Berkshire-B DCF Valuation

[therealbg]

I recently tried to value Berkshire Hathaway using Mohnish Pabrai's discount cashflow method in Chapter 25 of Mosaic.

I am new to DCF and normally use a NAV/EPV valuation.

However, I wanted to share this with the forum to see if I made obvious mistakes as all of my valuations are showing BRK-B to be quite undervalued even though it's trading at an all time high. This is making me question my valuation.

 

The DCF:

Growth Rate

I expect an average growth rate of 5% a year.

6% for years 1-5 and 3% thereafter.

This is far below analyst projections of 23% for the next 5 years

I also anticipate in the 10th year, the business can be sold for 12X year 10's FCF.

I used a discount rate of 20%, since I am hoping for an annual return of 15% so plugging in 20% would offer me a 33% margin of safety (5/20).

 

A Conservative DCF

Based on these numbers, the present value of BH’s future cashflows are $216B

I added this to the book value of BH, of $400B

That equals an intrinsic value of $616B

Since there are 2.28B shares outstanding, the intrinsic value per share is $270

(Current market price is about $650B and $285 a share)

 

Market Implied Growth Projection In Current Price

The market valuation today is suggesting that Berkshire will grow at 7% a year over the next 10 years, which creates a market cap value of about $650B or $285 per share.

 

Why I Think It Might Be An Opportunity

The market valuation is not factoring the earnings power of Berkshire’s non-controlled companies.

Buffet himself said that the non-controlled businesses net income are not shown on the annual report.

I calculated the FCF from the non-controlled businesses at $8.5B ($12B, minus maintenance capex of 30%).

When I did a DCF on the hidden earnings at 6% a year average growth for 10 years, I got a market value of $77B.

(The analysts projected the companies would grow at 10% so I was being conservative here).

 

Adding It Together

The value of the earnings from non-controlled interest not listed on the Annual Report is a $77B market cap.

That equals an intrinsic value of $616B.

Adding these together gave me $693B.

 

Margin Of Safety

For a discount rate, I used a 20% margin of safety, aiming for a 15% annual return.

This in effect, builds in a 5% margin of safety, or 33% before our annual return.

As well the difference between the current market cap of $650B and $693B in intrinsic value is $43B.

This is another 7%.

So 33% + 7% = 40% margin of safety.

 

Overall Things I Noted

-Revenue has grown at 10% a year

-ROE has been 9% a year

-FCF has grown 15% a year

-Net income has grown 21% a year

-Market cap has grown at 11.28% a year

-Analysts have projected 10% a year growth over the next 5 years for the non-controlled businesses

 

What do you think overall? Is BRK trading at a discount to intrinsic value based on this DCF, even though the price is at an all-time high?

Are my earnings projections or some other part of my DCF way off?

 

By the way, my NAV/EPV gave me the following valuation:

NAV: $221 a share

EPV: $383 a share

EPV > NAV indicates a competitive advantage (not a surprise to me)

EPV 73% above NAV seems a liittttle high though...

 

I also did an Owner Earnings Valuation:

Reported Earnings + Depreciation and Amortization less maintenance capex

 

This becomes:

Net Income + Depreciation and Amortization - Maintenance Capex

 

$42,521 + $10,596 - $12,000 =

$41,117

 

Add the 70% of hidden earnings (30% is maintenance cap)

$41,117 + 8,500 = $49,617

 

If we divide it by the cost of capital (6.5%)

$763B is the intrinsic value of Berkshire or $345 a share.

 

Edited May 12, 2021 by therealbg

[IceCreamMan]

3 hours ago, therealbg said:

I recently tried to value Berkshire Hathaway using Mohnish Pabrai's discount cashflow method in Chapter 25 of Mosaic.

I am new to DCF and normally use a NAV/EPV valuation.

However, I wanted to share this with the forum to see if I made obvious mistakes as all of my valuations are showing BRK-B to be quite undervalued even though it's trading at an all time high. This is making me question my valuation.

 

The DCF:

Growth Rate

I expect an average growth rate of 5% a year.

Growth rate of what? FCF?

 

3 hours ago, therealbg said:

6% for years 1-5 and 3% thereafter.

This is far below analyst projections of 23% for the next 5 years

I also anticipate in the 10th year, the business can be sold for 12X year 10's FCF.

What are you using for your starting FCF?

 

3 hours ago, therealbg said:

I used a discount rate of 20%, since I am hoping for an annual return of 15% so plugging in 20% would offer me a 33% margin of safety (5/20).

 

A Conservative DCF

Based on these numbers, the present value of BH’s future cashflows are $216B

I added this to the book value of BH, of $400B

Why are you adding book value to the present value of future cash flows? Most of book value measures assets that are used in generating the future cash flows.

 

3 hours ago, therealbg said:

That equals an intrinsic value of $616B

Since there are 2.28B shares outstanding, the intrinsic value per share is $270

(Current market price is about $650B and $285 a share)

 

Market Implied Growth Projection In Current Price

The market valuation today is suggesting that Berkshire will grow at 7% a year over the next 10 years, which creates a market cap value of about $650B or $285 per share.

 

Why I Think It Might Be An Opportunity

The market valuation is not factoring the earnings power of Berkshire’s non-controlled companies.

Buffet himself said that the non-controlled businesses net income are not shown on the annual report.

I calculated the FCF from the non-controlled businesses at $8.5B ($12B, minus maintenance capex of 30%).

