BERKSHIRE HATHAWAY BRK.A
December 17, 2012 - 7:07pm EST by
trev62
2012 2013
Price: 134,850.00 EPS $0.00 $0.00
Shares Out. (in M): 2 P/E 0.0x 0.0x
Market Cap (in $M): 223,330 P/FCF 0.0x 0.0x
Net Debt (in $M): 15,000 EBIT 0 0
TEV ($): 238,000 TEV/EBIT 0.0x 0.0x

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  • Insurance
  • Holding Company
 

Description

I won’t win any points for creativity on this one, but after the recent buyback announcement I think Berkshire Hathaway is a very attractive risk/reward.  Right now you can buy the greatest compounding machine of all time with an effective floor set on the share price right near current levels.  The best part is that shareholders will actually be better off in the long run if the price goes down below the floor and the company can use its huge cash pile to buy back shares. The reasonable downside case from here is that Berkshire compounds in the high single digits, and the most likely outcome is something in the teens. Combined with a risk profile that is significantly lower than that of the market as a whole, that seems like a very good deal in a low return environment.   

“At our limit price of 110% of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase                                             stock aggressively at our price limit or lower.” – Warren Buffett, 2011 annual report

“Heads I win, tails I win more”

I’ll keep this pretty simple and won’t rehash the basic Berkshire story since we all know it already.  While there are a few ways you can estimate Berkshire’s intrinsic value, I’m going to focus on price/book for a few reasons – it’s a simple proxy for the company’s overall value (especially in a directional sense), the company is now using P/B as the metric by which buybacks are determined, and the conclusion is basically the same regardless of the method you use.  For example Whitney Tilson has a detailed presentation that places a multiple of 8x on pre-tax earnings (excluding those from investments), adds in the value of investments, and comes up with intrinsic value of $180,000/share: http://www.tilsonfunds.com/BRK.pdf.  It’s also worth pointing out that Berkshire’s book value is likely an understated measure of intrinsic value, in part because it holds the accounting value of certain assets like GEICO at their original purchase price despite decades of growth since the purchases were made.

“…we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values.” – Warren Buffett, 2011 Annual Letter

VIC History:

Berkshire has been written up as a long three times in VIC’s history.  While each has resulted in a positive gain, the returns of the stock have lagged the growth in Berkshire’s book value in each instance:

Writeup Date

Stock Price

Price/Book Ratio

Book Value Growth Since

Return of Berkshire Stock Since

S&P 500 Return Since

28-Mar-11

$128,000

1.33

17%

7%

12%

18-Oct-07

$129,000

1.66

44%

5%

3%

21-Apr-05

$83,900

1.49

99%

61%

43%

 

So book and intrinsic value have continued to compound at nice rates but the stock has only gotten cheaper.  Looking forward I think intrinsic value will continue to compound but at current levels it’s also very unlikely that the multiple will compress further given the recently announced buyback that allows purchases up to 1.2x book value. While it’s an admittedly simple framework, one can think of your future returns from holding Berkshire as a function of 1) the rate at which book value compounds, and 2) the multiple of that book value that Mr. Market gives to the stock.  So let’s look at each of those in a bit more detail.

Book value growth from here:

Book value as of 09/30/2012 was $111,718 per class A share. The company’s ~$80 billion in listed investments is up slightly on the quarter, and overall book value has likely grown a couple percent quarter to date.  If you assume year-end book value of $114,000, than the 1.2x level at which Berkshire can buy back shares would be $136,800, above the current stock price.  If you don’t adjust for likely quarter-to-date gains, than the current cap for buybacks would be at $134,061.  The stock was actually below that level yesterday, and is only slightly above it today, so it’s possible the company has already bought back additional shares.

