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Stocks B / Berkshire Hathaway
|Subject: BRK valuation||Date: 11/6/2006 12:00 AM|
|Author: mhirschey||Number: 125206 of 212015|
Berkshire is a complicated company with main segments in insurance and 50-plus other operating businesses, utilities and energy, and finance and financial products. Getting to a correct valuation for the company can be daunting, with a multitude of considerations.
The insurance operation is the biggest part, and may be the toughest to evaluate. As of September 30, Berkshire's insurance operation held $36,905 million in cash, $24,283 million in bonds, and $55,564 million in equities. That's $116,752 million in all, or 75,763 per share. Such a valuation for Berkshire's insurance operations involves implicit assumptions concerning the value of the float. Float totaled approximately $49.7 billion at September 30, 2006, $49.3 billion at December 31, 2005 and $48.9 billion at September 30, 2005. The cost of float, as represented by the ratio of pre-tax underwriting gain or loss to average float, was negative in both the first nine months of 2006 and for the full year of 2005 as Berkshire's insurance businesses generated pre-tax underwriting gains. If Berkshire earned only the risk-free rate on insurance float going forward, and those earnings were discounted back to the present at that same risk-free rate, a conservative $49.7 billion estimate of the value of float would result. If the insurance operations are valued at only 75,763 per share, then they are worth only 13.2 times the $5,738 insurance group pre-tax earnings for the first nine months of 2006. That seems too cheap to me, especially in light of the fact that the industry multiple falls in the range of 12 times annual earnings.
Segment data for the third quarter suggests that Berkshire's noninsurance operations brought in pre-tax earnings of $1,572 million in 2006, up 52.3 percent from $1,032 in 2005. Nobody seems focused on how rapidly the noninsurance operations are growing, but I think it is noteworthy. Buffett says he looks for acquisitions selling for seven times pretax earnings or eleven times after-tax earnings. Using that criterion for the overall company, Berkshire's noninsurance operations should be worth $44,016 million. However, few diversified companies can boast such rapid, high margin growth. At a market multiple of 18 times net earnings, Berkshire's noninsurance operations would be worth $75, 456 million, or 48,966 per share.
On the basis of these too-conservative assumptions, Berkshire has a minimum value of 124,729 per share. However, that's a very cheap price based upon earnings. For example, assume the insurance operations merely breaks even in the fourth quarter, 2006 earnings per share would still come in at roughly $8,500. That a cheap P/E of only 14.67 times. In fact, that's too cheap.
A valuation of $135,000 to $150,000 seems about right at this juncture.
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