For those who are interested, I did an interview with John Mihaljevic, CFA who is the founder and Managing Editor of The Manual of Ideas. The interview is for their Greatinvestors.TV site.
We discuss how to become a better investor and my thoughts on Berkshire Hathaway and DIRECTV.
I am in the process of going back and carefully reading everything Buffett has to say about valuing assets.
If you have followed Buffett, you have probably read that he is not a big fan of P/E ratios. P/E ratios are a kind of shorthand. The problem is, that for all they may tell you about a business, there is a lot that they leave out, which brings me to my quick point.
When looking at a P/E ratio, train yourself to carefully look at how much capital was required to produce the “E” (earnings). This can tell you a lot about the quality of the earnings. A business producing $1 million of earnings utilizing $4 million in tangible assets is far different from a business producing $1 million of earnings that requires $9 million in tangible assets.
Both may have the same P/E. The P/E of the second business may even be lower, but that does not necessarily mean that it is cheaper.
Assume these are growth companies that you project to grow at 10% over the next ten years. From a GAAP perspective each business will generate about $17.5 million in “earnings” over the ensuing ten years, but there is a big difference in the economics of the two businesses. Assuming consistent returns on equity, the first business will require an additional $6 million of capital while the second business will require an additional $14 million.
All growth businesses are not created equal.
P/Es are a useful tool to make the first cut. But it is essential to go deeper and look at the amount of capital it took – and will take – to produce those earnings.
I was recently interviewed by The Manual of Ideas, which, if you are not familiar with it, is one of the best research and idea generating tools there is for serious value investors.
They have now generously offered to give away 1,000 copies of my new Kindle book How To Become a Better Investor. (The book was previously available here as an eBook entitled Ten Ways to Improve Your Investment Process, but I have moved it to Amazon to reach a wider audience.)
Professional value investors spend a lot of time on the investing process, and I think this little book contains some very useful ideas for improving your own process and becoming a better investor. These ideas are drawn from my study of the great value investors and from my own experience as an investor.
One last thing. If you do take the offer, although there is absolutely no obligation, I would be most grateful if, after you read it, you would write a quick review over on Amazon. Please call it like you see it.
I hope you get something out of the book and thank you for your continued readership of this blog.
Here is the link to get your free book: http://eepurl.com/kXuI5
Time to Read Annual Reports – Tom Brown, Bankstocks.com
Portfolio holdings of legendary investors – DATAROMA – Value investing – Steven Romick – FPA Crescent Fund
By my estimate, Berkshire Hathaway’s normal earning power after tax is approximately $18 billion. This puts the stock at an adjusted P/E ratio of 11x based on today’s share price.
To get there, I assume the following:
- Redemption of GE, GS and Swiss Re preferred
- Normalized but still low interest rates
- Normalized dividend for Wells Fargo and U.S. Bancorp
- 2012 dividend increase per consensus estimates
- IBM full-year dividend
- Full-year earnings for Lubrizol
- A more normal housing environment
Following Buffett, I also include undistributed earnings from Berkshire’s large equity holdings.
No adjustment has been made for Berkshire’s large cash holdings which I expect will approximate $40 billion after Q1, 2012, assuming no major purchases. This equates to almost $25,000 per A share.
Here is my data.
I welcome your comments on these adjustments and your thoughts on Berkshire Hathaway’s valuation.
A few years ago, we initiated a broad transformation of the company to become an end-to-end technology solutions company… Since the beginning of Fiscal 2011, we have acquired more than ten companies whose offerings and intellectual property enhance our solutions business…
Greenlight Capital Q4 2011 Investor Letter – See Einhorn’s discussion of Dell on page 4 of letter
Multimedia Commentary: Southeastern Asset Management, Inc. – See comments from Mason Hawkins under Southeastern Analysts’ Comments From Client Meeting – July 26, 2011
Whitney Tilson Agrees With Me, Dell Is Dirt Cheap – Seeking Alpha (September, 2011)