Berkshire Hathaway BRK.A BRK.B has to be one of the most simultaneously understood and misunderstood companies I have ever studied.
The conglomerate created by famous value investor Warren Buffett (Trades, Portfolio) consistes of a wide variety of business and investments. When you start to look under the hood, analyzing Berkshire becomes quite a complicated process. That's why there are only a handful of Wall Street analysts that currently have a price target on the stock.
Yahoo Finance analysts noted in a 2016 article that Berkshire doesn't give analyst meetings, and that Buffett has so much autonomy that traditional valuation processes are difficult; they never know what he's going to do next.
However, that is just Wall Street's viewpoint. Buffett himself has given some explanation in the past about the best way to place a value on the business. He's said that investors should consider the overall cash generation of the group and then place an appropriate discount rate on that cash generation.
Berkshire's insurance business
Of course, no valuation process is this simple, especially for Berkshire. Nowhere is this more apparent than in the insurance division.
Berkshire's insurance business is one of the largest in the world, which means it can take on risks others cannot touch. That's an invaluable competitive advantage, one that is certainly worth a premium.
At the 2019 Berkshire annual meeting of shareholders, Buffett described the insurance business's competitive advantages compared to the rest of the sector:
"Berkshire is really the ideal form for writing the business. Because we have this massive amount of assets that, in many cases, are largely uncorrelated with natural disasters. And we can — we don't need to buy reinsurance from anybody else. And we can use the money in a more efficient way than most insurance companies. It's interesting. The three — In the last 30 years, the three largest reinsurance companies...came close to extinction sometime in the last 30 years, or reasonably close. And we didn't really have any truly extraordinary natural catastrophes
It's really not a good business if you keep enough capital to really be sure you can pay anything that comes along, under any kind of conditions. And Berkshire can do that. And it can use the money in ways that it likes to use. So, it's a very valuable asset. I don't want to give you a figure on it. But we would not sell it. We certainly wouldn't want to sell it for its float value. And that float is shown on the balance sheet as a liability. So, it's extraordinary."
So how much is the insurance business worth? That's the $64 billion question. It's certainly worth more than book value, as Buffett said in 2019.
At the end of 2019, the float of the insurance businesses amounted to $129 billion. Some of the market's best publicly-traded insurance companies command a multiple of 2 times book value. This would imply a valuation of $258 billion for Berkshire's insurance business. With the company's whole market capitalization sitting at $429 billion as of the writing of this article, that suggests the rest of the company is worth $171 billion according to Mr. Market.
For 2019, Berkshire's five primary non-insurance businesses (BNSF, Berkshire Hathaway Energy, Manufacturing, McLane Company and Service and Retailing) reported pre-tax income of $22 billion. That suggests the non-insurance side of the business is trading at less than 10 times earnings.
Based on this back-of-the-envelope calculation, Berkshire looks exceptionally undervalued to me at the moment.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Warren Buffett on Risk: It's What You Know that Matters
- Warren Buffett: Kraft Heinz Is a Good Business, but the Price Was Wrong
- Warren Buffett on Why Amazon Could Be a Value Stock
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