BRK Valuation

[Mephistopheles]

I'm not saying it isnt cheap (and I'm long) but if you count the equities you are implicitly including a bunch of the value of the insurance. There were over $160 B in liabilities related to the insurance operation last quarter. I get the concept of float, but I think treating that as equity (vs a long term cheap loan) is an aggressive way to think about it.

 

If you wanted to sell the insurance cos without their financial assets but with their policy liabilities, you'd be sending a bunch of money out the door to get someone to take them.

 

bizaro86, not taking a shot at your thoughts on the float liability, but rather want to see if you can poke holes in how I think about it. I'll use a hypothetical company that is 100% capitalized by float as my example. Let's assume we issue a $1.0m policy at the beginning of every year that gets paid out at the end of the year. We take that $1.0m and invest it into Treasury bills at a 10% rate (day-dreaming over here, I know). Well at the end of the year we would have $0.1m in the bank, $1.0m in a Treasury bill, receive cash inflows of $1.0m for the new policy issued, and pay out $1.0m of insurance claims/expense for the beginning of the year policy (assuming cost of float is zero). In this situation, the equity holder would be able to receive a dividend of $0.1m, unencumbered by the float liability. We can have this same situation occur forever into perpetuity, collecting $0.1m every year. My question becomes, why knock something off of the equity value if we never have to truly pay back the float and it doesn't cost anything in interest? That's $0.1m in my pocket every single year, just as if I funded the company 100% with my own money.

 

 

Well, good way to think of it is-

 

would you rather have $1 m in equity or $1 m in float, all else being equal?

The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.

[widenthemoat]

I'm not saying it isnt cheap (and I'm long) but if you count the equities you are implicitly including a bunch of the value of the insurance. There were over $160 B in liabilities related to the insurance operation last quarter. I get the concept of float, but I think treating that as equity (vs a long term cheap loan) is an aggressive way to think about it.

 

If you wanted to sell the insurance cos without their financial assets but with their policy liabilities, you'd be sending a bunch of money out the door to get someone to take them.

 

bizaro86, not taking a shot at your thoughts on the float liability, but rather want to see if you can poke holes in how I think about it. I'll use a hypothetical company that is 100% capitalized by float as my example. Let's assume we issue a $1.0m policy at the beginning of every year that gets paid out at the end of the year. We take that $1.0m and invest it into Treasury bills at a 10% rate (day-dreaming over here, I know). Well at the end of the year we would have $0.1m in the bank, $1.0m in a Treasury bill, receive cash inflows of $1.0m for the new policy issued, and pay out $1.0m of insurance claims/expense for the beginning of the year policy (assuming cost of float is zero). In this situation, the equity holder would be able to receive a dividend of $0.1m, unencumbered by the float liability. We can have this same situation occur forever into perpetuity, collecting $0.1m every year. My question becomes, why knock something off of the equity value if we never have to truly pay back the float and it doesn't cost anything in interest? That's $0.1m in my pocket every single year, just as if I funded the company 100% with my own money.

 

 

Well, good way to think of it is-

 

would you rather have $1 m in equity or $1 m in float, all else being equal?

The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.

 

Personally, I think I would prefer $1.0m in float. I don't have to lay out a dime of my own money to earn $0.1m per year. If I'm laying out my own money to purchase the business from someone else, I would certainly prefer float if I wanted to grow the business - I would be able to distribute all earnings and grow them by using float instead of my own equity. I would also prefer float if it was profitable (i.e. essentially borrowing at a negative rate).

[ValueMaven]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

Thoughts?  It's an interesting way to triangulate valuation

[Cigarbutt]

I'm not saying it isnt cheap (and I'm long) but if you count the equities you are implicitly including a bunch of the value of the insurance. There were over $160 B in liabilities related to the insurance operation last quarter. I get the concept of float, but I think treating that as equity (vs a long term cheap loan) is an aggressive way to think about it.

