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Fools,

Fairly Nube Fool here who just discovered, sadly, the usefulness of the Fool BRK boards. I've sub'd to SA and typically have read those boards instead.

But Not anymore! :) Got pnt'd out to a few great posts on BRK on this board after starting a thread on SA about BRK's value and R/E exposure. Really enjoyed reading them all...

http://boards.fool.com/past-four-years-30272943.aspx
rationalwalk suggested that the A shares might be worth $185,682. Divide by 1500 to get the B share value of $123.79.

http://boards.fool.com/two-column-30189296.aspx
A month earlier, rationalwalk used a different method to calculate an intrinsic value of $182,400 for the A shares (or $121.60 per B share), and said the range of the actual value was almost definitely between $160,000 and $190,000 (or $107 to $127 for the B shares).

http://boards.fool.com/quotwould-the-portfolio-allocation-pe......
Here, LONGREITS came up with $180,000 (or $120 for the B shares).

First off, thx for all the great analysis. Had some questions relating to BRK in general and also in response to some of the above posts.

First off, Bigshan pts out in Column 1 and 2 valuation, that Cash and investments is not = in value to sh'holders as op earnings, seems to equate it to just excess cash on a BS and earning no real return. Any further commentary on this aspect of BRK? My inclination it is of some greater value than just excess cash, since the cash is put towards investments here that should earn x return, but of course I could be wrong. Would love to hear more thoughts / commentary here.

Also, curious about what ppl on this board think about Tangible Book Value vs Book Value when valuing BRK. WB has emphasized that BV is the best metric for valuing BRK and Im curious about the validity of TBV vs BV. Looking at BRK's past valuations, it has a TTM p/BV of approx 1.24, 10yr median of 1.56x, 5yr med of 1.36x, and 3yr med of 1.29x, vs for TBV a TTM multiple of 1.92x, 2.18x for 10yr, 1.97 for 5yr, and 1.87x for 3yr. Curious about this pronounced discrepancy in valuation and whether it may mean anything about BRK's true value.

Finally, a lot of ppl seem to argue that a multiple of about 10x seems reasonable for value of BRK's operating subsidiaries and an overall multple of 1.5x for BRK's entire value. My question is, other than WB asserting these are reasonable, what's the validity of these multiples as being fair indicators of Intrinsic Value? Granted, WB is a smarter guy than me. I simply think its smart to ask these questions, simply if to fight against confirmation bias, groupthink. IMO, a great way to see if an investment makes sense is to challenge the bullish / reasonable arguments, and if the challenge proves non-sensical, than perhaps the bull argument is much more valid and there is value yet to be recognized in x investment, here of course BRK.

Thanks again, hope to learn more.

Dom
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Hi Dom,

Have you tried the Dilly Bars at Dairy Queen? They're scrumptious!
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First off, Bigshan pts out in Column 1 and 2 valuation, that Cash and
investments is not = in value to sh'holders as op earnings, seems to
equate it to just excess cash on a BS and earning no real return.
Any further commentary on this aspect of BRK?


A first comment is that I believe that the "two column" approach is a
great way to understand Berkshire, but at best a so-so way to value it.
The reason is that no valuation of Berkshire can really be "good enough"
unless it understands how an insurance company works.
In particular, the two-column values published in the annual letters
implicitly assume that there will never be any underwriting profit or loss,
for the simple reason that they entirely ignore the fact that it's an insurance firm.
That being said, when today's price is far below intrinsic value measured
any number of different ways there isn't much point quibbling about
the most accurate process. I have moved to simpler and simpler valuation
methods over the last couple of years because fancy stuff isn't needed—for now.

To your question, you're right. The ongoing existence of the firm requires
that there always be a big pile of cash earning only very modest returns.
It can't all be deployed, and can't be paid out as dividends, so it
will always be a drag in that the earnings on those particular assets
will always be lower than the earnings on others.
So, one of these dollars of cash in the hands of Berkshire by itself
doing nothing is not worth as much as a dollar in the hand of a shareholder.
There are a couple of mitigating factors: first, as mentioned above,
Berkshire is an insurance firm and (unusually) one that definitely
earns an underwriting profit average through the years.
Thus, the overvaluation of a simple two-column approach which values
the cash as highly as anything else is offset by the undervaluation
because there is no estimate of ongoing average underwriting profits.
It's the insurance subsidiary that means the cash has to be there,
so it's fair to include the upsides of that subsidiary.
A second mitigating factor is that cash does earn interest in normal years.
The current ZIRP (zero interest rate policy) won't last forever.

