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Berkshire Hathaway Normalized After-Tax Look-Through Earnings at $18 Billion

April 12, 2012 | About:
Greg Speicher

Greg Speicher

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By my estimate, Berkshire Hathaway (BRK.A)(BRK.B)’s normal earning power after tax is approximately $18 billion. This puts the stock at an adjusted P/E ratio of 11x based on today’s share price.

To get there, I assume the following:

  • Redemption of GE, GS and Swiss Re preferred
  • Normalized but still low interest rates
  • Normalized dividend for Wells Fargo and U.S. Bancorp
  • 2012 dividend increase per consensus estimates
  • IBM full-year dividend
  • Full-year earnings for Lubrizol
  • A more normal housing environment
Following Buffett, I also include undistributed earnings from Berkshire’s large equity holdings.

No adjustment has been made for Berkshire’s large cash holdings which I expect will approximate $40 billion after Q1, 2012, assuming no major purchases. This equates to almost $25,000 per A share.

Here is my data.

I welcome your comments on these adjustments and your thoughts on Berkshire Hathaway’s valuation. Berkshire-adjusted-earnings-300x292.png

Original article.


About the author:

Greg Speicher
http://gregspeicher.com/

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Comments

manxman
Manxman premium member - 2 years ago
Thanks for posting, very useful.

A few comments.

You are using a 30% tax rate ($5,850/$19,500=30%) including on the pre-tax earnings for BNSF and Mid-American. However, on p. 11 of the 2011 AR, they show the after-tax earnings for these two and the tax rate is higher than 30%. Why not just use the actual after-tax numbers shown on p. 11 (or adjust your tax numbers to use the actual tax figures given on p.11)?

How are you arriving at your $4,380bn number for Look-through equity earnings? To the extent that the dividends received on these investments are already captured in your numbers in the top line 2011 pre-tax investment income, then only the undistributed part of the Look-through equity earnings should be added back. Note that Buffett said this number was "over $2 billion" in 2010 (see 2010 AR, p. 17) which is a lot less than your number of $4.38bn for 2011. Finally, this undistrubuted Look-through earnings number should be tax affected (15%, I believe) as they would be taxable if paid through to BRK; though, there's an argument that this should be discounted to take account of tax deferal since those companies are retaining those earnings. If they were approximately $2.0bn in 2010, as Buffett suggested, and if we assume 15% growth for 2011, this gives $2.3bn pre-tax, or $1.95bn after a 15% tax assumption, for 2011.

Greg Speicher
Greg Speicher premium member - 2 years ago
Maxman, thanks for the questions/comments.

Regarding the tax rate, I am following Buffett who used a tax rate of 30% when giving his estimate of normal earnings in his 2010 shareholder letter. He estimated pre-tax earnings to be $17 billion and after-tax earnings to be $12 billion. $5 billion/$17 billion = 29.4%. This figure may increase if Berkshire's earnings mix changes to more heavily taxed businesses. I welcome your thoughts on a more appropriate tax rate for Berkshire going forward. My rate may be low given the strong earnings from BNSF which are at a higher rate.

To arrive at my $4.380 billion figure I first calculated Berkshire's share of total earnings (before any distributions) by simply multiplying 2012 consensus EPS figures times Berkshire's share holdings. This came to $6.493 billion. I then subtracted my estimate of Berkshire's 2012 dividend income from those holdings, again based on 2012 dividend estimates. This figure was $2.11 billion and is included in my estimate of investment income in the spreadsheet above.

The difference is the $4.380 billion included in my estimate of look-through equity earnings. There is no double counting.

Regarding Buffett's comment about retained earnings being "over $2 billion" in 2010, my own estimate of 2010 earnings was $2.7 billion net of dividends. Buffett may have been being conservative in how he phrased it. 2012 will include Berkshire share of IBM's earning which will be approximately $750 million. These were not included in the 2010 figure given by Buffett, as shares were purchased in 2011. The rest of the difference can probably be explained by a recovery in earnings coupled with normal growth in earnings from reinvested retained capital over the two-year period.

Finally, in response to your question about taxes on retained earnings, I believe taxing them at 15% against current earnings is too high. The vast majority of this capital is invested in "permanent holdings" which will likely be held for at least another ten years and arguably much longer. Each investor will need to make their own estimate of the present value of this tax liability. I think it can be very reasonably argued that it is likely to be far smaller than you suggest.