If you wanted to sell the insurance cos without their financial assets but with their policy liabilities, you'd be sending a bunch of money out the door to get someone to take them.

bizaro86, not taking a shot at your thoughts on the float liability, but rather want to see if you can poke holes in how I think about it. I'll use a hypothetical company that is 100% capitalized by float as my example. Let's assume we issue a $1.0m policy at the beginning of every year that gets paid out at the end of the year. We take that $1.0m and invest it into Treasury bills at a 10% rate (day-dreaming over here, I know). Well at the end of the year we would have $0.1m in the bank, $1.0m in a Treasury bill, receive cash inflows of $1.0m for the new policy issued, and pay out $1.0m of insurance claims/expense for the beginning of the year policy (assuming cost of float is zero). In this situation, the equity holder would be able to receive a dividend of $0.1m, unencumbered by the float liability. We can have this same situation occur forever into perpetuity, collecting $0.1m every year. My question becomes, why knock something off of the equity value if we never have to truly pay back the float and it doesn't cost anything in interest? That's $0.1m in my pocket every single year, just as if I funded the company 100% with my own money.

Well, good way to think of it is-

would you rather have $1 m in equity or $1 m in float, all else being equal?

The real liability amount of float is less than, perhaps substantially so, then what is on the balance sheet but it is of course greater than zero.

Personally, I think I would prefer $1.0m in float. I don't have to lay out a dime of my own money to earn $0.1m per year. If I'm laying out my own money to purchase the business from someone else, I would certainly prefer float if I wanted to grow the business - I would be able to distribute all earnings and grow them by using float instead of my own equity. I would also prefer float if it was profitable (i.e. essentially borrowing at a negative rate).

Waiting for bizaro's more sensible and practical answer but here's a perspective.

Float can be free or can even have negative cost but it's conditional on a cushion of equity. One way to see it is if the characteristics of the insurance business allow you to discount the insurance reserve liabilities.

Take the following (simplified) and consider the ends of the spectrum:

Assets (float)=240, Liabilities (reserves)=160, equity=80

Scenario #1, poor business

You buy the business to put in runoff and pay about book value or a slight discount to BV (say 0.9 BV). So you pay 72 and record 8 as negative goodwill. A way to appraise the negative goodwill (as an equivalent) is to augment the value of the reserves (often done post-acquisition with a hit to acquired equity when such a business is acquired).

Scenario #2, great business, expect underwriting profit and growth (other end of the spectrum)

You buy the business, pay a premium to book value (say 2 BV). So you pay 160 and record 80 as goodwill. A way to appraise the goodwill (as an equivalent) is a contra-account to decrease the value of the reserves.

 

When you look at float as a source of financing (from policy holders), you can't choose it above other sources of financing but its value can be modified by the type of business you're running or acquiring.

Historically, insurance companies have behaved closer to scenario #1, which is a reason why reserves are not typically discounted and high premiums to BV are not the norm.

[Thrifty3000]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

Thoughts?  It's an interesting way to triangulate valuation

 

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.

[bizaro86]

I'm not saying it isnt cheap (and I'm long) but if you count the equities you are implicitly including a bunch of the value of the insurance. There were over $160 B in liabilities related to the insurance operation last quarter. I get the concept of float, but I think treating that as equity (vs a long term cheap loan) is an aggressive way to think about it.

 

If you wanted to sell the insurance cos without their financial assets but with their policy liabilities, you'd be sending a bunch of money out the door to get someone to take them.

 

bizaro86, not taking a shot at your thoughts on the float liability, but rather want to see if you can poke holes in how I think about it. I'll use a hypothetical company that is 100% capitalized by float as my example. Let's assume we issue a $1.0m policy at the beginning of every year that gets paid out at the end of the year. We take that $1.0m and invest it into Treasury bills at a 10% rate (day-dreaming over here, I know). Well at the end of the year we would have $0.1m in the bank, $1.0m in a Treasury bill, receive cash inflows of $1.0m for the new policy issued, and pay out $1.0m of insurance claims/expense for the beginning of the year policy (assuming cost of float is zero). In this situation, the equity holder would be able to receive a dividend of $0.1m, unencumbered by the float liability. We can have this same situation occur forever into perpetuity, collecting $0.1m every year. My question becomes, why knock something off of the equity value if we never have to truly pay back the float and it doesn't cost anything in interest? That's $0.1m in my pocket every single year, just as if I funded the company 100% with my own money.

