A member of the Value Investors Club named Den1200 has valued Berkshire Hathaway B shares at $125.05 per share in his March 28, 2011 write-up of the company. I think his approach and logic are sound. (You can sign up for guest access to the Value Investors Club to see the actual write-up.)
The $125 valuation is over 60% higher than Berkshire’s current trading price of about $77.
Let’s walk through Den1200’s logic.
He starts with the fact that in Warren Buffett’s 2010 letter to shareholders, Buffett estimates Berskhire’s normalized pre-tax earnings power to be $17 billion. This figure does not include insurance cat losses as Berkshire has shown the ability to operate at a combined ratio of less than 100%. (In my judgment, there is reason to believe that Berkshire’s insurance operations will be net profitable over the long-term which would further add to Berkshire’s value.)
Den1200 then proceeds to use a two-track approach to value Berskhire which values the business as the sum of its investments – which includes equities, fixed income, cash, and cash equivalents – and capitalized non-insurance operating earnings. This is the general approach used by Buffett in multiple shareholder letters.
Non-Insurance Operating Earnings
After subtracting all Berkshire’s investment income, Den1200 calculates that the non-insurance operating businesses earn normalized earnings of $12.07 billion pre-tax. If you include Lubrizol’s earnings, Berkshire pre-tax operating earnings grow to $13.04 billion. That equates to $9.13 billion after tax, given Berkshire’s 30% tax rate. Lubrizol is being acquired by Berkshire and its earnings were not included in Buffett’s normalized earnings estimate.
Den1200 then assumes that Berkshire’s earning can conservatively grow at 5% and will be $9.88 billion by December 31, 2012. That equates to $4.00 per B share or $60 of intrinsic value if valued at 15 times earnings.
Buffett has traditionally hinted at a higher multiple when valuing Berkshire. Given the high-quality nature of Berkshire’s operating businesses, a market multiple seams reasonable.
Investment per Share
In addition to the non-insurance operating businesses, Berkshire has $155.86 billion in investments. Den1200 makes several adjustments to this figure. He first subtracts $5.56 billion to account for deferred taxes on the equity holdings. He then subtracts $9.7 billion to account for the cash used in the Lubrizol purchase and adds $1.06 billion for pre-payment penalties from Goldman Sachs, GE and Swiss Re related to redemptions.
These adjustments yield $141.65 billion in investments or $57.40 per B share.
Finally, he notes that this figure probably understates the intrinsic value of Berkshire’s large equity holdings as several may be undervalued, namely AXP, JNJ, KFT, Munich Re, POSCO, WMT, USB and notably WFC.
Berkshire’s Intrinsic Value
Den1200 then estimates that Berkshire will earn $18.90 billion or $7.65 per B share between the time of the write-up (March 28, 2011) and December 31, 2012.
Adding it all together, Deb1200 calculates that the intrinsic value of Berskhire will be $125.05 in December, 2012 ($60.00 for its capitalized operating earnings + $57.40 for its investments + $7.65 future earnings through Dec 2012). That figure is 60% higher than Berkshire’s current price.
Berskhire’s derivative book has been a source of concern for several years now as investors have seen several companies blow up as a result of poor derivative bets. Den1200 argues that this level of risk is not likely present in Berkshire’s portfolio and calculates that even a major hit on those contracts would only equate to a relatively modest reduction in Berkshire’s intrinsic value.
Regarding Buffett’s eventual departure, Den1200 suggests that the negative case may already be baked into the stock; it’s hardly a secret that Buffett is 80. At the current price, if Buffett lives several more years – or even longer – his capital allocation decisions are available now as a free option.
Finally, Berkshire operates in a highly decentralized manner with highly skilled division CEO’s. Couple that with Berkshire’s strong culture and a talented board with plenty of skin in the game and it is not a stretch to conclude that Buffett’s departure will have little effect on day-to-day operations.
Long-term it is unreasonable to expect to find a capital allocator as good as Buffett. There was only one Michael Jordon. That doesn’t mean there are not very capable, talented players in the NBA today.