Along the same lines, the publicly listed shares held by Berkshire
are not worth quite as much as the same publicly listed shares if
they were spun off to Berkshire's shareholders. The reason is the
extra level of taxation on the dividends. This is a pretty small
effect, almost certainly made up for by the fact that the people who
work at Berkshire seem to be better than average at picking stocks.
The two-column approach has no place to include any profits from
buying low and selling high, which does happen from time to time.
e.g., the PetroChina investment.


Also, curious about what ppl on this board think about Tangible Book Value vs Book Value when valuing BRK.

A rather glib but vastly true viewpoint is that it just doesn't matter
because Berkshire has so many assets that don't show up in book value at all.
Another thing to note is that a surprisingly large fraction of the
goodwill on the books is from a single purchase of BNSF.
That purchase turned $X of cash into less-than-$X of tangible book.
But was value destroyed thereby? Isn't BNSF worth more as an
operating business than the scrap value of the rails and cars?
I think most people would agree that BNSF is worth at least what
was paid for it, so the goodwill from that is real value.
Besides, if it were still a listed company it would likely be on the
books at a very much higher value, probably tracking the other big rails.
So the acquisition created a goodwill asset you think you might have
to mark down when it would otherwise have created a huge unrealized
capital gain if it were not consolidated which we'd never question.
UNP's share price is up 128% (not 28%) since the day before the BNSF acquisition
was announced making the 30% premium to undisturbed price seem pretty minor!
Though this discussion addresses only BNSF, much of the other goodwill is similar:
the business in question is really worth more than its book value, not less,
since the goodwill generally came from the gap between tangible assets of the
purchase price of an operating company which is worth more than its original purchase price.
In short, no, I don't think a tangible book adjustment is necessary or even prudent.
If you track tangible book through time you'll see a big downwards
discontinuity because of the railway purchase which seems rather perverse.

Which moves us on to the issue of book value as a value metric at all.
As mentioned above, at huge discounts it doesn't matter what valuation
methodology you use, you'll still get the right answer.
But, price/book is not a very good metric. Short term rate of change
in book value is a not-bad but generally understated proxy for short
term change in value, but over time it's a problem. You can't compare
any two firms by price/book unless they are in substantially the same
business and have structures and balance sheets of very similar type.
You can't look at the 1.26x of Berkshire today and say it's cheaper
than the 5.35x of Coke. Similarly, and very much less obviously, you
can't say that the 1.26x of Berkshire today is 19% cheaper than the
1.55x of Berkshire five years ago because the structure of Berkshire
has been changing, again in large part because of the rails and utilities.
So, tracking price/book of Berkshire over time and saying it's cheaper
than its average is a very iffy proposition.
Price/book is a very crude yardstick, best avoided beyond quick
generalizations or when valuations are extreme.
I imagine Berkshire as it is currently constructed is worth
over 1.5x book, maybe 1.7x, but that may change as Berkshire changes.
The only good way to get that number is to value it a better way then
look at what multiple that value is of current book per share!

Finally, a lot of ppl seem to argue that a multiple of about 10x seems
reasonable for value of BRK's operating subsidiaries...


Indeed. Bear in mind that people are talking about 10x pretax earnings.
If you pencil in a rough tax estimate of 35%, that equates to a P/E of 10/(1-.35)=15.4x.
Personally I like to err to the conservative side and might use 9x.
That corresponds to a P/E of about 13.8x.
The average US listed firm since 1937 in the average year has traded at a P/E of
about 13.86x on-trend after tax earnings, so it certainly seems like a sane range.
In reality 10x pretax is probably justified for the simple reason that
Berkshire's operating companies are definitely of slightly higher
average quality than the average firm out there. Slightly higher
returns on equity, slightly better resilience and longevity of the business.

Back to the more general problem of valuation, you're never going to
get any two sensible people arriving at the same number.
But the good valuation methods will tend to cluster in a certain area,
and that's what should guide your investment decision.
One approach is to try a few pretty-good valuation methodologies and
apply them to the firm in each year since 1998.
(that year is chosen because the Gen Re acquisition was so transformative).
Check to see how the figures have evolved over time for each valuation
methodology, how closely clustered the various answers are, and how
the market price has tracked and diverged from an average estimate.
There is no guarantee that the average market valuation level in future
will be the same as it was in a typical year in the past, but it's
a very illustrative calculation because any reasonably good method can
be used for the following exercise: even if the valuation method is
always way too high or way too low, the historically observed average
ratio of price-to-value on that method can be used to estimate
the most likely market price today if valuations were similar to
what was seen in the past
. If you think average stock valuations
will be 20% lower in future, just knock 20% off that price.