Book value has grown at consistently high rates of return since Berkshire began in 1965. In fact there has never been a single 5 year period in which book value did not grow at a faster pace than the S&P 500.  Through inflation, deflation, numerous wars, multiple asset bubbles and subsequent crashes, Berkshire’s book value has consistently outperformed the market:

5 Year Rolling, Annualized

Year

BRK Book Value Growth

S&P Total Return

Difference

1969

18%

5%

13%

1970

16%

4%

12%

1971

15%

10%

5%

1972

17%

8%

9%

1973

14%

2%

12%

1974

12%

-2%

14%

1975

14%

3%

11%

1976

21%

5%

16%

1977

23%

0%

23%

1978

27%

4%

23%

1979

34%

15%

19%

1980

33%

14%

20%

1981

28%

8%

20%

1982

30%

14%

16%

1983

32%

17%

14%

1984

27%

15%

12%

1985

33%

15%

18%

1986

32%

20%

12%

1987

27%

16%

11%

1988

25%

15%

10%

1989

31%

20%

11%

1990

23%

13%

10%

1991

25%

15%

10%

1992

26%

16%

10%

1993

24%

15%

10%

1994

19%

9%

10%

1995

26%

17%

9%

1996

24%

15%

9%

1997

27%

20%

7%

1998

34%

24%

10%

1999

30%

29%

2%

2000

23%

18%

5%

2001

15%

11%

4%

2002

10%

-1%

11%

2003

6%

-1%

7%

2004

8%

-2%

10%

2005

8%

1%

7%

2006

13%

6%

7%

2007

13%

13%

0%

2008

7%

-2%

9%

2009

9%

0%

8%

2010

10%

2%

8%

2011

7%

0%

8%

 

So what will book value compound at going forward?  Obviously it depends on the economy and what markets do, but the past decade’s experience gives me confidence that high single digits is achievable even in a very tough economic environment and at Berkshire’s large size.  Given that size 20% growth is very unlikely, but 5 years from now GEICO will be insuring more people, Coca Cola will be selling more beverages, Burlington Northern should be producing higher cash flows, future cash flows will be reinvested into something else, etc.  The best relative performance will come if the S&P falls and if there is any chance the streak of outperformance ends it would be in a strong up market (Berkshire almost fell behind by 2007) – but Berkshire’s absolute returns should be just fine in that situation.  So depending on your view of the world I think you can reasonably plug in anywhere from 6%-12% in terms of where book value compounds from here, and if I had to pick a single number I’d use 8%.   

Price/book over time:

Today’s price/book is approximately 1.18x my estimate of year-end book value. This is low by historical standards and below the 1.2x cap at which Berkshire just announced it would buy back shares. What is particularly interesting to me is not only that the average price/book over time has been well above current levels, but that the multiple has been much, much higher even in recent years, when all the issues about the company's size, Buffett's age, etc. have been around. During the fall of 2008 it was almost 1.8x, during 2009 it was over 1.4x at times and in 2010 it almost hit 1.5x.  So while you don’t need big multiple expansion to get decent returns here, it’s certainly possible that at some point over the next few years the multiple grows.  If book value compounds at 8% for the next 3 years and the multiple goes back to 1.4x, Berkshire stock would compound at 14% from here.   

 

Average Price/Book Ratio

Maximum Price/Book Ratio

Since 1990

 1.67x

 2.89x

Since 2000

 1.51x

 2.00x

Since 2007

 1.34x

 1.93x

Today

1.18x

 

 

Risks:

I think it’s unlikely that we’ll see an outcome from here that is worse than a “muddle along” situation, where book value compounds at 6% or 8% and the multiple stays where it is.  The company’s recently disclosed, and increasing, willingness to return capital to shareholders is a huge mitigant to most of the major risks here. Warren is 82 and won’t live forever, but the board and remaining management team are very high quality and strongly aligned with shareholders. If he was hit by a truck tomorrow and the stock went down 10% or 15%, it’s a safe bet they would be buying back shares.  Book value should still grow over time, and the stock at current levels is not pricing in any heroic gains from re-investing future cash flows, despite the hiring of two very talented investors in Todd Combs and Ted Weschler.  Before the first buyback was announced last year I would have said there was a real risk that the company after Buffett could become a messy conglomerate trading at a huge discount to the sum of its parts, but that seems very unlikely after the two buyback announcements have been made. The quality and alignment of the board further decreases this risk – Bill Gates has over $8 billion and counting of his foundation’s assets invested in Berkshire for example.  I don’t think he’ll let the next management team at Berkshire decrease all of the good deeds he’s able to perform in the world by not returning capital if it clearly makes the most sense for shareholders.  It’s possible that book value could decrease but I think that’s a very small probability over a long period of time, and if it happens it’s likely that markets generally are down significantly and that Berkshire will have outperformed them by a wide margin. The private businesses should continue to grow and the listed equities seem reasonably priced at 13-14x earnings for high quality, global businesses (top 5 being Coca Cola, Wells Fargo, IBM, American Express, and Procter & Gamble). 

Overall:

There are various things investors can reasonably debate with Berkshire.  How should one value float?  What multiple of operating earnings is fair?  What IRR should be used for the reinvestment of cash flows?  How much cash is likely to be re-invested?  What will happen the day Warren passes away?  Should deferred tax liabilities be adjusted for?  Has Warren lost it with all this talk of raising taxes?  I’m happy to discuss any of those in the Q&A, but what does not seem debatable to me is that Berkshire’s current multiple is cheap, the company will continue to compound its intrinsic value over time, and the multiple is unlikely to get any cheaper from here because of the buyback announced last week.  The worst case return from here should equal the company’s book value growth, and if the multiple either goes up or down shareholders will end up with even better returns.  For a collection of growing, resilient, world class businesses this seems like a very attractive entry point.  

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued growth in earnings/book value/intrinsic value
Potential large acquisitions and/or new equity investments
Meaningful share repurchases
    sort by    

    Description

    I won’t win any points for creativity on this one, but after the recent buyback announcement I think Berkshire Hathaway is a very attractive risk/reward.  Right now you can buy the greatest compounding machine of all time with an effective floor set on the share price right near current levels.  The best part is that shareholders will actually be better off in the long run if the price goes down below the floor and the company can use its huge cash pile to buy back shares. The reasonable downside case from here is that Berkshire compounds in the high single digits, and the most likely outcome is something in the teens. Combined with a risk profile that is significantly lower than that of the market as a whole, that seems like a very good deal in a low return environment.   

    “At our limit price of 110% of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase                                             stock aggressively at our price limit or lower.” – Warren Buffett, 2011 annual report

    “Heads I win, tails I win more”

    I’ll keep this pretty simple and won’t rehash the basic Berkshire story since we all know it already.  While there are a few ways you can estimate Berkshire’s intrinsic value, I’m going to focus on price/book for a few reasons – it’s a simple proxy for the company’s overall value (especially in a directional sense), the company is now using P/B as the metric by which buybacks are determined, and the conclusion is basically the same regardless of the method you use.  For example Whitney Tilson has a detailed presentation that places a multiple of 8x on pre-tax earnings (excluding those from investments), adds in the value of investments, and comes up with intrinsic value of $180,000/share: http://www.tilsonfunds.com/BRK.pdf.  It’s also worth pointing out that Berkshire’s book value is likely an understated measure of intrinsic value, in part because it holds the accounting value of certain assets like GEICO at their original purchase price despite decades of growth since the purchases were made.

    “…we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values.” – Warren Buffett, 2011 Annual Letter

    VIC History:

    Berkshire has been written up as a long three times in VIC’s history.  While each has resulted in a positive gain, the returns of the stock have lagged the growth in Berkshire’s book value in each instance:

    Writeup Date

    Stock Price

    Price/Book Ratio

    Book Value Growth Since

    Return of Berkshire Stock Since

    S&P 500 Return Since

    28-Mar-11

    $128,000

    1.33

    17%

    7%

    12%

    18-Oct-07

    $129,000

    1.66

    44%

    5%

    3%

    21-Apr-05

    $83,900

    1.49

    99%

    61%

    43%

     

    So book and intrinsic value have continued to compound at nice rates but the stock has only gotten cheaper.  Looking forward I think intrinsic value will continue to compound but at current levels it’s also very unlikely that the multiple will compress further given the recently announced buyback that allows purchases up to 1.2x book value. While it’s an admittedly simple framework, one can think of your future returns from holding Berkshire as a function of 1) the rate at which book value compounds, and 2) the multiple of that book value that Mr. Market gives to the stock.  So let’s look at each of those in a bit more detail.