 

The risk of having to give back the float to its owner is more than the risk of having to give back the equity. Maybe that isnt very likely, but the probability is more than zero.

 

Secondly, BRK doesnt own any theoretical insurance companies. In the real world, they have to hold regulatory capital to write insurance, and some of it is equity. So that $1 MM of float comes with some money as cash earning 0%. That equity could be earning more in non-cash investment.

 

When Buffett is talking about how they need to keep $50 or $100 B in cash in case they need to cover a bunch of claims when equities do 30 or 40% drop, the opportunity cost of the float becomes pretty real.

 

[wabuffo]

One thing to keep in mind is that if the Democrats sweep the executive and legislative branches of US government in the fall (as seems likely at this time, though that may change), Biden has already indicated that he is raising the federal corporate tax rate to 28% - which he will be able to do if the Democrats have majorities in the House and the Senate.

 

BRK was a huge beneficiary of the corporate tax rate cut in 2017 and will consequently get hurt if/when it is raised.  It will get hurt two ways - large US subsidiaries like BNSF would see lower operating earnings and cash flows.  But the after-tax values of the equity portfolio would fall as well.  Not as big an effect as it was going from 35% down to 21% - but our partner, Uncle Sam is raising his stake from 21% to 28% without paying us for the larger ownership stake in all future pre-tax earnings.

 

wabuffo

[ValueMaven]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

 

Thoughts?  It's an interesting way to triangulate valuation

 

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.

 

 

how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

[Guest longinvestor]

This on Insurance/Float/Goodwill, from the 2016 AR,

 

Insurance

Let’s now look at Berkshire’s various businesses, starting with our most important sector, insurance. The property/casualty (“P/C”) branch of that industry has been the engine that has propelled our growth since 1967, the year we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Today, National Indemnity is the largest property/casualty company in the world as measured by net worth.

One reason we were attracted to the P/C business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as claims arising from exposure to asbestos, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their own benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume. Consequently, as our business grows, so does our float. And how it has grown, as the following table shows:

Year Float (in millions)

1970 $ 39 1980 237 1990 1,632 2000 27,871 2010 65,832 2016 91,577

We recently wrote a huge policy that increased float to more than $100 billion. Beyond that one-time boost, float at GEICO and several of our specialized operations is almost certain to grow at a good clip. National Indemnity’s reinsurance division, however, is party to a number of large run-off contracts whose float is certain to drift downward.

We may in time experience a decline in float. If so, the decline will be very gradual – at the outside no more than 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate or near-term demands for sums that are of significance to our cash resources. This structure is by design and is a key component in the unequaled financial strength of our insurance companies. It will never be compromised.

If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it.

Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous indeed that it sometimes causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses.

8

This outcome is made more certain by the dramatically lower interest rates that now exist throughout the world. The investment portfolios of almost all P/C companies – though not those of Berkshire – are heavily concentrated in bonds. As these high-yielding legacy investments mature and are replaced by bonds yielding a pittance, earnings from float will steadily fall. For that reason, and others as well, it’s a good bet that industry results over the next ten years will fall short of those recorded in the past decade, particularly in the case of companies that specialize in reinsurance.

Nevertheless, I very much like our own prospects. Berkshire’s unrivaled financial strength allows us far more flexibility in investing than that generally available to P/C companies. The many alternatives available to us are always an advantage; occasionally, they offer us major opportunities. When others are constrained, our choices expand.

Moreover, our P/C companies have an excellent underwriting record. Berkshire has now operated at an underwriting profit for 14 consecutive years, our pre-tax gain for the period having totaled $28 billion. That record is no accident: Disciplined risk evaluation is the daily focus of all of our insurance managers, who know that while float is valuable, its benefits can be drowned by poor underwriting results. All insurers give that message lip service. At Berkshire it is a religion, Old Testament style.

So how does our float affect intrinsic value? When Berkshire’s book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to think of float as a typical liability is a major mistake. It should instead be viewed as a revolving fund. Daily, we pay old claims and related expenses – a huge $27 billion to more than six million claimants in 2016 – and that reduces float. Just as surely, we each day write new business that will soon generate its own claims, adding to float.

