Is it worth buying shares in Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) after the stock's recent performance?
The answer to this question, as you might expect, is not straightforward. There are so many moving parts to Berkshire that it is challenging to compute the underlying intrinsic value of the business.
With this being the case, it might be better to look at the question from a different perspective. Rather than asking if the business is worth buying at current levels, it might be better to establish if shares in the conglomerate are dealing below intrinsic value.
Calculating intrinsic value
A great place to start when establishing an intrinsic value estimate is to take a look at book value per share. Based on the company's financials for the year ending December 2019, Berkshire's book value was around $175 per B Share. At the time of writing, shares in Warren Buffett (Trades, Portfolio)'s conglomerate are changing hands at $189 per share. That suggests that the stock is dealing at a price to book value of 1.08.
Considering the fact that Buffett's share repurchase boundary used to be 1.2 times book value, these figures suggest that the stock is worth buying.
However, there are a couple of other points to consider here. First of all, Buffett abandoned the idea of using book value as an indicator of value for Berkshire several years ago. And secondly, Berkshire's book value has almost certainly fallen over the past three-and-a-half months because equity values have taken a hit.
It's difficult, at this stage, to quantify the exact impact this has had on the conglomerate's vast equity portfolio. We don't know if Berkshire still owns all the stocks that it reported on its latest 13F, which detailed positions held at the end of 2019. We do know that Buffett has been selling airlines, but we only have limited information on sales.
On the other hand, we don't know if he has been buying into a falling market. It will be some time before we have complete clarity on the state Berkshire's equity portfolio; even then, the information will be out of date.
This is the complicated position anyone who tries to value Berkshire will face. There are so many moving parts to the operation that it is difficult to come up with a real-time figure. The best solution, in my opinion, is to use a combination of book value, cash generation and the less accurate measure of Buffett's repurchases to get some idea of what the stock is worth.
For example, last year the conglomerate generated $38.7 billion of cash from operations. Spending on property, plant and equipment totaled $16 billion, giving a rough free cash flow figure of $22.7 billion for the year. Assuming no free cash flow growth for the next 10 years, a risk-free rate of 5% gives a discounted cash flow value of $187 per B Share. A risk-free rate of 5% and 0% going forward is quite aggressive, but I'm looking for a conservative figure here.
With regards to buybacks, Buffett was willing to repurchase B Shares up to around $207 last year.
Taking these three values and averaging them gives a weighted average value of $189.70. This very rough estimate does suggest that the stock is appropriately priced at current levels.
However, I should also note that the figures are designed with a margin of safety in mind. The true intrinsic value is undoubtedly above this level, in my view. As Buffett was happy to buy up to $207, I would argue that the actual figure is at least 20% above this figure.
Nevertheless, from a conservative angle, I estimate $189.70 per B Share to be an appropriate valuation.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Seth Klarman's Baupost Is Buying
- Warren Buffett: Mistakes of Omission Are More Costly Than Bad Investments
- Buffett Sells More Stocks: Has His Strategy Changed?
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