    Book value growth from here:

    Book value as of 09/30/2012 was $111,718 per class A share. The company’s ~$80 billion in listed investments is up slightly on the quarter, and overall book value has likely grown a couple percent quarter to date.  If you assume year-end book value of $114,000, than the 1.2x level at which Berkshire can buy back shares would be $136,800, above the current stock price.  If you don’t adjust for likely quarter-to-date gains, than the current cap for buybacks would be at $134,061.  The stock was actually below that level yesterday, and is only slightly above it today, so it’s possible the company has already bought back additional shares.

    Book value has grown at consistently high rates of return since Berkshire began in 1965. In fact there has never been a single 5 year period in which book value did not grow at a faster pace than the S&P 500.  Through inflation, deflation, numerous wars, multiple asset bubbles and subsequent crashes, Berkshire’s book value has consistently outperformed the market:

    5 Year Rolling, Annualized

    Year

    BRK Book Value Growth

    S&P Total Return

    Difference

    1969

    18%

    5%

    13%

    1970

    16%

    4%

    12%

    1971

    15%

    10%

    5%

    1972

    17%

    8%

    9%

    1973

    14%

    2%

    12%

    1974

    12%

    -2%

    14%

    1975

    14%

    3%

    11%

    1976

    21%

    5%

    16%

    1977

    23%

    0%

    23%

    1978

    27%

    4%

    23%

    1979

    34%

    15%

    19%

    1980

    33%

    14%

    20%

    1981

    28%

    8%

    20%

    1982

    30%

    14%

    16%

    1983

    32%

    17%

    14%

    1984

    27%

    15%

    12%

    1985

    33%

    15%

    18%

    1986

    32%

    20%

    12%

    1987

    27%

    16%

    11%

    1988

    25%

    15%

    10%

    1989

    31%

    20%

    11%

    1990

    23%

    13%

    10%

    1991

    25%

    15%

    10%

    1992

    26%

    16%

    10%

    1993

    24%

    15%

    10%

    1994

    19%

    9%

    10%

    1995

    26%

    17%

    9%

    1996

    24%

    15%

    9%

    1997

    27%

    20%

    7%

    1998

    34%

    24%

    10%

    1999

    30%

    29%

    2%

    2000

    23%

    18%

    5%

    2001

    15%

    11%

    4%

    2002

    10%

    -1%

    11%

    2003

    6%

    -1%

    7%

    2004

    8%

    -2%

    10%

    2005

    8%

    1%

    7%

    2006

    13%

    6%

    7%

    2007

    13%

    13%

    0%

    2008

    7%

    -2%

    9%

    2009

    9%

    0%

    8%

    2010

    10%

    2%

    8%

    2011

    7%

    0%

    8%

     

    So what will book value compound at going forward?  Obviously it depends on the economy and what markets do, but the past decade’s experience gives me confidence that high single digits is achievable even in a very tough economic environment and at Berkshire’s large size.  Given that size 20% growth is very unlikely, but 5 years from now GEICO will be insuring more people, Coca Cola will be selling more beverages, Burlington Northern should be producing higher cash flows, future cash flows will be reinvested into something else, etc.  The best relative performance will come if the S&P falls and if there is any chance the streak of outperformance ends it would be in a strong up market (Berkshire almost fell behind by 2007) – but Berkshire’s absolute returns should be just fine in that situation.  So depending on your view of the world I think you can reasonably plug in anywhere from 6%-12% in terms of where book value compounds from here, and if I had to pick a single number I’d use 8%.   