If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability. Owing $1 that in effect will never leave the premises – because new business is almost certain to deliver a substitute – is worlds different from owing $1 that will go out the door tomorrow and not be replaced. The two types of liabilities, however, are treated as equals under GAAP.

A partial offset to this overstated liability is a $15.5 billion “goodwill” asset that we incurred in buying our insurance companies and that is included in our book-value figure. In very large part, this goodwill represents the price we paid for the float-generating capabilities of our insurance operations. The cost of the goodwill, however, has no bearing on its true value. For example, if an insurance company sustains large and prolonged underwriting losses, any goodwill asset carried on the books should be deemed valueless, whatever its original cost.

Fortunately, that does not describe Berkshire. Charlie and I believe the true economic value of our insurance goodwill – what we would happily pay for float of similar quality were we to purchase an insurance operation possessing it – to be far in excess of its historic carrying value. Indeed, almost the entire $15.5 billion we carry for goodwill in our insurance business was already on our books in 2000 when float was $28 billion. Yet we have subsequently increased our float by $64 billion, a gain that in no way is reflected in our book value. This unrecorded asset is one reason – a huge reason – why we believe Berkshire’s intrinsic business value far exceeds its book value.

************

 

[Thrifty3000]

How I derive Berkshire’s Look Through Earnings

 

Based on 2019 Earnings (In Billions USD except per share info)

 

Non-Insurance Business Earnings: $17.7

 

Less CapEx Adjustment (Maintenance CapEx less Depreciation): $3

Plus Acquisition-related Amortization: $1.3

 

TOTAL ADJUSTED NON-INSURANCE BUSINESS EARNINGS: $16

—————————————————————————————————

 

Equities

 

Dividends: $4

Estimated Equity Retained Earnings: $9

 

TOTAL EQUITIES LOOK THROUGH EARNINGS: $13

—————————————————————————————————

 

TOTAL SHARED HOLDINGS EARNINGS (Kraft-Heinz, Berkadia, Flying J): $1

 

EARNINGS FROM TREASURIES & CASH EQUIVS (Assume 1% yield. #lazy): $1.25

 

INSURANCE COMPANIES (After tax operating profit - I think Buffett ignores this): $.325

 

TOTAL LOOK THROUGH EARNINGS: $32 BILLION

 

Average Equivalent B Shares Outstanding (3/31/2020): 2,434,333,367

 

LOOK THROUGH EARNINGS PER B SHARE: $12.97

 

Post-Covid New World Order 20% Impairment (#reallyLazy): $10.37 per B share

 

So, above we have the breakdown of 2019 look through earnings. Now let's take a look at 2018 look through earnings laid out in the same form. But, first try to guess the look through earnings growth rate for the final year of the longest economic expansion in history. Was it 8.5%? 6%? Less than 6%? Drum roll please...

 

Based on 2018 Earnings (In Billions USD except per share info)

 

Non-Insurance Business Earnings: $16.8

 

Less CapEx Adjustment (Maintenance CapEx less Depreciation): $3

Plus Acquisition-related Amortization: $1.4

 

TOTAL ADJUSTED NON-INSURANCE BUSINESS EARNINGS: $15.2

—————————————————————————————————

 

Equities

 

Dividends: $3.8

Estimated Equity Retained Earnings: $8

 

TOTAL EQUITIES LOOK THROUGH EARNINGS: $11.8

—————————————————————————————————

 

TOTAL SHARED HOLDINGS EARNINGS (Kraft-Heinz, Berkadia, Flying J): $1.3

 

EARNINGS FROM TREASURIES & CASH EQUIVS (Assume 1% yield. #lazy): $1.32

 

INSURANCE COMPANIES (After tax operating profit - I think Buffett ignores this): $1.58

 

TOTAL LOOK THROUGH EARNINGS: $31 BILLION

 

Average Equivalent B Shares Outstanding (3/31/2020): 2,434,333,367

 

LOOK THROUGH EARNINGS PER B SHARE: $12.82

 

So, what was the year over year look through earnings growth rate? A spectacular, breathtaking, hair raising, jaw dropping, 1.2%!

 

Are we going to set a new look through earnings record this year? Spoiler alert... nope. Next year? Maaaaybe, IF we get a vaccine AND if BRK converts $50 to $80 billion of cash/treasuries into something that actually earns money.

