BRK Valuation

[aryadhana]

Is the big problem here not all the uninvested cash, but all the equity investments they do have in excess of whatever is reasonably required to cover potential insurance liabilities?  And cash flow from their operating businesses should count towards what's available for payouts as well.  It seems remarkably tax inefficient to hold equities that don't serve any operating purpose, such as being available for sale to service liabilities, in an entity subject to a corporate tax (one that will likely increase by 33 percent in the near future). 

 

It would be an entirely different story if they actually acquired the same companies they hold equity in since intercorporate cash allocation bypasses any tax.  It would also be a different story if they were uniquely situated to make these investments, which may be true in some cases but not at all the case for most of the publicly traded stock in their portfolio.  Their reports make it seem like deferred tax liabilities on all their unrealized gains are in fact an asset, in the form of a free loan on taxes that would otherwise be owed.  Had there been distributions of all this excess, of course, shareholders would have owned the same stock in their own name without owing any corporate tax on the gains at all. 

 

The cash they hold technically suffers from the same problem -- why pay corporate taxes on interest from Treasuries? -- but rates are very low.  Putting that cash in equity increases the required return from their assets as a whole (now riskier) but the excess return they can expect to realize over time from doing so doesn't increase commensurately by definition since market prices are not set between people who are double taxed on that investment.  This is probably much more dramatically an issue over the past 3-5 years than it was before, since in the past they probably didn't hold in public equities so much in excess of what was necessary.

 

I think WEB just likes picking stocks, but unfortunately not enough to have taken advantage of last March.

 

I don't know -- does he?  Doesn't seem like there's a lot of stock picking going on, and anyway his edge would have to be enormous to justify incurring unnecessary taxes in doing so.  I imagine BRK price would react positively and performance would improve if he sold most of the investments in common stock and kept the extra cash saying "we expect over time possible acquisition opportunities will justify our keeping at least $300 billion in cash".  The "cost of capital" of keeping cash so supremely in excess of what's reasonably necessary is very low and maybe even justified if they really anticipate large deals over the next decade. 

 

You say "unfortunately [they don't like picking stocks] enough to have taken advantage of last March."  Maybe, but had they not owned all the stock in the first place they wouldn't have recorded enormous losses either.  I think you're right that he / they fashion themselves as long-term investors bullish on the ultimate performance of American equities.  Which is an appropriate view, maybe just not on a corporate balance sheet.  (And of course it's different if they weren't so overcapitalized). 

 

They wouldn't suffer from this problem if they acquired outright any of their more notable investments, and avoiding the corporate tax on capital gains should mean they are willing to pay quite a bit more for the same company as they would otherwise, on top of any value from the freedom they would have to reinvest target co cash flow across the enterprise.  Why not buy AXP?  Or an assortment of the smaller companies in their portfolio -- even if it entailed a hefty premium

[John Hjorth]

aryadhana,

 

A very belated welcome to you here on CoBF! [ : - ) ] [Our paths here on CoBF haven't crossed, until now ...]

 

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What do you mean by : "... It seems remarkably tax inefficient to hold equities that don't serve any operating purpose ..."?

[maxthetrade]

You are getting double taxed. First the company has to pay taxes on earnings and then Berkshire has to pay taxes on dividends and on capital gains vs. only taxes on earnings for wholy owned subs.

 

[John Hjorth]

You are getting double taxed. First the company has to pay taxes on earnings and then Berkshire has to pay taxes on dividends and on capital gains vs. only taxes on earnings for Berkshire subs.

 

Max,

 

Where do you see these taxes? [At least since '67]?

[aryadhana]

Thank you for the welcome.

 

My thinking is just that the appropriate way to own equities is through something that is taxed directly, whether that's owning it yourself outright or through a fund or investment company where the only taxes owed are personal taxes on income and capital gains.  Of course, if Berkshire isn't able to satisfy with exceptional likelihood possible insurance claims from its cash and future earnings, then some portion of the stock it holds isn't an excess investment as much as well-employed "working capital" for its insurance business -- but I don't think this characterizes much of its equity portfolio given the amount of cash and other consolidated business it has. 

 

Biden might be a catalyst here.  The prospect of a 28 percent tax rate might get them to realize gains at the lower rate.  And my proposition is that this move would create value even if they did nothing with all that cash because shareholders aren't undertaking any additional risk for which they are undercompensated (which by definition is the case for any corporate tax payer that holds stocks beyond what is necessary for some operating purpose). 

