mephistopheles on June 29, 2020, 05:22:21 PM
In March, during the depths of the crash when the Dow was falling thousands of points per day, what % of investors would have predicted that we would be at or near all times highs in a matter of months?

And if you guessed wrong that doesn't mean you are dumb. Assume the Fed failed to act as aggressively as they did. We would easily be in a very different scenario right now, both with the market and the economy. Imagine if the GOP and Dems couldn't agree on terms for the CARES Act? Imagine if the virus became deadlier and more transmissible. Note that the 2nd wave of the 1918 Flu Pandemic was significantly worse than the 1st wave.

Buffett said at the AGM that the range of probabilities included some very nasty outcomes. It is safe to say that the 40% market rebound within less than a quarter is likely the best possible outcome in that range. People don't give the man credit for preparing for a shitstorm that didn't happen but was at a high risk of happening. The game isn't over yet, he may be proven right once again.
Title: Re: BRK Valuation
Post by: bizaro86 on June 29, 2020, 06:04:07 PM
In March, during the depths of the crash when the Dow was falling thousands of points per day, what % of investors would have predicted that we would be at or near all times highs in a matter of months?

I never would have thought the market would rebound as fast as it did, but I still meaningfully bought equities in late March. A big decline has generally been a good time to buy stocks and reduce cash weighting, and the perfect is the enemy of the good there. Even a simple re-balance would have seen a bunch of equities purchased.
Title: Re: BRK Valuation
Post by: CorpRaider on June 29, 2020, 06:35:08 PM
People are tripping.  BRK didn't announce the BNSF acquisition until like 6 months after the bottom in 2009. 

Pretty much every reputable voice acknowledges a high probability of another round of covid in the fall not even counting the continued blossoming in the South of the U.S.
Title: Re: BRK Valuation
Post by: CorpRaider on June 29, 2020, 06:42:01 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

Munger has commented on a similar way of approaching the question a number of times.  I noted one time he mentioned this maybe a week ago when I was watching an annual meeting on the cnbc archive.  I think I tweeted about what year it was.  I will see if I can find it.  He also has said before (essentially), "It used to be like shooting fish in a barrel, you could buy Berkshire below the book price of the marketable securities and get the insurance and the other wholly owned subs for free."
Title: Re: BRK Valuation
Post by: ValueMaven on June 30, 2020, 05:06:31 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

Munger has commented on a similar way of approaching the question a number of times.  I noted one time he mentioned this maybe a week ago when I was watching an annual meeting on the cnbc archive.  I think I tweeted about what year it was.  I will see if I can find it.  He also has said before (essentially), "It used to be like shooting fish in a barrel, you could buy Berkshire below the book price of the marketable securities and get the insurance and the other wholly owned subs for free."

Yes - would be interested in seeing this ... Thx
Title: Re: BRK Valuation
Post by: AzCactus on June 30, 2020, 08:53:00 AM
Buffett has said time and again that "it's better to be approximately right than precisely wrong."  I think it's less important to know whether Berkshire's intrinsic value is $235/$240 and more important to know that it's significantly higher than it's current market price today.

Title: Re: BRK Valuation
Post by: LC on June 30, 2020, 09:03:28 AM
Buffett has said time and again that "it's better to be approximately right than precisely wrong."  I think it's less important to know whether Berkshire's intrinsic value is $235/$240 and more important to know that it's significantly higher than it's current market price today.

Right. And I think you can get there looking at the cash + earnings/valuations of the wholly owned subs + the equity portfolio.
Title: Re: BRK Valuation
Post by: aws on June 30, 2020, 08:54:56 PM
My back of the envelope calculation has Q2 book value at 164.67, so based on today's closing price we would be trading at 1.08 times book.

This is based on a presumed 28.7b net increase in book value from the equity portfolio, estimated by the change in portfolio value since 3/31 after adjusting for the sales we know about and the additional deferred tax liability on the unrealized gains.  Not surprisingly the vast majority of the gains are from Apple, which alone increased in value 28b pretax.

