Category Archives: Berkshire Hathaway

Berkshire Hathaway’s 2012 look-through earnings from stock investments look to be $4.5 billion

Buffett has long underscored that GAAP can sometimes obfuscate the economic performance of a business. To wit, Buffett introduced the notion of look-through earnings, which comprise both reported earnings AND any undistributed earnings of a company’s investees. (See Berkshire Hathaway’s Owner’s Manual for more details.) Buffett has underscored that including these earnings in a calculation of a business’s normal earnings power is highly useful in understanding where the business stands and in valuing the business. The tree still falls, even if nobody hears it.

In his 2011 letter to shareholders, Buffett made it a point to note that Berkshire’s share of the earnings of Coca-Cola, American Express, Wells Fargo and IBM – the “Big Four” – was $3.3 billion. Under GAAP, only $862 million of dividends were reported. The press mostly ignores or is ignorant of this reality in reporting Berkshire’s earnings. Therefore, many have a poor understanding of Berkshire’s true earnings power.

I made my own estimate of Berkshire’s 2012 look-through earnings from its equity investments. My estimate is $6.5 billion of which just under $2 billion will be paid to – and reported by – Berkshire as dividends. That leaves $4.5 billion that Berkshire will likely earn in 2012 that will not be reported. That is substantial. Buffett wrote in his 2010 letter that he estimated Berkshire’s normal after-tax earnings power to be $12 billion.

Berkshire’s total 2012 after-tax earnings – including look-through earnings – could be as high as $16.5 billion, or more.

One other detail should be mentioned. Years ago, when Buffett would provide a calculation of look-through earnings in his shareholder letters, he would deduct an amount equal to the additional taxes that Berkshire would have paid if all owner earnings were paid as dividends. In my judgment, that is overly conservative. Buffett is generally a very long-term holder of common stocks. The present value of the deferred taxes on the capital gains that will be derived from these retained earnings will be far less than the taxes due if these earnings were distributed as dividends in the years they were earned. Nevertheless, some adjustment should be made to any estimate of intrinsic value based on look-through earnings to account for Berkshire’s deferred tax liability.

Finally, my estimate is largely based on consensus 2012 earnings estimates for Berkshire common stock investments.


100 Ways to Beat the Market #20: Buy Berkshire Hathaway at 1.1x book value or less

One simple way to beat the market is to buy and hold Berkshire Hathaway stock at a good price. Buffett acknowledges that it is challenging to find intelligent ways to invest Berkshire’s massive and growing cash holdings. Nevertheless, he is clear that his goal is still to beat the S&P 500 which he believes he can do, albeit at a diminished level of outperformance vis-a-vis Berkshire’s earlier halcyon days. It is worth noting that Buffett is famously conservative in his missives about his ability to continue to outperform.

Berkshire’s recent performance compared to the S&P 500 is noteworthy. Berkshire has outperformed the S&P 500 in each of the ten most recent five-year periods by an average margin of just over 7%. For the record, Berkshire has never had a five-year period where it underperformed the market.

Buffett believes that Berkshire’s stock is undervalued at 1.1x book value (or approximately $109,000 per A share). He’s right. If you net out the equity investments ($67 billion as of Q3, 2011) and use Buffett’s estimate of normalized after-tax earnings ($12 billion), Berkshire has an earnings yield of about 10%. These earnings are being generated by a diversified portfolio of high-quality businesses that includes a number of bullet-proof, growing world-class franchises such as GEICO and BNSF.

Berkshire enjoys a number of advantages which should continue to increase its intrinsic value.

  1. Berkshire has outstanding veteran managers who are unencumbered by bureaucracy or quarterly earnings numbers. They focus solely on building long-term value.
  2. Berkshire can not only purchase operating businesses, but also marketable securities. This gives it a much higher likelihood of finding attractive investments compared to the typical S&P 500 corporation which is constrained to allocate capital within its own industry. Moreover, Berkshire has advantaged access to many deals based on Berkshire’s reputation, deep pockets, and ability to act quickly.
  3. Berkshire has a shareholder-oriented culture. Board members (excluding Buffett) own over $3 billion in stock, and compensation is completely aligned with shareholder interests. Moreover, Berkshire is imbued with a culture of frugality. This means that Berkshire’s wealth will increase the value of shares rather than line the pockets of management.
  4. Berkshire enjoys cheap leverage in the form of insurance float. Although it is impossible to predict with any amount of precision, it seems likely – based on Berkshire’s track record – that float will continue to grow. Berkshire can also borrow at low rates given its strength.
  5. Buffett is still at the top of his game and getting better. The IBM purchase shows his savvy and growing circle of competence and, in my humble opinion, has a reasonable likelihood of adding $10 billion in value over the next 10 to 15 years. Todd Combs and Ted Weschler are warming up in the bull-pen and were hand picked by the same guy who spotted Lou Simpson.

