How much is Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) really worth? It is challenging to provide an accurate answer to this question, but that has not stopped investors and Wall Street analysts trying to do so in the past.
Warren Buffett (Trades, Portfolio) has been asked to explain his process for calculating the business's intrinsic value at Berkshire's annual meeting of shareholders. Specifically, at the 2003 annual meeting, one investor asked Buffett if he could provide some guidance on his process for calculating Berkshire's intrinsic value.
The Oracle of Omaha started his answer by giving a rough overview of what intrinsic value actually meant. He noted:
"The intrinsic value of any financial asset, you know, is the stream of cash that it'll produce between now and Judgment Day, discounted by an interest rate that equates between all the different possible assets."
As he went on to explain, this applies to virtually every asset. From real estate to oil wells and equities, every single asset's intrinsic value can be determined by discounting its stream of future cash flows at an appropriate interest rate.
The trick is to find a business that has predictable cash flows. There's never going to be a straightforward answer to this specific question, but if you stick with businesses you know and understand, according to Buffett, it's much easier to predict future cash flows.
This approach might seem unscientific and unpredictable. After all, there's a lot of guesswork involved in predicting a company's future cash flows. There's also a lot of guesswork involved trying to estimate the correct discount rate to use.
However, Buffett went on to state in 2003 that just because the method is "fuzzy to calculate" does not mean that "it's not the proper way to think about it."
With this being the case, the Oracle of Omaha went on to explain that there are two questions investors have to answer when trying to place a value on Berkshire's equity:
"You've got the question of what the businesses we own now are worth. And then, since we redeploy all the capital they generate, you have to figure out what you're willing to assume about what we do with the capital."
The answer to this first question is relatively easy to compute. By looking at the group's balance sheet, we can determine how much all of the businesses are worth on paper.
The next stage is a bit more complex. The rate of return Berkshire has been able to achieve on its investments has deteriorated over the years as it has increased in size. That being said, Buffett has indicated that he is unwilling to accept a rate of return below 10%. That's something recent deals seem to confirm. So, given the conglomerate's track record, I think it would not be unreasonable to use this figure in the second part of the equation.
There is no correct answer to the question of how much Berkshire is worth. No one knows the business better than Buffett, and based on recent share repurchase transactions, it seems that at the beginning of the year, he thought the intrinsic value was above $220 for the B-class shares.
It is also possible that the conglomerate may be worth more than traditional valuation methodologies suggest. These methods do not consider the critical criteria of size, which works in Berkshire's favor. The group can complete insurance contracts no other business can take on, that could be a priceless competitive advantage. Thanks to the group structure, it also has some of the lowest costs of capital in the utility and railroad industries. These are all factors we need to consider when placing a value on this one-of-a-kind business.
Disclosure: The author owns shares in Berkshire Hathaway.
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