 

(WARNING: When I did this analysis after the annual report was published I did it quickly with zero expectation of voluntarily sharing it with hundreds or thousands of people. It's probably flawed (I'd love to know where - preferably without insult). And, don't forget you get what you pay for.)

[Thrifty3000]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

 

Thoughts?  It's an interesting way to triangulate valuation

 

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.

 

 

how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

 

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

 

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

 

I think the value of BRK will ultimately correlate with earnings potential.

[steph]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

 

Thoughts?  It's an interesting way to triangulate valuation

 

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.

 

 

how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

 

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

 

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

 

I think the value of BRK will ultimately correlate with earnings potential.

 

Putting a multiple on earnings on the cash is a bit strange, no?

 

Top equity position by miles at year end was Apple, which is up 21%. 

[Thrifty3000]

The Rational Walk on twitter posted this and I totally agree with this approach...its neat way to value BRK:

 

3/31/20: Cash & Investments = $349.5B + $33B gain in Q2 = $382B vs. Market Cap of $427B

 

Implied Value of $45B for non-insurance wholly owned subs (BNSF, GEICO, Clayton, PCP, Utility etc etc) .... man this thing is CHEAP

 

He also pegs P/BV at 1.08x

 

 

Thoughts?  It's an interesting way to triangulate valuation

 

My hesitation is that it values cash and equities at 27 times peak-cycle cash/equity earnings of approx $14 billion. A 3.7% peak-cycle earnings yield.

 

 

how does that value cash and equities at 27x p/e?  I dont follow ... fine - apply a 50% discount and its still cheap.  I'm just saying this is one of several interesting ways to value BRK

 

Assume cash and equities are worth approx $382 billion. In 2019 the cash and equities had look through earnings of around $14 billion. That's a multiple of 27 and change.

 

At year end 2019 the top 10 equity positions consisted of a credit card company, 5 banks, and an airline. Enough said.

 

I think the value of BRK will ultimately correlate with earnings potential.

 

Putting a multiple on earnings on the cash is a bit strange, no?

 

Top equity position by miles at year end was Apple, which is up 21%.

 

Apple Diluted Earnings Per Share 2018: $11.91

Apple Diluted Earnings Per Share 2019: $11.89

Growth: Negative

Apple Share Price: $353.63

Multiple of 2019 Earnings: 29.74

 

FWIW Morningstar puts Apple's fair value at $240 per share. No matter how you swing it $353 feels a bit sporty.

[aws]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

[bizaro86]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

 

The consensus seems to be that the value of the float liability is less than dollar for dollar because maybe it never needs to be paid back.

 

If you invert that, what's the value of a cash asset that earns ~0 and may never be put to productive use? Possibly less than dollar for dollar is appropriate there as well.

[Thrifty3000]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

 

I agree. Lumping together cash and investments is a gummed up way of evaluating BRK. I only pointed out the high PE of those two items because another poster mentioned the Rational Walk's grouping of cash and investments when making their point that the rest of BRK is cheap.

 

I personally Love investments with multiple earnings streams, and I feel like I run into the argument that "you get the rest for free" All The Time. In fact, I've been plenty guilty of wanting to use that phrase when evaluating things like Altius, or FFH, or FFH Africa/India, or even something like St. Joe back in the day.

 

IMHO (and talking to myself too) it's probably best if that phrase is deleted from the value investor lexicon. 9 times out of 10, if I keep pushing myself to uncover what the true look through earnings potential of each earnings stream is, I come to find that if you're getting "part of an investment for free" in a highly liquid, highly informed, free market system it's because you're paying too much for the other parts.

 

In the case of Berkshire, we know we're paying too much for Apple, etc. In fact, another COBF thread is currently discussing the merits of shorting Apple if you hold BRK. (Maybe worth exploring if you'd normally sell an equity for a 40% premium to fair value.)

 

For me, the biggest curve balls in recent months are how to think about Covid and the deployment of cash. And, one of the biggest surprises of my investing life is that Buffett was fearful when all others were fearful. I'm sure for very good reason, which only time will tell, but that wasn't supposed to be in his DNA (especially with $100+ billion of cash).