[maxthetrade]

You are getting double taxed. First the company has to pay taxes on earnings and then Berkshire has to pay taxes on dividends and on capital gains vs. only taxes on earnings for Berkshire subs.

 

Max,

 

Where do you see these taxes? [At least since '67]?

 

Well, you see them whenever Berkshire receives a dividend or realizes capital gains by selling an investment. The fact that some of these tax liabilities are deferred for a very long time makes them less onerous but wholy owned subs are still way more tax efficient. Sometimes Berkshire was able to avoid those taxes by buying the whole shebang, e.g. Geico, or by some creative deal structures, e.g. Procter&Gamble or Washington Post.

 

[LC]

1- Brk has never to my knowledge acted on political imperatives - and I think that is unlikely to change.

 

2- On the taxes, remember that one aspect of owning the utilities & BNSF is the ability to capture depreciation tax benefits. These are essentially bond like income with an added benefit of requiring large capital investments to upkeep - which allows WB to offset equity capital gain taxes and expand incomes at the same time.

[DooDiligence]

I wish he'd sell out of Apple.

 

That plus the cash pile would make a nice downpayment on Greenland.

[aryadhana]

1- Brk has never to my knowledge acted on political imperatives - and I think that is unlikely to change.

 

2- On the taxes, remember that one aspect of owning the utilities & BNSF is the ability to capture depreciation tax benefits. These are essentially bond like income with an added benefit of requiring large capital investments to upkeep - which allows WB to offset equity capital gain taxes and expand incomes at the same time.

 

I mean top marginal corporate tax rate has been going down for decades, so this might be the first time one might reasonably anticipate much higher taxes in the future.  Doesn't seem political to the extent circumstances suggest it's reasonably possible (e.g. D control government).  Is there a reason the depreciation tax benefits need to be paired and offset with capital gains as opposed to his other operating income? 

 

I too wish he would sell out of Apple (we can get all that embedded risk without the corporate taxes through a few good index funds).  Who wouldn't pay a much higher multiple on the rest of the business without all the equities.  The exception might be some bank stocks with a good dividend profile (where capital appreciation isn't as much the point), since I think there's a dividends earned deduction for corporations).

[John Hjorth]

Income taxes paid by Berkshire Hathaway [the parent] during the last nine years :

 

2019 : USD 3.531 B ^[1]

2018 : USD 2.790 B ^[1]

2017 : USD 2.076 B ^[1]

2016 : USD 3.583 B ^[2]

2015 : USD 3.180 B ^[2]

2014 : USD 2.512 B ^[2]

2013 : USD 4.080 B ^[3]

2012 : USD 3.406 B ^[3]

2011 : USD 1.882 B ^[3]

 

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Sources :

 

[1] : Berkshire 2019 Annual Report , p. K-115,

[2] : Berkshire 2016 10-K, p. 113, &

[3] : Berkshire 2013 10-K, p. 109.

[thepupil]

To jump in here,

 

Aryadana is correct that a C Corp isn’t the “right place” to hold an equity portfolio. Put yourself in the position of a non-taxed entity like an IRA / pension/ endowment etc. would you rather hold Coke purchased in the 90s directly or through Berkshire? Directly, because KO pays taxes, then you receive KO divvies and are not taxed on them. There’s a purity to owning businesses or assets in via pass through entities or directly rather than through a corporation that has another layer of taxation

 

But, Berkshire has historically nevertheless been extremely tax efficient and made the absolute best of a “suboptimal” situation. Berkshire is not an actively traded equity portfolio. They don’t need to sell to make new investments and have deferred like $30B of stock related taxes and $30B+ of taxes as it relates to BNSF and BE, so Berkshire in practice pays a very low cash tax rate and has had more than adequate capital to make new investments without having to sell highly appreciated stock. As noted by others, Berkshire has found ways to convert highly appreciated stock to wholly owned businesses (Duracell, Phillips, Washington Post)

 

For better and worse, Berkshire doesn’t really sell winners, so it’s not that big of a problem, and the DTL (as pointed out by the chairman himself) has very low present value; it’s an interest free loan.

 

Furthermore, by retaining all capital Berkshire is very tax efficient vehicle for holding outside of a tax advantaged retirement account , particularly for those of us who have state taxes to pay on gains/ dividends and partocularly if Biden gets rid of the advantage of long term cap gains for high earners. Also I believe  insurance companies do pay lower rates on dividends; I have read this in the past but can’t find a source now.