Of course, not losing money should be top of mind when considering an investment. Berkshire has a fortress balance sheet with massive cash holdings as a hedge against economic disruption that puts Buffett in a position of strength to take advantage of opportunities when others are scrambling. Also, Berkshire’s commitment to repurchase shares below 1.1x book puts a floor under the stock.

IBM’s 2015 Roadmap and 2011 Business Review

IBM’s 2015 Roadmap and 2011 Business Review – source: IBM

IBM has a financial “roadmap” telling investors how profitable it intends to be in the next five years and how it will get there. By 2015 the firm wants its earnings per share almost to double, to “at least” $20. The roadmap also helps, according to Mark Loughridge, the chief financial officer, “to keep the same level of intensity” as during the near-death experience of the early 1990s. “If you ask executives about the roadmap 2015, they can tell you immediately how their plans are lined up to that longer-term goal,” he says. – The Economist

The human platform has an important drawback: it is expensive to maintain and to extend, says Carl Claunch of Gartner, a market-research firm. That also means, however, that it is costly for others to replicate or invade. And given the complexity of the world and how much of it is still to be digitised, IBM’s human platform looks unlikely to reach its limits soon. Perhaps not for another 100 years. – The Economist


Teledyne: Possible archetype for Berkshire Hathaway’s future?

Henry Singleton, Teledyne’s legendary chief executive, was a gifted capital allocator who created enormous shareholder value. Warren Buffett is a great admirer of Singleton and believes, “Singleton of Teledyne has the best operating and capital deployment record in American business.”

Singleton’s repurchases at Teledyne shed light, I believe, on what Buffett is doing at Berkshire. Financial journalists writing about Berkshire’s recently announced share repurchase policy – now actively underway – are often ill-informed and sometimes clueless.

The following article provides a good overview of Singleton’s record of capital allocation and will give you insight on how to think about and value Berkshire Hathaway’s stock, particularly as it regards the addition of share repurchases to Buffett’s capital allocation toolbox.

Teledyne and Henry Singleton a CS of a Great Capital Allocator

See previous blog post: Henry Singleton: A Master of Capital Allocation

Potential Game-changer: Berkshire Hathaway Authorizes Repurchase Program

OMAHA, Neb., Sep 26, 2011 (BUSINESS WIRE) — Berkshire Hathaway Inc. BRK.A +3.77% BRK.B +4.07% –Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.

Berkshire plans to use cash on hand to fund repurchases, and repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire.

Berkshire may repurchase shares in open market purchases or through privately negotiated transactions, at management’s discretion. The repurchase program is expected to continue indefinitely and the amount of purchases will depend entirely upon the levels of cash available, the attractiveness of investment and business opportunities either at hand or on the horizon, and the degree of discount from management’s estimate of intrinsic value. The repurchase program does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B shares.

This release contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which contain words such as “expect,” “believe” or “plan,” by their nature address matters that are, to different degrees, uncertain. These uncertainties may cause actual future events to be materially different than those expressed in our forward-looking statements, including with respect to the duration of the repurchase program. We do not undertake to update our forward-looking statements.

Berkshire Hathaway and its subsidiaries engage in diverse business activities including property and casualty insurance and reinsurance, utilities and energy, freight rail transportation, finance, manufacturing, retailing and services. Common stock of the company is listed on the New York Stock Exchange, trading symbols BRK.A and BRK.B.

SOURCE: Berkshire Hathaway Inc.

Horizon Kinetics: P/B values and the valuation of the S&P 500 vs. Berkshire Hathaway

Horizon Asset Management (now Horizon Kinetics) has done an interesting analysis of the price-to-book value of the S&P 500 compared to that of Berkshire Hathaway. It’s worth a careful read.

Here’s the Reader’s Digest version (all data is as of 4/11/2011):

The S&P’s P/B ratio is 3.68x.

Berskhire Hathaway’s P/B ratio is about 1.3x.

The P/B ratio is a backdoor way of forecasting future return-on-equity expectations. For example, holding constant for other variables, in an environment where the expectation for high-quality long-term corporate bonds was around 6%, we might expect companies expected to earn an ROE of 20% to trade in the range of 3x to 3.5x book value.

The market is in effect projecting average ROEs in the S&P 500 to be 20% or more on a going-forward basis. This is noteworthy because not only is it high per se, but also is builds off a foundation of near record profit margins in many of the major component companies.

Investors should ponder that the market is saying that the ROE expectations for the S&P 500 are 2.85x that of Berkshire Hathaway. This is all the more interesting when put it in historical context. As Horizon states, “The highest ROE ever sustained for the longest time period by any company is, of course, that of Berkshire Hathaway at about 20% per annum.”

The market is either very optimistic about the S&P 500 or companies are being purchased for non-economic reasons, such as inclusion in index oriented mutual funds or ETFs. On the other hand, the market seems to be very pessimistic about Berkshire’s future and is overlooking what I judge to be numerous structural advantages.

Here’s the complete analysis.

