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Analysis of Berkshire Hathaway - There can be many different ways to evaluate Berkshire but let's take Warren Buffets words and try to see what we can deduce.
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"Though Berkshire's intrinsic value cannot be precisely calculated, two of its three key pillars can be
measured. Charlie and I rely heavily on these measurements when we make our own estimates of Berkshire's value.
The first component of value is our investments: stocks, bonds and cash equivalents. At yearend these
totaled $158 billion at market value.
Berkshire's second component of value is earnings that come from sources other than investments and insurance underwriting. These earnings are delivered by our 68 non-insurance companies.
For the forty years, our compounded annual gain in pre-tax, non-insurance earnings per share is 21.0%.
During the same period, Berkshire's stock price increased at a rate of 22.1% annually. Over time, you can expect our stock price to move in rough tandem with Berkshire's investments and earnings. Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.
There is a third, more subjective, element to an intrinsic value calculation that can be either positive or negative: the efficacy with which retained earnings will be deployed in the future."
-- Warren Buffet in his 2010 Annual Letter
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First component Value:
(Investments and cash) = $158 Billions = $63 per class B shares (roughly)
Second Component Value:
Buffet has indicated in past that multiple of 12 is fair value of Berkshire operating businesses. We will be conservative and use the multiple of 10. We are taking 2010 figure but normalized earnings will also come in same range.
Operating earnings of non-insurance business in 2010 Annual report = $5926/share of class A = $4/share of class B
Value of second component = 10 * $4 = $40 per class B shares (roughly)
Third Component value:
This is the main reason people buy Berkshire. Value of this can be either negative if money allocation decisions are going to be bad or positive is money allocation decisions are going to be good. We feel, it's a very big positive given Buffet is responsible for money allocation decision at this moment. He might not be able to compound the money at same rate because Berkshire has become so huge and also age is not on his side. Still we feel it's very big bonus. To be conservative, we will ignore this component and assign zero value.
Value of third component = $0
Total Value of Berkshire at the end of 2010 = $63 + $40 + $0 = $ 103 per class B shares (roughly)
If we go by Berkshire record of increasing operating earnings of non-insurance businesses by over 20%/year business then we can safely assume that earnings in coming years will be lot higher even if it does not increase by 20%/year. Similarly, investment and cash component is going to be lot higher as well in future. So for 2011 end it won't be very wrong to estimate that conservative valuation of Berkshire is 6-8% higher.
Conservative intrinsic value estimate of Berkshire Hathway at the end of 2011 = $110 per class B share (roughly)
Current market price for class B share : $74-$75
So we have roughly 50% upside. Now let's see the downside because without looking at downside, upside does not mean much to us.
So when we pay $75 dollar for class B share, we get cash equivalent of $63 and also get all businesses of Berkshire. So we are effectively paying $11-12 for all operating businesses.
As we calculated earlier, the operating earning of non-insurance business in 2010 Annual report = $4 per class B share.
So we pay $75 dollar for each class B share and receive $63 of cash equivalent and bunch of high quality businesses which earns roughly $4 each year. These high quality businesses have very good moat and they are likely to earn more in future, we are paying only 3 times operating earnings for such businesses. Clearly the downside is very limited.
We took some approximations and used rough numbers at times but given that the estimate is very conservative one, the over all analysis should still hold true. We love a situation where upside is roughly 50% but downside is very limited. Off course we have big cat event in insurance time to time but Berkshire combined ratio and reserve release record has been pretty decent. Here odds are high in our favor.
Feel free to poke holes in the idea/thought process. There are couple of different ways to evaluate berkshire but all of them points to the same conclusion at this moment. I posted this to simply jump start a discussion on it if anyone is interested.
-----------------------------------------------
"Though Berkshire's intrinsic value cannot be precisely calculated, two of its three key pillars can be
measured. Charlie and I rely heavily on these measurements when we make our own estimates of Berkshire's value.
The first component of value is our investments: stocks, bonds and cash equivalents. At yearend these
totaled $158 billion at market value.
Berkshire's second component of value is earnings that come from sources other than investments and insurance underwriting. These earnings are delivered by our 68 non-insurance companies.
For the forty years, our compounded annual gain in pre-tax, non-insurance earnings per share is 21.0%.
During the same period, Berkshire's stock price increased at a rate of 22.1% annually. Over time, you can expect our stock price to move in rough tandem with Berkshire's investments and earnings. Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.
There is a third, more subjective, element to an intrinsic value calculation that can be either positive or negative: the efficacy with which retained earnings will be deployed in the future."
-- Warren Buffet in his 2010 Annual Letter
----------------------------------------------------
First component Value:
(Investments and cash) = $158 Billions = $63 per class B shares (roughly)
Second Component Value:
Buffet has indicated in past that multiple of 12 is fair value of Berkshire operating businesses. We will be conservative and use the multiple of 10. We are taking 2010 figure but normalized earnings will also come in same range.
Operating earnings of non-insurance business in 2010 Annual report = $5926/share of class A = $4/share of class B
Value of second component = 10 * $4 = $40 per class B shares (roughly)
Third Component value:
This is the main reason people buy Berkshire. Value of this can be either negative if money allocation decisions are going to be bad or positive is money allocation decisions are going to be good. We feel, it's a very big positive given Buffet is responsible for money allocation decision at this moment. He might not be able to compound the money at same rate because Berkshire has become so huge and also age is not on his side. Still we feel it's very big bonus. To be conservative, we will ignore this component and assign zero value.
Value of third component = $0
Total Value of Berkshire at the end of 2010 = $63 + $40 + $0 = $ 103 per class B shares (roughly)
If we go by Berkshire record of increasing operating earnings of non-insurance businesses by over 20%/year business then we can safely assume that earnings in coming years will be lot higher even if it does not increase by 20%/year. Similarly, investment and cash component is going to be lot higher as well in future. So for 2011 end it won't be very wrong to estimate that conservative valuation of Berkshire is 6-8% higher.
Conservative intrinsic value estimate of Berkshire Hathway at the end of 2011 = $110 per class B share (roughly)
Current market price for class B share : $74-$75
So we have roughly 50% upside. Now let's see the downside because without looking at downside, upside does not mean much to us.
So when we pay $75 dollar for class B share, we get cash equivalent of $63 and also get all businesses of Berkshire. So we are effectively paying $11-12 for all operating businesses.
As we calculated earlier, the operating earning of non-insurance business in 2010 Annual report = $4 per class B share.
So we pay $75 dollar for each class B share and receive $63 of cash equivalent and bunch of high quality businesses which earns roughly $4 each year. These high quality businesses have very good moat and they are likely to earn more in future, we are paying only 3 times operating earnings for such businesses. Clearly the downside is very limited.
We took some approximations and used rough numbers at times but given that the estimate is very conservative one, the over all analysis should still hold true. We love a situation where upside is roughly 50% but downside is very limited. Off course we have big cat event in insurance time to time but Berkshire combined ratio and reserve release record has been pretty decent. Here odds are high in our favor.
Feel free to poke holes in the idea/thought process. There are couple of different ways to evaluate berkshire but all of them points to the same conclusion at this moment. I posted this to simply jump start a discussion on it if anyone is interested.
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