 

I'm confident that if Berkshire deploys cash into equities - including share buybacks - it is with an expectation of high single digit or low double digit returns over time (see Buffett's recent commentary on airline investment justification - there was a double digit return expectation). For that reason I don't think you look at the value of cash as worth less than $1 for each $1 of cash held (despite any inflation-induced decline in near-term purchasing power).

 

Theoretically, $100 billion of cash could be deployed tomorrow at a 10% after tax return. Or, more likely, it could be deployed in chunks over several years (while more cash is piling up). So, you can do what Semper Augustus does and pick the "normalized" long term earnings power you're comfortable with for the $100 billion, and tack it on to your "normal" look through earnings estimate. It's probably not conservative enough to say the $100 billion represents $10 billion of after tax earnings potential, but it's probably perfectly safe to estimate $4 to $6 billion.

 

If look through earnings in 2018 and 2019 were around $31 billion, then after whatever covid impairments you choose to make, you could reasonably add $4 to $6 billion to represent the normal long-term earnings potential of the cash.

 

I already own plenty of BRK, so I'm not currently making an upward earnings adjustment for the cash. But, I have in the past, I probably would now if I had seen at least a few billion deployed in March, and who knows, I could change my mind tomorrow.

[StevieV]

I also don't like - "you get the rest for free" analysis.  How big is the "Free" part?  How sure are you of the valuation of the "fairly valued" part?  If you change the multiple of the "not free" part maybe you aren't getting anything for free or the "free" part only represents a small discount.

 

Theoretically, $100 billion of cash could be deployed tomorrow at a 10% after tax return. Or, more likely, it could be deployed in chunks over several years (while more cash is piling up). So, you can do what Semper Augustus does and pick the "normalized" long term earnings power you're comfortable with for the $100 billion, and tack it on to your "normal" look through earnings estimate. It's probably not conservative enough to say the $100 billion represents $10 billion of after tax earnings potential, but it's probably perfectly safe to estimate $4 to $6 billion.

 

I'm concerned about the value of this $100 B, the ability to deploy it at high rates and the timing of doing so.

 

 

[Mephistopheles]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

 

The consensus seems to be that the value of the float liability is less than dollar for dollar because maybe it never needs to be paid back.

 

If you invert that, what's the value of a cash asset that earns ~0 and may never be put to productive use? Possibly less than dollar for dollar is appropriate there as well.

 

I agree with this line of thought. Maybe the best way to discount the float liability for the IV calculation is just take out the amount in cash that we are never going to see. Buffett talks about $20 billion minimum, it's probably more realistically $40 billion. 20 minimum he refuses to spend and add another 20 that will never be spent fast enough as it is made. Add another $10 billion to be safe. So that is $50 billion cash that for shareholder purposes, we will never see.

 

So out of $130 billion float, we can consider as free money approx (130-50) = 80 billion of it.

 

The stock is still insanely cheap with these numbers.

 

People tend to weigh recent trends too heavily. Would we be talking about discounting the cash balance if we didn't see this massive upswing in stock prices? Would people be questioning Buffett's judgment for not repurchasing in March if S&P was even lower today?

 

BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

 

That cash pile will quickly look heroic if/when we have another downswing. For that reason by buying BRK you are naturally hedging against the downside.

 

The expectations are so low right now that any sort of good news will cause a huge jump. Imagine next Q we see $10 billion in repurchase activity?

[bizaro86]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

 

The consensus seems to be that the value of the float liability is less than dollar for dollar because maybe it never needs to be paid back.

 

If you invert that, what's the value of a cash asset that earns ~0 and may never be put to productive use? Possibly less than dollar for dollar is appropriate there as well.

 

 

BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

 

I agree with this entire post, but especially the part about sentiment. I converted a big chunk of my BRK position from shares to LEAPs on Friday. 2:1 ratio of deep ITM calls to shares. If it continues to drop I'll do more. Biggest reasoning is I think risk of permanent impairment at the current price is very low.

[Thrifty3000]

I think AAPL is overvalued as well, but I still see no logic in your including the cash in the calculation.  If he sold all the Apple and retained that as cash, then your ratio would appear much worse as the look-through earnings numerator would have decreased but the cash+portfolio denominator would stay the same excluding taxes.

