What are you buying today?

[wknecht]

Hi longinvestor,

I think investment / share will overstate BRK  IV

http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/i-hate-this-post/msg213620/#msg213620
http://brooklyninvestor.blogspot.com/2013/03/value-of-investments-per-share.html
http://brooklyninvestor.blogspot.com/2011/12/so-what-is-berkshire-hathaway-really.html

I'm confused by the concept of retained earning being a separate component of value. When you are valuing investments / share & the current estate of operating businesses, does not the value thereof include the PV of their reinvested earnings? Isn't an earnings multiple simply a shorthand DCF with an implied growth rate? The growth comes from reinvested retained earnings, right?

In your post on the other thread your argument seems to be that the float should not be added back because the assets are invested in low yielding securities. Can you clarify this? Why are the assets at all relevant to the valuation of the liabilities?

Seems to me you should value them separately, and if you think the assets earn below market returns, then subtract from the assets, not the float.

[wknecht]

I think an argument could be made that adding the float back is conservative because it doesn't go far enough. The float has produced income uninterrupted for a long time (12 years if my memory serves), absent any contribution from the assets, so are arguably assets.

[thepupil]

The assets are related to the liabilities because the $80B or so of cash and short term high quality fixed income that berkshire keeps around is effectively to collateralize the float. Brooklyn investor speaks about it more eloquently than I can in the other links.

Unless you think some of that $80B is excess capital and can be freed up (which may be the case, if so adjust for that), then shareholders don't effectively own that cash as it is required to run the business. Instead they own the spread between what that cash and fixed income earns and the cost to obtain it.

Since that spread is not high enough to justify a value that effectively adds back the whole float, I think investments / share is inherently flawed.

[longinvestor]

Hi longinvestor,

I think investment / share will overstate BRK  IV

http://www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/i-hate-this-post/msg213620/#msg213620
http://brooklyninvestor.blogspot.com/2013/03/value-of-investments-per-share.html
http://brooklyninvestor.blogspot.com/2011/12/so-what-is-berkshire-hathaway-really.html

I'm confused by the concept of retained earning being a separate component of value. When you are valuing investments / share & the current estate of operating businesses, does not the value thereof include the PV of their reinvested earnings? Isn't an earnings multiple simply a shorthand DCF with an implied growth rate? The growth comes from reinvested retained earnings, right?

I thought about that and to keep past clearly separate from future, the PV only includes RE from year 2012 onwards. All prior RE ignored in PV calculation. Also on #2,  used a 10x multiple for a business where earnings have grown 20% for a very long time. Surely no double counting, no ?

RE, as described by WEB is in lieu of dividend payouts. If $400B were to be paid out over the next 20 years and we reinvested it, isn't that separate from operating earnings? Both BNSF and BHE, where the lion's share is being retained are choosing to do this (100%). So yes, Vinod's suggestion is to estimate BRK's IV from earnings growth rate. If my thesis is correct, the recently burgeoning RE story should show up in a higher earnings growth than 20%! Just working with my boredom and tired of only using past #s

[Lance]

AMIGY

Thanks,
Lance

[vinod1]

10% on the asset or 10% after the effect of leverage?

10% after leverage. Basically ROE.

Since they are likely to keep about $30 billion on average in cash and need to pay taxes on capital gains, leverage basically pays for the drag of these two. So we end up with ROE of about 10%

Vinod.

[vinod1]

Estimates of IV suggests that the 1.2xBV is a 50 cent dollar.

Hi longinvestor,

Does this mean that your estimate of IV for BRK is 2.4x BV? Just curious, I have never been able to justify much above 2x BV even in my most optimistic scenario.

Thanks

Vinod

Thanks!

I'm not the numbers type, yet indulged because of boredom that comes with owning BRK. Playing around with assumptions (discount rate, owner earnings etc.), my IV range is between $240,000 and $340,000. The big range supports my vaguely correct posture and I'm comfortable with it. While I may be over optimistic, the market continues to under estimate BRK as the norm. Been buying more.

While on the subject, I've seen many calculators / calculations using two columns, using DCF etc. But not much discussed about the "third (more subjective) element" which deals with the efficacy with which retained earnings will be deployed. WEB covers this on page 123-124 of the AR.

Your thoughts on this? After all, retained earnings is the story of Berkshire since 2009. Curious as to your take on this.

Thanks

I think Buffett is happy to deploy capital when he can get a very high probability of 10% returns. His investments - WFC, IBM, Capex at Utilities, his various preferred investments, etc - all indicate he is happy with 10%.  He might get a chance on occasion to deploy capital at higher rates but they are going to be only a few such opportunities.

Some of the internal reinvestment opportunities are going to be at higher rates and he is going to pay premiums for new businesses that generate high ROIC or ROE.

But I think all in all, a 10% return on retained earnings is what we can expect. So that is my estimate for "efficacy with which retained earnings will be deployed".

IMO - For the really small subset of very high quality companies like Berkshire, Coke, Walmart, etc. it is more useful to estimate the growth rate of IV rather than focusing on IV itself. This would allow you to estimate what returns you are likely to get over the very long term if you just hold this investment. This way you avoid the most speculative component of valuation - changes in multiples. 

Vinod

If IV is made up of 1. Investments/share + 2. Operating Earnings per share + 3. Incremental return on Retained Earnings

Readily Calculable
1) = $140,000
2) = 10x $11,000 = $121,000

Efficacy of RE deployed - estimate of future
3) = NPV of incremental earnings from RE= $81,000
  How I get to this: RE for 2012-13-14: $14B, $20B, $20B; If we held RE constant at $20B for the next 20 years (WEB has stated this "as far as the eye can see") and the retained earnings start producing a 10% return 3 years out; 10% Discount rate

So 1+2+3 = $342,000;  There's my 2.4x BV. Conservative enough? If you ask me, they will retain far more than what I'm assuming, earn better than 10%. Agree with you, they look for a near certain 10% return; 

The retained earnings is of growing significance just by sheer magnitude. A standout comment by Munger in his commentary, "BRK will do fine without ever making another acquisition" perhaps has this baked in.

IMO, the multiple you put on #2 is based on "the efficacy with which retained earnings will be deployed".

If you do it this way, in effect you are saying a $1 of operating earnings are worth about 27.4 times. So you are putting a PE multiple of 27.4

$121,000 + $81,000 = $202,000 value for operating businesses.

These are earning pre-tax about $11,000.

At a 33% tax rate, after tax earnings are $7370.

PE multiple = 202,000/7370 = 27.4


You would certainly be able to justify these depending on your assumptions about expected returns, required return, retention and length of the period where expected returns exceed required returns. But to me they would not be conservative. But again, that would just be me and I have a tendency to be very conservative in my estimates.

Vinod

[Schwab711]

Assets are only worth what they produce. A lot of those investments are used for liquidity purposes and the benefit is already accounted for through lower interest rates and better deals. Try calculating the pass-through earnings.

[saltybit]

DTEGY and NTLS

[Matti]

NTLS