So what do I think the firm is worth?
The various values you cite in the $180k range are well thought out.
Here's another one http://www.tilsonfunds.com/BRK.pdf
But personally I'm a little more conservative and might lean towards a figure in the $160s.
For one thing, the broad US market is probably 40% overvalued right now,
so the ~$52k per share in equities might need a haircut of ~$15k.
But whether the value is $160000 or $190000 doesn't make that much
difference given the current market price of $135000.
The really nice thing about waiting is that by the time the market
price catches up to the value, the value will have grown some more,
while taking essentially zero risk of a blow-up.
I like having most of my money in a firm that will survive the next depression or world war.

Jim
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Have you tried the Dilly Bars at Dairy Queen? They're scrumptious!

You sure about that? I thought they were scrumpdillyicious.
We aim for precision here at the Berkshire board.

Jim
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I still think that it is quite difficult to come up with an intrinsic value estimate for Berkshire under the $160,000 to $165,000 range unless one wishes to use extremely bearish projections for Berkshire's future growth and also demands a high projected return (which would require a high discount rate on top of bearish projections). For example, if one assumes that book value will only grow by 3% annually over the next decade, book value per A share might only be around $145K in 2022 and the P/B ratio would likely contract due to such poor results, maybe to around 1.0x book meaning A shares would trade at $145K in ten years. If a buyer today demanded a 10% expected return and bought into these bearish assumptions, one should not pay more than $56K/A share - that's the price you could pay today and still expect 10% annualized if the ending share price in ten years is $145K. That's about 50% of book value per share.

I think this scenario is ridiculous but it would represent a bearish outlook based on the inputs provided.

While I think it is possible to get to intrinsic value estimates in the $180K to $190K range based on still reasonable assumptions, I prefer to not get overly aggressive. This is why I use a 8x pre-tax multiple (around 12x after-tax) on the non-insurance subsidiaries even though Buffett has strongly implied that he uses a 10x multiple. And unlike Tilson's model, I do not assume any normalized underwriting profits at all ... which is conservative given Berkshire's history of underwriting profits over multiple cycles.

Using the float based model, one can get pretty much any valuation desired which is a huge weakness and small changes in variables such as the assumed rate of return on investments, assumed cost of float, growth of float, and discount rates can radically change the valuation. So while I still think the float model is perhaps the most intellectually appropriate way to measure Berkshire's value, it may also be the least useful AND the most prone to investor biases given the sensitivity of the valuation to input assumptions. I still use the float based model but cross check with other models and try to use conservative assumptions on the input variables.

I think tangible book is quite useless for Berkshire due to the obvious economic goodwill that exists in many of the non-insurance subsidiaries not to mention many of the primary insurance businesses as well as GEICO. GEICO's economic goodwill is huge if one considers Progressive to be a comparable company and looks at what the market assigns to Progressive's goodwill. I do track P/TBV but it isn't particularly meaningful.

In my opinion, having multiple models for Berkshire (as well as other companies) is very important because it allows for cross checking and also imposes a more rigorous test when it comes time to consider selling. It is important to not mess with input variables randomly or based on transitory factors ... but obviously sometimes changes are justified. It's just important to make sure that psychological factors are not prompting model changes. It's easy enough to fall into that trap especially with the float based model which is why I didn't recognize the shares as fully valued or overvalued in late 2007 (or late Sept/early Oct 2008) and failed to sell a meaningful number of shares.
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Rational,

Your post makes me think of an alternative way of valuing Berkshire that has not been discussed here, as far as I can recall. Clearly, float is valuable, and profitable underwriting is also valuable, so excluding underwriting profit, and conservatively ignoring the value of float, is going to significantly undervalue a company which is still primarily an insurance company.

But say that we divided Berkshire differently, not into op companies and investments, but rather, op companies, insurance companies and remaining investments. In other words, we find comparable insurance companies, like Progressive as a comparable for GEICO, or Munich Re as a comparable for GenRe and Berkshire Re; that already takes care of most of the insurance company value. Then we need some way of assessing how much of Berkshire's investments are needed for those insurance companies. So if, for instance, Progressive is worth $13 billion (a little over 2x book), with its $15.5 bn in revenue, then at first blush, GEICO, with its $15.4 bn in revenue, is also worth about $13 billion. We might adjust GEICO down a bit, since Progressive's profits seem to be a bit higher ($1 billion a year), as opposed to GEICO's (avg of about $800 mn in the last 3 years), so let's say $12 billion for GEICO.

Same thing for GenRe and BHRG.