 

The consensus seems to be that the value of the float liability is less than dollar for dollar because maybe it never needs to be paid back.

 

If you invert that, what's the value of a cash asset that earns ~0 and may never be put to productive use? Possibly less than dollar for dollar is appropriate there as well.

 

 

BRK sentiment is just far too negative right now, which is part of the reason I am buying LEAPS. The option prices say it all, such a low amount of volatility priced in. But we have seen BRK move huge amounts in short periods of time in the past and we will see it again. Not to mention the ridiculously low Price/Book ratio.

 

I agree with this entire post, but especially the part about sentiment. I converted a big chunk of my BRK position from shares to LEAPs on Friday. 2:1 ratio of deep ITM calls to shares. If it continues to drop I'll do more. Biggest reasoning is I think risk of permanent impairment at the current price is very low.

 

Man, I hope you guys are right. I invested a small fortune in March thanks to trade triggers that were based on a pre-covid view of the world.

 

If you take the pre-covid look through earnings of $31 billion, and then add a $5 billion upward adjustment for the cash holdings, you get normal earnings of $36 billion, or $15 per B share (close to the Semper Augustus expectation of normal earnings). If you slap an 18 multiple on it you get a fair value of $270 per B share. If the value doubles over the next 7 to 10 years and you pay today's price of $175 then you'll earn your spot in value investor heaven. Hopefully investing turns out to be that easy.

 

But why did one of the greatest investment minds in history... who knows the salient financial details of thousands of businesses, the interworking of global supply chains, the price history of commodities and their impact on the raw material costs of his dozens of investments (including the price of sugar's impact on the profitability of an 8 ounce serving of coke), whose best friend Bill Gates is also a founder of one of the most valuable companies on the planet and who predicted the enormous global economic pain of a pandemic years before it happened, who together with Gates jointly funds a foundation with its finger on the pulse of the highest probability solutions to covid, who has any world leader and several of the world's greatest risk handicappers - like Ajit Jain - on speed dial... stop buying back shares in March?

 

It wasn't because he's ill-informed.

[steph]

He probably was too well informed. Bill Gates scared him and he got very little time to buy at prices he really found attractive.

 

Never forget that in 2008 he didn't buy anything meaningful in the stockmarket.  He responded to very attractive offers made to him with preferreds,etc....

 

 

[JPerez]

I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.

He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.

This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.

The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.

He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.

That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.

What is the upside of going all in in the march low? A few extra points of performance for the next few years?

What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?

Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.

What if the vaccines don't work, what if the government reduce the stimulus?

Both are unlikely but there isn't a zero chance of them

On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.

Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.

At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.

How is that a bad outcome?

We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.

By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.

Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.

The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense

[Guest longinvestor]

I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.

He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.

This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.

The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.

He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.

That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.

What is the upside of going all in in the march low? A few extra points of performance for the next few years?

What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?

Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.

What if the vaccines don't work, what if the government reduce the stimulus?

Both are unlikely but there isn't a zero chance of them

On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.

Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.

At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.

How is that a bad outcome?

We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.

By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.

Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.

The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense

+1

 

Agree wholeheartedly that he’s not terribly excited about buying back. That said, he’s acutely aware that the next guy needs buybacks in his toolkit. Likely the main tool. The longer the  undervalued situation can continue the easier it is for the next guy. “You all have to endure us” Munger!

 

[ValueMaven]

Chris Bloomstrain from the Manual of Ideas on 3/26

 

'Berkshire is a big position for us, and I think they’re in pretty good shape. That’s the proper

way to think about it. When I think about Berkshire — I said it at the year end — they had

about $42 billion in economic earnings. That includes $3 billion for the optionality of the

cash, and everybody can make their own decision about that, so $40 billion. It won’t be $40

billion this year, but discounting 2021 and beyond, I think $40 billion is right. When the

stock traded at a market cap of less than $400 billion, I don’t recall a time that Berkshire

has traded at 10x what I would call normalized earnings. It’s got a fortress balance sheet,

and it’s got a lot of businesses inside it that are about as well protected against the

downturn as you can have. It made no sense to me that the stock traded at 160.'

[Thrifty3000]

I think the reason why he is so cautious is because, as he said, the range of outcomes in the pandemic is so wide.

