Following my recent articles (which you can find here and here) on the process Warren Buffett (Trades, Portfolio) has said he uses to value securities, in this article, I will take a look at some of the biggest positions in his portfolio to try and determine how much they could be worth based on this method.
Please note that this is only a demonstration exercise. The experiment below is only designed to illustrate what I believe to be onecomponent of the strategy the Oracle of Omaha uses to place a value on securities. This is only the quantitative factor of the equation.
We know Buffett does a tremendous amount of qualitative research before he initiates a position. So, the analysis below is by no means a comprehensive evaluation of the businesses profiled. However, it could be used as a starting point for further research and analysis.
The Warren Buffett way
From his past statements, we know that Buffett uses a version of the discount cash flow analysis to determine how much a business is worth. Although Charlie Munger (Trades, Portfolio) has said that he's never seen Buffett calculate a discount cash flow projection, based on the Oracle's past comments, I think this - or at least his own unique derivative of it - seems to be the most likely method.
Buffett once said he likes to use a discount rate of around 3% above the risk free rate. The 30-year Treasury rate was 1.53% at the time, with the rate on the 10-year sitting at 0.74%. With a 3% margin, the prospective discount rate was 4.53% to 3.74%. I'll be using these figures for the rest of the article - keep in mind, this is only an experiment.
Buffett has also said that he likes to stick with companies where the growth rate is reasonably predictable. For this article, I'm going to stick with the top non-financial holdings in Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) equity portfolio and use the average free cash flow growth rate over the past 10 years to arrive at a growth figure.
Coca-Cola
To start, I'm going to look at one of Buffett's best-known holdings, Coca-Cola (KO, Financial).
According to Gurufocus data, Coca-Cola's free cash flow has grown at a compound annual growth rate of 0.8% per annual for the past decade. In its last full financial year, the company reported free cash flow of $8.4 billion.
Plugging the above figures into a discount cash flow analysis gives an implied valuation of just under $68 per share at a discount rate of 3.7% and just over $53 per share at the higher discount rate of 4.5%. Both of these numbers suggest the stock is trading under intrinsic value at current levels.
Apple
Let's move on to the largest position in the Berkshire portfolio today, Apple (AAPL, Financial).
Over the past decade, the company has reported annual free cash flow growth of 21%. This seems relatively high, and it's unlikely the company will continue to achieve this growth rate in perpetuity.
Over the past four years, free cash flow has grown at a compound annual growth rate of 2.3%. So, for this exercise, I'm going to use this lower rate. In its last full financial year, the group reported a free cash flow of $59 billion. Based on these growth and cash flow figures, at a discount rate of 3.7%, the stock could be worth as much as $252. At 4.5%, the valuation falls to $160.
Kraft Heinz
Finally, the third non-financial holding in Berkshire's top five positions was Kraft Heinz Co (KHC, Financial) at the end of the second quarter of the year.
This has been a relatively poor investment for Berkshire and its investors over the past few years. Buffett himself has even admitted that he overpaid for the company. But how much might it be worth today?
Between 2014 and 2019, free cash flow increased from $1.8 billion to $2.7 billion, despite some bumps along the way. That was a compound annual growth rate of 7%. Once again, this seems a little optimistic. A reduction to 3% gives a rough lower-end projection that may be more sustainable in the long term.
Based on this growth rate, a discount rate of 3.7% gives a value of $325 and 4.5% suggests a stock price of $151.
Disclosure: The author owns shares in Berkshire Hathaway. I should caution that the above are only rough figures based on the assumptions of the experiment.
Read more here:
- Warren Buffett on Discount Rates: Stick With What You Know
- Warren Buffett: Finding a Good Business Is More Important Than the Price
- Warren Buffett's 3% Discount Rate Margin
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