Then I just assumed operating earnings would breakeven for the quarter.  That may be way too conservative, so you could maybe add another $1 or $2 per share but in any case it's not going to have anywhere near as big of an impact on book value as the much more obvious change in the stock portfolio.  The 28.7b stock represents a 11.81 EPS and that adds to the prior quarter ending book value of 152.86 gets me to the 164.67.
Title: Re: BRK Valuation
Post by: wescobrk on June 30, 2020, 09:14:13 PM
Buffett has said time and again that "it's better to be approximately right than precisely wrong."  I think it's less important to know whether Berkshire's intrinsic value is $235/$240 and more important to know that it's significantly higher than it's current market price today.
According to Buffett, it isn't trading at a discount to intrinsic value. He didn't buy any in March when it was cheaper than what it is now. If Buffett showed signs of dementia at the 2020 annual meeting, then it would be easy to dismiss him, but he was as sharp as he has been the last 10 years. I think Buffett knows more about intrinsic value for Berkshire than anyone else. I don't mean for that to come across as a criticism of your post, just that the man that created Berkshire and knows more about the company than anyone on the planet disagrees with you.
Title: Re: BRK Valuation
Post by: aceskc on June 30, 2020, 10:16:50 PM
BRK may have been priced lower but not necessarily cheaper relative to book, when marked to market. Even when Berkshire traded into the 160s, AAPL their biggest holding  was in the 220s. That one position alone reflects a difference of 35B or  b/w March lows and end of qtr mark to market.  Thats not to say buybacks are happening in volumes, cos that does seem unlikely given how the stock is trading but P/B <1.1 is cheap relative to history, relative to other securities and relative to Buffett's past comments , and may not be as conflicted as it may appear by his inaction through April lows, when his book has been decimated,  economy shutdown and acquisition opportunities front run by the actions of the Fed.
Title: Re: BRK Valuation
Post by: kab60 on July 01, 2020, 05:19:15 AM
It seems the range of outcomes in March was higher than it is now. Covid19 has hardly been the deadly killer some feared though the economic impact of the close-downs are obviously hard to gauge. On that account I'd venture it's a much better risk/reward today than it was back then. And correct me if I'm wrong, but he did seem to indicate it was cheap at 160 - but also that it wasn't possibly to accumulate anything meaningfully since it just traded down for a short while. I really hope he took advantage of the price in Q2, but I'm not getting my hopes up based on his meager buyback track record. On the other hand, he's never had as much cash, and so little to deploy while at the same time Berkshire trades at a - relative to history - very low price.
Title: Re: BRK Valuation
Post by: SwedishValue on July 01, 2020, 11:52:40 AM
Buffett has said time and again that "it's better to be approximately right than precisely wrong."  I think it's less important to know whether Berkshire's intrinsic value is $235/$240 and more important to know that it's significantly higher than it's current market price today.
According to Buffett, it isn't trading at a discount to intrinsic value. He didn't buy any in March when it was cheaper than what it is now. If Buffett showed signs of dementia at the 2020 annual meeting, then it would be easy to dismiss him, but he was as sharp as he has been the last 10 years. I think Buffett knows more about intrinsic value for Berkshire than anyone else. I don't mean for that to come across as a criticism of your post, just that the man that created Berkshire and knows more about the company than anyone on the planet disagrees with you.

I think you make a very good point, but like Buffett said - Things change. Maybe Buffett considers the worst case scenarios to be far less likely today?

I’d argue that Berkshire could be considered cheaper at year-end 2019 than it was around the lows in march, and that Berkshire today is cheaper than it was at year-end 2019 again.

Covid aint going nowhere for now, but we have eliminated a lot of the worst case scenarios. If Buffett disagrees we’ll now soon enough.
Title: Re: BRK Valuation
Post by: buffetteer1984 on July 01, 2020, 01:58:49 PM
Buffett has said time and again that "it's better to be approximately right than precisely wrong."  I think it's less important to know whether Berkshire's intrinsic value is $235/$240 and more important to know that it's significantly higher than it's current market price today.
According to Buffett, it isn't trading at a discount to intrinsic value. He didn't buy any in March when it was cheaper than what it is now. If Buffett showed signs of dementia at the 2020 annual meeting, then it would be easy to dismiss him, but he was as sharp as he has been the last 10 years. I think Buffett knows more about intrinsic value for Berkshire than anyone else. I don't mean for that to come across as a criticism of your post, just that the man that created Berkshire and knows more about the company than anyone on the planet disagrees with you.

I think you make a very good point, but like Buffett said - Things change. Maybe Buffett considers the worst case scenarios to be far less likely today?

I’d argue that Berkshire could be considered cheaper at year-end 2019 than it was around the lows in march, and that Berkshire today is cheaper than it was at year-end 2019 again.

Covid aint going nowhere for now, but we have eliminated a lot of the worst case scenarios. If Buffett disagrees we’ll now soon enough.

I agree with this assessment.  Warren said the difference between intrinsic value and price was not significantly greater during march crash than when he bought in q1 around 220.  Now the price is close to the march lows with a few variables that have changed.  One, less uncertainty around the pandemic and how the feds and markets would react.  Two, some of his bigger holdings have increased substantially in price from the lows namely apple, bnsf (i assume this one based on other rails) while brk stock has languished.  178 today is a better bargain than 178 in march imo and I'd be surprised if he didn't dip his toe into buybacks this time around.
Title: Re: BRK Valuation
Post by: CorpRaider on July 01, 2020, 07:16:44 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

Munger has commented on a similar way of approaching the question a number of times.  I noted one time he mentioned this maybe a week ago when I was watching an annual meeting on the cnbc archive.  I think I tweeted about what year it was.  I will see if I can find it.  He also has said before (essentially), "It used to be like shooting fish in a barrel, you could buy Berkshire below the book price of the marketable securities and get the insurance and the other wholly owned subs for free."

Yes - would be interested in seeing this ... Thx

He briefly mentioned it in the 1999 meeting in response to a question about how to value berkshire.  I think the other time I am rememebering was at a DJCO meeting, maybe a year or two ago, where he was kind of discussing why he's rich and you are not (haha) and he was really kind of like "duh, you could get BRK for less than securities portfolio and get operating businesses and negative cost float for free."