 

In sum, I don’t think Berkshire trades at a discount  because of deferred tax related to equities. I don’t think that’s “the problem”.

[John Hjorth]

... Also I believe  insurance companies do pay lower rates on dividends; I have read this in the past but can’t find a source now. ...

 

+1 - I tried the exact same exercise today before posting my last post! - By my recollection, it was a Berkshire Press Release, issued with Mr. Hamburg as the sole signatory [, however I couldn't find it today - I will eventually dig it up and post a link to it here].

 

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It's all about "tax drag" & Hold Co. costs.

[gfp]

https://www.businesswire.com/news/home/20110830006354/en/Berkshire-Hathaway-News-Release

[John Hjorth]

lol!

 

[i actually knew in advance, that exactly a [neutral] link from gfp would be the outcome of this discussion! [ : - D ]].

 

-Thank you, gfp.

 

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Edit :

 

Talk to me about being in control of your sh!te!

[gfp]

There are a few funny lines, as usual, in the 1986 Chairman's Letter (which discusses the change to the current tax rate on investments inside insurance companies).  This one seemed almost timely:

 

"Mrs. B, Chairman of Nebraska Furniture Mart, continues at

age 93 to outsell and out-hustle any manager I’ve ever seen. 

She’s at the store seven days a week, from opening to close. 

Competing with her represents a triumph of courage over judgment.

 

    It’s easy to overlook what I consider to be the critical

lesson of the Mrs. B saga: at 93, Omaha based Board Chairmen have

yet to reach their peak.  Please file this fact away to consult

before you mark your ballot at the 2024 annual meeting of

Berkshire."

 

(source - https://berkshirehathaway.com/letters/1986.html )

[ValueMaven]

Decent outperformance this week for our favorite (and extremely cheap) company!  Up +1.7% vs. -1.7% for the S&P 500...it's one week - but I wonder if the market - or maybe Berkshire - is starting to notice cheap this thing is.  There might be some gaming ahead of what his likely the August results which will show Berkshire bought back $5B in equity.  Thoughts? 

[thepupil]

https://www.businesswire.com/news/home/20110830006354/en/Berkshire-Hathaway-News-Release

 

there it is. thanks gfp!

 

So Berkshire pays an equal to (and in many cases lower) tax rate on dividends as individuals, and has historically done a wondrous job of deferring realization of capital gains.

 

Biden wants to make capital gains and dividends taxable at the ordinary income rate, and to increase the top federal rate to 39%. this means for californians, marylanders, new yorkers, etc. that one could pay an effective income tax rate on divvies/cap gains of over 50% (39%+13% for a wealthy californian).

 

Holding low turnover equities through an insurance company that retains all earnings can be much more tax efficient than holding directly in a taxable account, particularly for high income blue staters.

 

So again, I don't think tax inefficiency is a reason for a berkshire discount. if anything, some people seek out berkshire for its tax efficiency. I know I like it for that (in planning out my family's tax situation, i can count on Berkshire not generating income). whether you own $10 or $10mm of berkshire, the tax bill is the same: $0 (as long as a wealth tax is not enacted, which we did just see AOC propose a tax on unrealized gains for billionaire NYers and have seen wealth taxes proposed by democrats, mostly on very very wealthy)

 

Recall that 97%+ of shareholders voted against a dividend. there's a reason for that. trust in the capital allocation, but also fear of generating taxable income for berkshire's wealthy shareholders.

 

https://www.sandiegouniontribune.com/sdut-berkshire-hathaway-shareholders-reject-dividend-2014may03-story.html

 

also aryadhana, Berkshire can't buy American Express, because then Berkshire would become a bank holding company which would have lots of regulatory consequences. the have had to seek exceptions to own >10% of Bank of America and have had to pledge to be a passive holder of AXP of which they own 18% through holding the stock forever as AXP has eaten up its share count.

 

https://www.pymnts.com/news/2017/buffett-wants-to-hold-tight-on-amex-stake/

 

[John Hjorth]

... Holding low turnover equities through an insurance company that retains all earnings can be much more tax efficient than holding directly in a taxable account, particularly for high income blue staters. ...

 

Here we go! [Non-US [residents & tax payers] left aside [My family and I are in that turf].]

[gfp]

If Berkshire were actually like a mutual fund, as it is sometimes misrepresented, the C-corp would obviously be a bad choice - as Charlie has pointed out over the years.  But Berkshire is an insurance-focused conglomerate, one of the largest enterprises in the world - not an investment partnership or fund.