He has lived through many recessions in his live and despite the differences they all have many things in common and I am sure He has developed a mental model to apply to recessions so He is comfortable buying stocks during those times.

This case is different, this situation is new for all of us, nobody has any experience living through this and nobody know what the consequences will be.

The way he has built his wealth and Berkshire is betting on companies that will do well but most importantly that have no risk, in his mind, to become worthless.

He has repeatedly said he would never invest in a share that could be a 10 bagger if there is any small chance that it could be a zero.

That is why he doesn't invest in technology, before he invests in a company he has to visualize and become comfortable with how the company would look in 5 or 10 years and that is very difficult to do with technology companies.

What is the upside of going all in in the march low? A few extra points of performance for the next few years?

What was the downside if the pandemic was worse or if the Fed wouldn't have acted the way it did?

Even now though the range of outcomes is narrowing, still there are lots of unknowns. And spend your cash doesn't seem to me like the best idea.

What if the vaccines don't work, what if the government reduce the stimulus?

Both are unlikely but there isn't a zero chance of them

On the other hand I find ridiculous all the bashing of Buffett and Berkshire over the recent months because of the underperformance.

Has Berkshire underperformed the S&P 500, not to talk about the Nasdaq over the last 5 and 10 years by a good margin? Obviously yes but consider this.

At the top of the last cycle (December of 2007) Berkshire book value was 78000 per A share at the end of December 2019 it was 262000, more than tripled over 12 years.

How is that a bad outcome?

We can also compare what their cash, securities, earnings power was then and now and in my opinion Berkshire has done an excellent job in the last decade at growing intrinsic value taking very few risks.

By the way the share price has gone from150000 at the end of 07 to 337000 at the end of 2019. So the multiple for Berkshire is lower while the multiple of the market as a whole has gone up substantially hence the underperformance.

Going forward I think they will outperform the index, not because they will have crazy returns but because I think it is hard to see the market going up 8% a year in the next decade while it is easier to see that kind of compounding from Berkshire.

The only things that bothers me a little about the way the company is managed is that I don't think they will do substantial buybacks while Buffett is managing it (I hope I am wrong). I think he is a collector of businesses and I don't think he wants to erode his capital base in any substantial manner so that he can acquire big companies when the opportunity arises. I think he would love for Berkshire to be the biggest company in the world and that could blind him and reduce the buybacks even when they would make sense

 

Yeah, I think you're on to something with the recession mental model point...

 

Imagine being Buffett in March. His operations and suppliers in China have already gone dark. The US is just starting to work through a shutdown - averting what was already happening in Italy. He already sees the cash drain on Dairy Queen China, suppliers delaying deliveries, orders being canceled, plummeting rail car loads, a massive drop in daily auto insurance claims, planes not flying, assembly lines halting, and employees being furloughed.

 

His buddy Billy G. advised a vaccine is 18 months away at best, and that the first iterations may not protect the at-risk population (so buckle up for prolonged behavior changes). He's surely talked to his top managers about downside risk scenarios, and about the parental support potentially needed to survive 18, 24, or even 36 months. He's likely urged them to look out for good competitors in financial trouble. In other words he's handicapped Berkshire's risk, so he can more fully focus on opportunity.

 

He knows there's an unprecedented amount of corporate debt sitting one notch above junk. He knows financial markets are gumming up, and companies like AIG are at the mercy of commercial paper. He knows full well the lock down can only subsist about 45 days before businesses globally start dropping like flies. There could soon be opportunities aplenty.

 

He has no idea how the government will respond to this crisis, or how the economy will respond to the government. (The CARES act was introduced to the Senate floor on March 19, at least 9 days after Buffett's last Q1 share repurchase - for $214 per B share.)

 

He does know the Warren Buffett help line is starting to ring...

 

My conclusion:

 

It makes perfect sense for those events to trigger a "recession mental model." Therefore, it makes perfect sense for Buffett to halt repurchases at that time, as the option value of cash was potentially worth FAR more than a moderately discounted share of Berkshire Hathaway. In fact, now that we've talked it out, I'd be scratching my head a bit if he HAD kept buying back shares. So, to that I say well played, Buffett.