Offsetting the tax liability are considerable value in Berkshire's BAC warrants, which I did not include and the value of Berkshire's cash. This cash - reasonably around $30 billion if Buffett retains a minimum cash buffer of $10 billion - has significant optionality if redeployed for share repurchases, acquisitions or equity investments.

Again, I appreciate your thoughtful questions. It helps us all get a a better understanding of an appropriate valuation for Berkshire. I welcome your further comments.

zippbrain
Zippbrain - 2 years ago


vensriram
Vensriram - 2 years ago


Good article and lots of leg work. I will take the calculations are correct and let others comment on it. I will comment on the market pricing of it.

The p/e of around 10 implies that there is not much growth in future. [If you use DCFand use 10% discount rate (or expected return) and no growth in future and all cash is distributed, it will result in a value that is 10 times the earning or p/e = 10]

Lack of growth is a valid assumption for an enterprise of this size. That is, some businesses will do well in each business climate and others will lag with the net resulting in no growth or at best growth rates keeping up with inflation rates.

I think rather than thinking of it as net growth on all current businesses in hand, it is better to think of Berkshire as a capital allocation machine. That is the growth is achieved by deploying capital in hand for new businesses. That is, purchasing superior businesses at say 80 cents on dollar with cash available. Many businesses acquire but rarely with the same skill as WEB. This is a different growth strategy than most companies. I see that this may warrant a slight premium.

If stock is selling at less than 8 times the earnings, it is a buy but at current levels it is hold if all of your calcualtions are correct.

Again great work! .

Regards,

ram

http://dollarbillsforless.blogspot.com/
manxman
Manxman premium member - 2 years ago
Thanks for your responses.

Just to clarify... To the extent that you are including all of BRK's share of the WFC and USB 2012 retained earnings in your $4,380m figure for Look-through earnings then is it not double counting to also include the $200m and $30m of normalised dividends for these holdings in your adjustment for Pre-tax investment income? Either this $230m is counted as dividend income to BRK or as part of Look-through equity earnings but cannot be both as this would double count this $230m. No?

While I cannot see the detail of how you arrived at your $4,380m figure, and whether or not you adjusted the estimated 2012 EPS and DPS numbers for these holdings in arriving at $4,380m, I did the calculations myself using the table of investments on p. 16 of the 2011 annual report and 2012 EPS and DPS consensus estimates from Bloomberg; I arrive at a number of $4,398m for 2012 Look-through equity earnings and this is very close to your number (the difference may be in the assumed P/E ratio and payout ratio for the "Others" line item - I assume a 2012 P/E ratio of 13 and a payout on these "Others" shares of 40%). Given that my number is close to yours and that it was arrived at by using full-year 2012 EPS and DPS estimates, I think your WFC and USB normalised adjustments in your Pre-tax investment income section may be double counting (these total $230m). Or did you reduce the forecasted 2012 reatined earnings for WFC and USB to account for your assumed higher (40%) payout ratio by these companies?

Also... Could you give some detail on the make up of the $4,725m number for 2011 Pre-tax investment income? I'm just having trouble reconciling the size of this number with the assets on the blance sheet in the Insurance and Other section. From my analysis of the 2011 Look-through equity earnings, I come up with dividend income to BRK from the equities listed on page 16 of $1,715m. That leaves another $3,010m of pre-tax investment income to account for. Where did all of this come from? The interest earned from the cash must be small given interest rates... I see the $31.2m of bonds on the balance sheet, but where can I find detail on how much these paid in 2011? Can you give any color on where the $3,010m came from?

Also, why use the $4,725m number instead of the $4,792m number showing on the 2011 Income statement?

Finally... I am trying to make sure no expenses are being missed. Here's where I see an issue... The $248m of pre-tax Insurance underwriting profit for 2011 shown on page 10 can be reconciled with the numbers on the Income statement as follows: Insurance premiums earned minus Insurance losses and loss adjustment expenses minus Life, annuity and health insurance benefits minus Insurance underwriting expenses (to get to $248m). OK, that leaves the Cost of sales and services, SG&A and Interest expenses remaining in the Insurance and other section... The Cost of sales and SG&A numbers add to $68,509m... However, this is $1,270m larger than the Operating expenses showing for the MS&R operations on page 12... What are these additional $1,270m of SG&A expenses related to and are you capturing them in your analysis?

Many thanks for any feedback. This is good.

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