|Shares Out. (in M):||1,643K||P/E||0||0|
|Market Cap (in $M):||367,144||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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I recommend the purchase of BRK (and shorting out downside risk using IWM).
Back in 2004 at a talk at Columbia by Bill Ruane, people were skeptical when Ruane stressed he was sure WEB could compound investments and business earnings at a 12% or higher compound rate for some time. Man was he right. Here are some BRK numbers.
- Pre-tax, non-insurance, business earnings per share have increase at a compound annual rate of 21.0% for 40 years. From 1970 to 1980 it was 20.8%, from 1980 to 1990 it was 18.4%, from 1990 to 2000 it was 24.5% and from 2000 to 2010 it was 20.5%. These numbers are just amazing.
- Or look at the net earnings per A share. In 2011 the earnings were $6,215 per A share, in 2015 they were $14,656. The majority of these net earnings were based on business earnings per share including underwriting profit for the insurance businesses, and only a small part was investment, dividend and interest income. That is a compound rate of 23.5%. Again quite amazing numbers.
So what might be driving this unique performance? I think it is not just WEB’s investing acumen which is pretty much unparalleled. (I know others have great performance as well, but none have done it with the vast amounts of money WEB has.) The key also I think is the unique corporate culture that exists at BRK. I keep hearing about Trump’s business brand, but the guy with the real business brand that is vastly more valuable is WEB. Here is an example, a friend of mine brokers commercial insurance for a large insurance brokerage, basically any form of insurance a business might need. When talking about BRK he mentioned how hard it is to place business with them. Basically he said, they choose who they want to insure. He said they are expensive and only pick the best risks. Other BRK businesses profit from this too. There is a reason why BRK has been attaching the BRK name to its businesses.
In addition I believe that being bought by BRK upgrades the performance of many of the businesses. First the managers are shielded from Wall Street’s need for earnings management and told to increase the size of the moat. The managers also get access to large pool of needed growth capex capital and so they can do what they always wanted to do but felt they couldn’t sell to Wall Street. No wonder some of these businesses have shown such attractive growth rates.
Anyway, I think BRK is an amazing business with a unique culture. I also believe that we will still see good performance of the underlying businesses for some time after WEB goes away. First there is a quality board that understands what the business is about. And on the other hand if you slow down the fast pace of growth capex within a short period of time earnings will increase markedly as they normalize to the level of a slower growing business. In short, we will have continued momentum from past growth capex.
So now to the numbers. At the end of 2015, per equivalent A share, BRK had $159,794 in investments and cash. Also we had about $38,421 per share in deferred tax liabilities. Now we are not paying this tax liability today. Actually BRK has been accumulating this tax liability for many years now. The present value of that payment is much lower than the $38,421 per A share that is on the books. It is highly likely that this tax liability will continue to grow. So instead of taking the whole amount I will take 50% into account, or $19,211 per A share. That gives me a net value for investment and cash ex 50% of the deferred tax liability of $140,583 per A share.
In addition net business earnings per A share were $12,304 in 2015. (FYI. This number excludes income from investments, but does include the insurance underwriting income.) In the past WEB has inferred he thinks BRK’s business earnings should be worth about 17 times net earnings. Now it has been a while that WEB has made this inference and BRK is a lot larger now. So in order to adjust for that I will take a multiple of 15 times which gets me a value of the net business earnings of $184,560 per A share.
The sum of $140,583 in investment plus cash ex the 50% of the deferred tax liability per A share and $184,560 in net business income value per A share equals $325,143 per A share in intrinsic value at the end of 2015. ($216.76 per B share)
Now this all refers to 2015, but what about the future for BRK. I think it is highly likely that growth will sustain itself at a decent level. Maybe given the current size of BRK, we cannot assume the 20% plus compound growth rate we have seen for more than 40 years, but 10% seems to be a reasonably number. If I assume 10% compound growth through the end of 2017 we end up with net business earnings of $14,888 per A share. Btw, based on the latest 10K net earnings for Precision Castparts are $912 per BRK A share, so we are already 1/3rd the way to $14,888 using the Precision Castparts purchase.
Also it seems that cash and investment per share are doing quite well too. If one looks at the deferred tax liability for Q2 2016, one will see it has already grown from $63,126 in Q4 2015 to $72,180 in Q2 2016. Most of that deferred tax liability is the increased value of investments. In short, it seems the investment portfolio has been doing just fine in 2016.
So how much is BRK worth at the end of 2017? Well if we take $14,888 per A share in net business earnings and take a 15 multiple on that then we get a value for the businesses of $223,320 per A share. If we also assume that by the end of 2017 cash and investment goes up by 10%, then we get a value of $175,733 in cash and investments per A share. Adjust that for the projected deferred tax liability at the same time I get a value of $154,642 in cash and investments ex 50% of the deferred tax liability per A share.
$223,320 plus $154,642 makes $377,962 per A share in intrinsic value at the end of 2017.
So what about the downside? Well a serious economic downturn would impact the investments per A share. Also net business earnings per A share would be impacted. On the other hand with the massive amounts of cash WEB has available he would be able to invest large amounts of cash at attractive returns. It is hard to predict what will happen, but there is plenty of worrisome stuff out there. For example,
· The chance of a new recession goes up exponentially every year you get farther away from the last recession. And in the US the last recession ended 7 years and 2 months ago in June 2009. Since the Great Depression we have had three period where the time between recessions were longer than 7 years and 2 months. With the 1969 recession we went 8 years and 10 months, in the 1990 recession we had gone 7 years and 8 months and with the tech bubble we had gone 10 years.
· China’s economy is clearly not growing at 6%. The Chinese economy seems to be struggling to maintain momentum. The logical release to that would be a currency devaluation. A 20% devaluation would have a large impact on the global economy. Kyle Bass makes this case and it is quite convincing.
· Europe is still struggling. Its banking system is clearly still in bad shape. According to the WSJ if Europe would stress test its banks using the US metrics, European banks would have to raise $125 billion. Little chance they could do so in the current environment in private capital markets. The Euro crisis is only one step/recession away from flaring up. The only reason why things have died down is the ECB and European governments increasing deficit spending again. What happens when China devalues and Europe ends up with another recession and tax receipts fall of a cliff again? Also what happens to the banking system in Italy in that instance? Don’t even mention Greece where more than half of all loans are in default. Europe really is only one recession away from disaster.
Anyway, if you believe that the same risks are out there I would suggest that you own safe assets on the long side, like BRK, and that you short out the IWM. I wrote up IWM not too long ago. It is valued to perfection, and a recession or Chinese devaluation or European collapse would send the IWM down to much lower regions. That way you are hedged and when things are low enough to cover the IWM short, WEB will be right there buying businesses and growing the value of BRK shares.
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