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Tom Gayner’s approach to valuing Berkshire Hathaway

The June 30, 2011 edition of Value Investor Insight includes an interview with Tom Gayner, the President and Chief Investment Officer of Markel Corporation. Gayner is a highly respected value investor.

In the interview, Gayner explains his approach to valuing Berkshire Hathaway. Per, Markel has a 7.15% equity weighting in BRK.B and a 6.39% equity weighting in BRK.A. Combined, Berkshire Hathaway is Markel’s largest equity position.

Gayner uses a sum-of-the-parts analysis and looks at the company in three parts: 1) the investment portfolio, 2) insurance operations, and 3) non-insurance operating businesses.

Gayner’s approach is of particular interest not only because he is a great value investor, but also because of his expertise in the insurance business.

For the investment portfolio, he considers a range of values. On the low end, he figures it will earn 3% up to a high-end of 10-12%.

For the insurance premiums, he considers a low case where Berskhire does not earn an underwriting profit, a middle case where its earns a 4 to 5% profit on insurance premiums, and a high case where it earns 8 to 9%.

Finally, he calculates his estimate of normalized earnings for the non-insurance operating businesses. He does this by looking at Berkshire’s cash flow over the past three years and then trying to estimate what this will look like over the next few years.

He then sums the earnings from the three parts and applies a 10x, 14x and 18x multiple. This gives him a range for his estimate of Berkshire’s intrinsic value.

I used Gayner’s general approach to value Berkshire and came up with a intrinsic value range for BRK.B of $55 to $208 with an average value of $128. Here is my data (click to enlarge).








I used Berkshire’s investment portfolio value from the 2011, first quarter 10-Q. To calculate insurance earnings, I used Berkshire’s 2010 insurance premiums. For normalized operating earnings, drawing upon Buffett’s own estimate of normalized earnings given in the 2010 shareholder letter, I used $9 billion as my estimate of normalized after-tax earnings for the non-insurance operating businesses.

I stress that this is my own estimate of intrinsic value based on Gayner’s approach as put forth in the interview. I am not privy to Gayner’s input data, particularly his estimate of Berkshire’s future cash flows for the operating businesses.

In the interview in Value Investor Insight, Gayner stated that based on his estimates, “At even the low ends of the range, the resulting value is significantly higher than today’s share price.”

The absolute low of my range, $55, is actually lower than Berkshire current share price of around $76. However, Berkshire is certainly selling near the bottom of my range of intrinsic value.

In closing, Gayner made an interesting observation that, although Berkshire is widely known, many don’t get around to actually analyzing the company. There are Buffett devotees who are “all in” because of Buffett, and those who dismiss the stock because they’ve already made up their minds without looking at the facts.

Perhaps that creates opportunity for those of us willing to do a little math.

Value Investors Club write-up values Berkshire Hathaway B shares at $125

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.

Closing Thoughts

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.

Notes from the 2011 Berkshire Hathaway Shareholder Meeting

My friend Jyotisko Sinha attended the Berkshire meeting last week and has kindly agreed to share his notes. Jay is a very bright, passionate MBA candidate at the Fisher College of Business -The Ohio State University who has caught the value investing bug in a big way. He is also a formidable networker: on his first trip to Omaha he met Charlie Munger, Mohnish Pabrai, Tom Gayner, Steve Markel, Andrew Kilpatrick, Jeff Benedict, Ron Olson and Peter Buffett!

The David Sokol Scandal and Recency Bias

The recent discussions about how the David Sokol matter reflects on Warren Buffett and Berkshire Hathaway have been largely impacted by the recency effect. Wikipedia defines this as, “The tendency to weigh initial events more than earlier events.”

Because of the scandal, Berkshire has been the subject of a lot of criticism that it is operated too loosely and that it lacks the corporate governance structure of other large corporations.

Does running Berkshire Hathaway in a fashion that is light on rules and regulations provide cover for those who wish to get away with something? Probably. Does running a company with tons of rules and regulations stop people of mal-intent from carrying out their malfeasance? Sometimes, but not always. And although the desired outcome of extra rules and regulations is less than guaranteed, that it will have unintended consequences and impact productivity is virtually assured.

People quickly forget the enormous benefits that Berkshire has enjoyed by Buffett running it in a decentralized, lean fashion. This unleashes human potential in the same way that it has driven unprecedented productivity and wealth in the United States. If you have smart, talented people, the best thing you can do is to get out of their way.

This lack of structure has provided a platform to fuel the entrepreneurial drive of Berkshire’s scores of talented, proven managers and has provided Buffett with the time to do what he does best: allocate capital. Shareholders are far richer for it.

Is Berkshire perfect? No. But, its many virtues should not be obscured by this most recent incident. Lessons will be learned from it and necessary corrections made. This isn’t Buffett or Munger’s first rodeo.

One lesson for us is to once again observe how the media is driven by recency bias. The good news is we don’t have to go there. We are free to ask better questions and seek a broader perspective. It is wise to be on guard against the many cognitive biases that can negatively impact our judgments and actions.