 

There are a lot of great sections to that 1986 letter, I enjoyed re-reading it as Buffett was a lot more talkative about important things back then.  (you can skip the section on selling encyclopedias to keep it interesting.  "5 cents per page!")

 

As for the "why does Berkshire hold all these stocks inside a corporation?" question and the currently popular "why does Berkshire hold so much excess capital in cash equivalents?" question - he addresses them in 1986 pretty clearly:

 

Marketable Securities

 

    During 1986, our insurance companies purchased about $700

million of tax-exempt bonds, most having a maturity of 8 to 12

years.  You might think that this commitment indicates a

considerable enthusiasm for such bonds.  Unfortunately, that’s

not so: at best, the bonds are mediocre investments.  They simply

seemed the least objectionable alternative at the time we bought

them, and still seem so. (Currently liking neither stocks nor

bonds, I find myself the polar opposite of Mae West as she

declared: "I like only two kinds of men - foreign and domestic.")

 

    We must, of necessity, hold marketable securities in our

insurance companies and, as money comes in, we have only five

directions to go: (1) long-term common stock investments; (2)

long-term fixed-income securities; (3) medium-term fixed-income

securities; (4) short-term cash equivalents; and (5) short-term

arbitrage commitments.

 

Common stocks, of course, are the most fun.  ...(continues)

 

 

[DooDiligence]

Buffetts style appeals to my sense of frugality.

Notably, a person can be frugal without being cheap.

His lifestyle & charitable donations clearly illustrate the difference.

 

The stock looks cheap but I think it's really just being frugal.

 

There's a certain kind of karmic effect here that I believe gets rewarded over a lifetime.

 

HODL on!

[Cigarbutt]

^Minor complementary information concerning BRK corporate tax and dividends received

 

With the 2017 TCJA, the effective tax rate for P&C insurers, for domestic dividends:

By combining the effect of the reduced DRD deduction with the lower tax rate,

-on greater than 20% owned stock from 11.2% to 10.7625%

-less than 20% owned stock from 14.175% to 13.125%.

 

i wonder if tax considerations should be a primary concern for holding BRK but suspect that Mr. Buffett, in a karmic way, knows these numbers to the third decimal place.

[wabuffo]

i wonder if tax considerations should be a primary concern for holding BRK.

 

They will be for the valuation of BRK common equity if the Federal corporate tax rate is increased from 21% to 28%.

 

wabuffo

[John Hjorth]

Income taxes paid by Berkshire Hathaway [the parent] during the last nine years :

 

2019 : USD 3.531 B ^[1]

2018 : USD 2.790 B ^[1]

2017 : USD 2.076 B ^[1]

2016 : USD 3.583 B ^[2]

2015 : USD 3.180 B ^[2]

2014 : USD 2.512 B ^[2]

2013 : USD 4.080 B ^[3]

2012 : USD 3.406 B ^[3]

2011 : USD 1.882 B ^[3]

 

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Sources :

 

[1] : Berkshire 2019 Annual Report , p. K-115,

[2] : Berkshire 2016 10-K, p. 113, &

[3] : Berkshire 2013 10-K, p. 109.

 

Berkshire Hathaway Hold. Co. costs :

 

2019 : USD 0.122 B ^[1]

2018 : USD 0.216 B ^[1]

2017 : USD 0.159 B ^[1]

2016 : USD 0.080 B ^[2]

2015 : USD 0.073 B ^[2]

2014 : USD -0.001 B ^[2] [<- ? [ 0_0]]

2013 : USD 0.094 B ^[3]

2012 : USD 0.133 B ^[3]

2011 : USD 0.196 B ^[3]

 

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Sources :

 

[1] : Berkshire 2019 Annual Report , p. K-114,

[2] : Berkshire 2016 10-K, p. 112, &

[3] : Berkshire 2013 10-K, p. 108.

[rb]

i wonder if tax considerations should be a primary concern for holding BRK.

 

They will be for the valuation of BRK common equity if the Federal corporate tax rate is increased from 21% to 28%.

 

wabuffo

In all fairness that will be a consideration for every company's valuation of its common equity.

[wabuffo]

In all fairness that will be a consideration for every company's valuation of its common equity.

 

Yes - but its a double-whammy for BRK.  They are a little different due to their large deferred tax liabilities (in addition to the tax on operating earnings which affect US domiciled public companies). 

 

wabuffo