But then we would have to figure out how much of Berkshire's investments are to be assigned to these insurance operations, and how much are just part of Berkshire Hathaway 'free and clear' of their insurance operations? For instance, Progressive has about $16 bn in long term investments, to go along with its $16 bn in total liabilities.

Do you think this might be a worthwhile valuation exercise? Have you tried to calculate the business value of the insurance operations, basing it on comparable businesses, not on investments +/- float?

Regards, DTM
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So if, for instance, Progressive is worth $13 billion....

FWIW
I think a better approach would be to figure out the cyclically
adjusted value of an insurance company is given a few key input
variables like book value, premiums, float, and decade-average cost of
float, and perhaps some small factor for growth potential.
Comparison to other firms will swing wildly with prevailing market valuations
and is useful only to "fairness" consultants getting paid to justify overpriced acquisitions.

One complication with this approach is the difficulty of drawing the line
between which assets comprise the regulatory capital backing the float
liability and which investments are the free and clear assets.
All the cash and short term fixed income into insurance, plus a pro rata
percentage of the rest of the investments till you get to the right number?

Jim
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Hey, not everyone is perfect!
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Have you tried to calculate the business value of the insurance operations, basing it on comparable businesses, not on investments +/- float?

This is an interesting approach but I have not pursued it except in the case of Progressive which I think is a good comparable for GEICO.

Most of Berkshire's reinsurance subsidiaries operate on a principle of enormous capital strength which makes Berkshire the provider of choice for primary insurers. The question is what level of "enormous capital strength" is required for Berkshire's reinsurance operations to enjoy the pricing and market share that they command in the marketplace? How much capital can be withdrawn from the insurance subsidiaries without eroding this advantage?

There could be reasonable assumptions one could make to at least ballpark the valuation of the insurance operations versus comparable insurers by making assumptions regarding capital that is truly "excess" - meaning that it could be withdrawn without impacting market perceptions. But without thinking about it much more I'm not sure exactly how to go about such an exercise.
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Wow, be careful what you wish for :) lots of thinking going into 1 post, still wrapping my head around all of it, but nonetheless very much appreciate all the thoughts n opinions.

I can see how TBV is a fairly inaccurate metric for BRK, given that the Goodwill on BRK's books has more value than just goodwill. BRK does not seem to be very balance sheet driven in the first place per se, since a lot of the firm is comprised of insurance subsidiaries, investments, and other not necessarily hard physical assets. Can also see how BRK's return on its acquisitions have more than made up for the goodwill over the original purchase price.

One interesting point I did find was Jim's point that book value is overall not really that great a valuation metric. I would generally agree, since real value is what really counts, but it seems the notion of book value gets tossed around a lot with BRK how to value the firm. WB even says its his best metric for measuring BRK's operating peformance, book value per share, and I believe also for generally valuing the firm, hence his mandate to iniiate a buy-back if and when the stock trades at 1.1x book value. My assumption is he strongly feels that BRK should never be worth much less than 1.1x, otherwise he wouldnt do that, IMO, but of course what do I know. Could BRK perhaps be valued using cash flow or would that not be a relevant metric either?

I also find it interesting that everyone seems to agree that BRK is mostly now an insurance firm. I always viewed it as traditionally WB's investment vehicle for placing his bets on the market. What about all the other firms in the "Berkshire basket?" I originally got interested in BRK because I wanted to know about its R/E exposure, which seems quite considerable with all the R/E subsidiaries operating within the firm. I wonder if valuing it as purely an "insurance firm" may cloud its true value and result in either an over or undervaluation of its true value, given the circumstances of the other subsidiary firms. Would love to hear more thoughts hear on this subject as well as the extent of BRK's exposure to R/E and perhaps its value.

Another point from this, so if WB is essentially letting BRK morph from a pseudo mutual / hedge fund to a more pure-based insurance firm, what does that say about his confidence in his current mgmt and eventual successor? Is he transitioning the firm to a more 'stable' business model, ie insurance, because he feels he can't find a successor / succession team that can pick stocks and make great acquisitions like he did?

Also definitely agree that having multiple models / valuations is key. This seems especially true for a firm like BRK that seems to have soo many moving parts. No one valuation will, IMO, give an exact measurement of true intrinsic value. True IV, by itself is kind of a misnomer too one could argue. Coming up with multiple valuations that all seem to be well within a reasonable range of each other would be the best way of making sure we are not fooling ourselves, lower-case f.


Love the thoughts, hope to hear more.

Dom
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>"The current ZIRP (zero interest rate policy) won't last forever."

I think so too, but as Japan has demonstrated, it can last a very long time.
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