    Price/book over time:

    Today’s price/book is approximately 1.18x my estimate of year-end book value. This is low by historical standards and below the 1.2x cap at which Berkshire just announced it would buy back shares. What is particularly interesting to me is not only that the average price/book over time has been well above current levels, but that the multiple has been much, much higher even in recent years, when all the issues about the company's size, Buffett's age, etc. have been around. During the fall of 2008 it was almost 1.8x, during 2009 it was over 1.4x at times and in 2010 it almost hit 1.5x.  So while you don’t need big multiple expansion to get decent returns here, it’s certainly possible that at some point over the next few years the multiple grows.  If book value compounds at 8% for the next 3 years and the multiple goes back to 1.4x, Berkshire stock would compound at 14% from here.   

     

    Average Price/Book Ratio

    Maximum Price/Book Ratio

    Since 1990

     1.67x

     2.89x

    Since 2000

     1.51x

     2.00x

    Since 2007

     1.34x

     1.93x

    Today

    1.18x

     

     

    Risks:

    I think it’s unlikely that we’ll see an outcome from here that is worse than a “muddle along” situation, where book value compounds at 6% or 8% and the multiple stays where it is.  The company’s recently disclosed, and increasing, willingness to return capital to shareholders is a huge mitigant to most of the major risks here. Warren is 82 and won’t live forever, but the board and remaining management team are very high quality and strongly aligned with shareholders. If he was hit by a truck tomorrow and the stock went down 10% or 15%, it’s a safe bet they would be buying back shares.  Book value should still grow over time, and the stock at current levels is not pricing in any heroic gains from re-investing future cash flows, despite the hiring of two very talented investors in Todd Combs and Ted Weschler.  Before the first buyback was announced last year I would have said there was a real risk that the company after Buffett could become a messy conglomerate trading at a huge discount to the sum of its parts, but that seems very unlikely after the two buyback announcements have been made. The quality and alignment of the board further decreases this risk – Bill Gates has over $8 billion and counting of his foundation’s assets invested in Berkshire for example.  I don’t think he’ll let the next management team at Berkshire decrease all of the good deeds he’s able to perform in the world by not returning capital if it clearly makes the most sense for shareholders.  It’s possible that book value could decrease but I think that’s a very small probability over a long period of time, and if it happens it’s likely that markets generally are down significantly and that Berkshire will have outperformed them by a wide margin. The private businesses should continue to grow and the listed equities seem reasonably priced at 13-14x earnings for high quality, global businesses (top 5 being Coca Cola, Wells Fargo, IBM, American Express, and Procter & Gamble). 

    Overall:

    There are various things investors can reasonably debate with Berkshire.  How should one value float?  What multiple of operating earnings is fair?  What IRR should be used for the reinvestment of cash flows?  How much cash is likely to be re-invested?  What will happen the day Warren passes away?  Should deferred tax liabilities be adjusted for?  Has Warren lost it with all this talk of raising taxes?  I’m happy to discuss any of those in the Q&A, but what does not seem debatable to me is that Berkshire’s current multiple is cheap, the company will continue to compound its intrinsic value over time, and the multiple is unlikely to get any cheaper from here because of the buyback announced last week.  The worst case return from here should equal the company’s book value growth, and if the multiple either goes up or down shareholders will end up with even better returns.  For a collection of growing, resilient, world class businesses this seems like a very attractive entry point.  

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Continued growth in earnings/book value/intrinsic value
    Potential large acquisitions and/or new equity investments
    Meaningful share repurchases

    Messages


    SubjectRE: RE: RE: Re: There is no floor / Paul Singer
    Entry12/19/2012 07:41 AM
    Membercuyler1903
    Charlie - Thanks for the commentary.  Those are all very good points and they're well taken.  How would you say that sentiment and contagion affects market price?  While mathematically I'm sure you're correct about WFC or the other financial holdings taken in isolation, clearly if there were a derivative blowup at one of the big banks there would probably be others due to complex weave of counterparties that none of us could ever understand.  
     
