Warren Buffett has led Berkshire Hathaway since 1965. In that period of 45 years, Warren has grown the book value of the firm by 20.2%. Market value of Berkshire has grown at close to book value. Over the last 20 years, Berkshire book value has grown by 22.25 times – an annual compounding of 16.8%. The market value has grown by 16.42 times – an annual compounding of 15%. How many companies or fund managers can match that.
Opportunity
The above also brings us to the opportunity in Berkshire. For the longest period, Berkshire was way over the book value because of Buffett premium. Over the last 20 years that premium has shrunk. This coupled with a few one-off events like Underwriting losses (expected) in 2011, Sokol-gate and market idiosyncrasies now provides us some fantastic opportunity to start a position in Berkshire. Below are 2 ways to value Berkshire.
Approach 1
Current price/share is 111,045 $. Thus the discount is 22%
Assumptions:
Approach 2
Current price/share is 111,045 $. Thus the discount is 18%
Assumptions:
With very conservative assumptions above for both approaches 1 and 2, we still get a discount of 20%
for Berkshire. Thus we have a small margin of safety for Berkshire investment. Now let us look at the qualitative factors for Berkshire.
Qualitative Factors
Qualitative factors are a key ingredient to how the investment works out in the long term. Some of the key ones that I consider are:
Conclusion
Disclosure: Long Berkshire. Looking to increase position on dips.
Opportunity
The above also brings us to the opportunity in Berkshire. For the longest period, Berkshire was way over the book value because of Buffett premium. Over the last 20 years that premium has shrunk. This coupled with a few one-off events like Underwriting losses (expected) in 2011, Sokol-gate and market idiosyncrasies now provides us some fantastic opportunity to start a position in Berkshire. Below are 2 ways to value Berkshire.
Approach 1
Current price/share is 111,045 $. Thus the discount is 22%
Assumptions:
- Above approach counts the $66 Bn of float as part of investments/share with the expectation that the float will remain stable over the years (ideally, it will grow).
- I have used pre-tax earnings multiplier of 8 for Berkshire vs 10.5 for S&P 500 (PE is around 15 for S&P 500. Assuming 30% tax rate, pre-tax earnings multiplier is 10.5).
Approach 2
Current price/share is 111,045 $. Thus the discount is 18%
Assumptions:
- Exclude the $66 Bn of float as part of investments/share.
- Assume 10% return on the float (vs more than 20% ROI that Warren has produced during his career).
- We are not accounting for any growth in float over time.
- I have used pre-tax earnings multiplier of 8 for Berkshire vs 10.5 for S&P 500 (PE is around 15 for S&P 500. Assuming 30% tax rate, pre-tax earnings multiplier is 10.5).
With very conservative assumptions above for both approaches 1 and 2, we still get a discount of 20%
for Berkshire. Thus we have a small margin of safety for Berkshire investment. Now let us look at the qualitative factors for Berkshire.
Qualitative Factors
Qualitative factors are a key ingredient to how the investment works out in the long term. Some of the key ones that I consider are:
- Management: This is one of the best aspects about Berkshire. Warren has been running Berkshire for 45 years and he is the best management-owner one can hope to get. He always considers the return on investment before making any investment. He judges himself by that yardstick and that is one of the reason Berkshire has done so well.
- Culture: Berkshire culture is very long term oriented. This allows them to be patient when markets are not favorable. This allows them to make logical decisions without getting pressured
into what the street is thinking or what their competitors are doing. - Unique businesses: Berkshire has collected an eclectic mix of businesses that have unique competitive advantages. This allows them to handle down markets relatively well. It also allows the businesses not to be as impacted by the market competition thus preserving profitability.
Conclusion
- Berkshire is currently trading at least 20% below the intrinsic value.
- Berkshire has the some of the best qualitative factors. This allows the investor to be very comfortable and not have to worry about short term impacts.
- This is a phenomenal opportunity to invest in one of the best businesses available at a
discount with very limited downside risk.
Disclosure: Long Berkshire. Looking to increase position on dips.