When I did a DCF on the hidden earnings at 6% a year average growth for 10 years, I got a market value of $77B.

(The analysts projected the companies would grow at 10% so I was being conservative here).

How are you treating the equity portfolio? Valuing it at market value? Including or excluding dividends in your FCF figures? Remember to exclude mark-to-market changes.

 

3 hours ago, therealbg said:

 

Adding It Together

The value of the earnings from non-controlled interest not listed on the Annual Report is a $77B market cap.

That equals an intrinsic value of $616B.

Adding these together gave me $693B.

 

Margin Of Safety

For a discount rate, I used a 20% margin of safety, aiming for a 15% annual return.

This in effect, builds in a 5% margin of safety, or 33% before our annual return.

As well the difference between the current market cap of $650B and $693B in intrinsic value is $43B.

This is another 7%.

So 33% + 7% = 40% margin of safety.

 

Overall Things I Noted

-Revenue has grown at 10% a year

-ROE has been 9% a year

-FCF has grown 15% a year

-Net income has grown 21% a year

-Market cap has grown at 11.28% a year

Over what periods?

3 hours ago, therealbg said:

-Analysts have projected 10% a year growth over the next 5 years for the non-controlled businesses

 

What do you think overall? Is BRK trading at a discount to intrinsic value based on this DCF, even though the price is at an all-time high?

Are my earnings projections or some other part of my DCF way off?

 

By the way, my NAV/EPV gave me the following valuation:

NAV: $221 a share

EPV: $383 a share

EPV > NAV indicates a competitive advantage (not a surprise to me)

EPV 73% above NAV seems a liittttle high though...

 

I also did an Owner Earnings Valuation:

Reported Earnings + Depreciation and Amortization less maintenance capex

 

This becomes:

Net Income + Depreciation and Amortization - Maintenance Capex

 

$42,521 + $10,596 - $12,000 =

$41,117

 

You're going to need to adjust net income. Berkshire's net income includes investment gains and losses.

3 hours ago, therealbg said:

 

Add the 70% of hidden earnings (30% is maintenance cap)

$41,117 + 8,500 = $49,617

 

If we divide it by the cost of capital (6.5%)

$763B is the intrinsic value of Berkshire or $345 a share.

 

 

[therealbg]

Thank you for taking a look - I appreciate it.

On 5/12/2021 at 8:07 PM, IceCreamMan said:

Growth rate of what? FCF?

Growth rate in FCF for my DCF. I was looking at growth rate in earnings for the analyst projections (the 23% number).

 

What are you using for your starting FCF?

I had operating cashflow of $40B and maintenance capex of 12B, giving me a starting FCF of $28B

 

Why are you adding book value to the present value of future cash flows? Most of book value measures assets that are used in generating the future cash flows.

I wasn't going to, but I saw Pabrai did in his blog post so I figured I should - to be honest, I was confused about what to do here.

Should I only add the net cash and assets that can be safely taken out without impairing the businesses ability to generate cashflows? It seems hard to know with Berkshire. Their EPV is so high above their NAV, it looks like a lot of the assets are un-needed, but since they are investment holdings, they are. It's a strange company to value in some ways.

http://www.chaiwithpabrai.com/uploads/5/5/1/3/55139655/intrinsic_value.pdf

 

How are you treating the equity portfolio? Valuing it at market value? Including or excluding dividends in your FCF figures? Remember to exclude mark-to-market changes.

For the non-controlled equity businesses, I valued them at market value. I then found the % Berkshire owns, and the total FCF they generated for each of the main holdings. I then multiplied the total FCF by BH's total ownership. I found the analyst projected 5 years earnings growth rate for each of these holdings and I built a DCF for them all. I used 8% for the first 5 years and 4% for the remaining 5 years. I also subtracted 30% for maintenance capex as that is the overall maintenance capex I found.

 

Over what periods?

I did a 10 year, 2 stage DCF (2 5 year periods).

 

You're going to need to adjust net income. Berkshire's net income includes investment gains and losses.

This is helpful, what numbers would you use for this? I just took FCF. Would you look at the gain and loss for each non-controlled holding?

 

Edited May 14, 2021 by therealbg

[IceCreamMan]

On 5/13/2021 at 12:16 PM, therealbg said:

Should I only add the net cash and assets that can be safely taken out without impairing the businesses ability to generate cashflows?

Yes.

 

On 5/13/2021 at 12:16 PM, therealbg said:

For the non-controlled equity businesses, I valued them at market value. I then found the % Berkshire owns, and the total FCF they generated for each of the main holdings. I then multiplied the total FCF by BH's total ownership. I found the analyst projected 5 years earnings growth rate for each of these holdings and I built a DCF for them all. I used 8% for the first 5 years and 4% for the remaining 5 years. I also subtracted 30% for maintenance capex as that is the overall maintenance capex I found.

I don't understand whether you valued them at market or built a DCF for each equity holding.

 

On 5/13/2021 at 12:16 PM, therealbg said:

You're going to need to adjust net income. Berkshire's net income includes investment gains and losses.

This is helpful, what numbers would you use for this? I just took FCF. Would you look at the gain and loss for each non-controlled holding?

One method would be to exclude all investment gains, losses, and dividends. Then value the equity portfolio at market value.

[Spekulatius]

Since the assets that constitute the Book value also generate the FCF, adding the Book value to the NOV of the FCF is double counting.