    The challenge as I see it is that there is a lot of complexity, many unknowns and quite a few leaps of faith here - I still don't think anyone has commented on the environment for generating returns in insurance and banking for the foreseeable future.  Presumably, there will be meaningful premium increases (a stealth form of inflation that hits the middle class the hardest) but is the risk higher for insurance companies in a ZIRP environment?  (Gundlach talked about this in his last conference call)
     
    The premise of the writeup is that there is a floor on BRK shares at the current level.  So I guess the question is do you agree?  BRK went from 147k to 90k in two months in 2008, and then fell to 73k in March 2009.  Some might argue the downside is better this time as banks are less leveraged, but on the other side of the coin what is the ability of the Feds to step in and bail out a bunch of big banks again in a way that preserves common equity?
     
    In a complex financial world driven almost entirely by confidence, I think it's naive to say there's a floor on anything, much less a financial company.  I'm sure we've all owned much simpler investments that were trading below net cash and watched the price fall 15 or 20% simply because it's an inefficient market.  To think a simple share repurchase program puts a "floor" in a $225 billion financial conglomerate seems a little silly.
     
    Cuyler

    SubjectRE: RE: RE: RE: RE: working cap
    Entry12/19/2012 08:20 AM
    Memberaagold
    Urban,
     
    The mistake you're making is that $20B of cash is worth $20B, not $0.  Yes, short-term interest rates are currently at around 0% so it appears superficially that any amount of cash is worth $0, but that's not really true.  It can be expected that interest rates will rise at some point in the future, at which time the cash will start earning some reasonable amount of interest income.  So $X dollars of cash sitting in a risk-free interest-bearing bank account is still worth $X, period.  You're correct to take this $20B into account when calculating Berkshire's Enterprise Value - i.e., it shouldn't be considered *excess cash* in an EV calculation - but to just assign it a value of $0 because short-term interest rates happen to be low at the moment is ridiculous.
     
    - aagold
     
     

    SubjectRE: RE: RE: RE: RE: RE: RE: RE: working cap
    Entry12/19/2012 10:17 AM
    Memberaagold
    If we conservatively assume that underwriting profits are zero long term - which is really conservative in Berkshire's case - then the float is essentially a perpetual loan at zero interest.  The $20B in cash is sitting in an interest-bearing bank account, which over time will earn the risk-free interest rate, not zero.  Therefore the NPV of the float liability is $0 while the NPV of the $20B interest-bearing cash asset is $20B.
     
    - aagold

    SubjectRE: Re: There is no floor / Paul Singer
    Entry12/20/2012 09:18 AM
    Memberchuck307
    Great debate and enjoyable dialogue. This is VIC truly serving a healthy prupose of bringing together thoughtful minds in a safe forum.
     
    That said, Cuyler, your criticism here seems to offer an unachievable standard - that if in a global financial crisis like we had in 2008/9, a company's share price doesn't exhibit a floor near where I bought it, then it lacks merit as an investment.
     
    egec later went to critique the company because its book value fell by 13% in 2008/9 - given how much of the portfolio is subject to mark-to-market and somewhat near term underwriting fluctuations, I might highlight that as a merit of the BRK investment! ;)
     
    By way of example, let's say we hit another epic crisis at the end of next year - the 3rd or 4th in the last 80 years, depending on how you count them:
    - Book value had grown by 8% between now and then and then falls 13%, leaving you with a BV 6% below today's.  Frightening!  
    - At that point, perhaps Mr. Market chooses to re-rate BRK back to 1x book for what, the second or third time in 40 years or so?  
    - So, book fell by 6%, Mr. Market clips you for another 17% and the stock is down low 20s%.  In an epic crisis.  This is the basic downside thesis.
     
    Is this our primary criticism of this write-up?  That under horrific circumstances, the share price might fall by 22% in the next year even if the business value falls less?  
     
    I'd appreciate someone showing me the business that doesn't offer that risk.
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