The idea for investment sometimes is not very far from us. Especially when there is a lot of blood in the market like it’s having now. Now I submit to value idea contest a investment idea which is right here, next to us, recommended by our investment idol, Warren Buffett. And today’s idea is Berkshire Hathaway.
The board of Berkshire Hathaway, lead by Warren Buffett, the first time ever in history, has proposed to buy back its share in the market. The buybacks has indicated that Buffett strongly believes that at the current price of $100,000 - $110,000, Berkshire Hathaway is deeply undervalued.
The price of $100,000 - $110,000, the whole company is valued at $165- $180 billion. Now we need to look at different separate fields in Berkshire Hathaway business to see how cheap it is at this current price, as both Charlie Munger and Warren Buffett often said the consolidated numbers, which might obscure the earning power in each segments in the company itself, is not very helpful to guide the valuation.
There are three main fields that we can tackle to value the sophisticated Berkshire Hathaway. First is the current fair value of its investment and the value of the insurance business and the float it generated, second is the earning power of 68 operating subsidiaries under the house of Berkshire Hathaway, and the last one is the efficacy which the retained earnings would be deployed into the future. Out of three, the first two points are easier to evaluate and the last item depending on the successor of Warren Buffett when he stepped down.
Fair value of its investment
Its investment can be categorized into 03 main items: the fixed maturities securities (including US treasury, State, municipalities and political subdivision, foreign governments, corporate bonds and mortgaged back securities) totalled $35.8 billion at June 2011. Next is the investment into equity securities including banks, insurance and finances, consumer products and commercial, industrial and other fields, stays at $67.5 billion. And last are the preferred securities of Goldman Sachs, Wrigley, Dow Chemical and General Electric, those are with the fair value of around $17 billion. This table below will illustrate it better:
So the fair value of all Berkshire Hathaway investment at the end of June 2011 worth $120.3 billion, already 67% of the company’s market capitalization now.
Value of the insurance business
One of the main operations in Berkshire Hathaway is the insurance business, which produce a lot of float. The float is the amount of money that Berkshire doesn’t own; just temporarily hold it to pay out in claims. If the insurance underwriting breaks even, meaning that the premiums company receives equal the losses and expenses it incurs, the float will be “free”.
At the end of 2010, it is reported that Berkshire Hathaway got the float of around $65 billion, and dated back in 1970, where it just had $39 million in float, it has experienced fantastic float growth during the last 40 years, 20.4% annual compounded growth. In the earning side, if conservatively the growth of float is assumed to be 5% to infinity, only a fifth of its historical record and Berkshire Hathaway only generated only 10% on its float, so it would be $6.5 billion on $65 billion float, and using 10% discount rate. So the value of its insurance business can be calculated using the Gordon Growth model:
So with the earning power that we can very conservatively estimated at 10% on its float, float growth is only 5%, and the required rate of return is at 10%, the value of its insurance business stays at $136.5 billion.
Operating companies
The insurance floats have funded Berkshire into the investment into equities, debts, preferred securities as well as buying businesses. Currently, Berkshire is having 68 operating businesses in different segments. In the shareholder letter of Warren Buffett, he divided into three main segments: Manufacturing, Services and Retail; Regulated, Capital intensive Businesses (which has MidAmerican and BNSF); and Finance and Financial Products.
Over three years in 2008, 2009 and 2010, those operating companies total earn the average earnings of $14.3 billion, at the earning yield of conservative 10%, the value of the operating companies would be worth $143 billion.
Enterprise value
At the end of June 2011, Berkshire Hathaway got nearly $48 billion in cash and cash equivalent for all of the company. And total notes payable and borrowing from different segments has totalled $56 billion. So with the market capitalization of nearly $180 billion, enterprise of Berkshire Hathaway stays at $188 billion.
Valuation of Berkshire Hathaway
So the valuation of Berkshire Hathaway is equal the sum of the value in the operating companies plus the value of the investment it has made. The operating companies have been estimated to worth $143 billion, and the fair value of its investment stands at $120.3 billion. However, with its float on hand, if we expect the float would grow at 5% to infinity and Berkshire keeps earning 10% on its float, the value of the insurance business would be $136 billion. So fundamentally Berkshire Hathaway should be worth around $263 – $279 billion. At the enterprise value of $188 billion, it is trading at around 70% off its intrinsic value.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
The board of Berkshire Hathaway, lead by Warren Buffett, the first time ever in history, has proposed to buy back its share in the market. The buybacks has indicated that Buffett strongly believes that at the current price of $100,000 - $110,000, Berkshire Hathaway is deeply undervalued.
The price of $100,000 - $110,000, the whole company is valued at $165- $180 billion. Now we need to look at different separate fields in Berkshire Hathaway business to see how cheap it is at this current price, as both Charlie Munger and Warren Buffett often said the consolidated numbers, which might obscure the earning power in each segments in the company itself, is not very helpful to guide the valuation.
There are three main fields that we can tackle to value the sophisticated Berkshire Hathaway. First is the current fair value of its investment and the value of the insurance business and the float it generated, second is the earning power of 68 operating subsidiaries under the house of Berkshire Hathaway, and the last one is the efficacy which the retained earnings would be deployed into the future. Out of three, the first two points are easier to evaluate and the last item depending on the successor of Warren Buffett when he stepped down.
Fair value of its investment
Its investment can be categorized into 03 main items: the fixed maturities securities (including US treasury, State, municipalities and political subdivision, foreign governments, corporate bonds and mortgaged back securities) totalled $35.8 billion at June 2011. Next is the investment into equity securities including banks, insurance and finances, consumer products and commercial, industrial and other fields, stays at $67.5 billion. And last are the preferred securities of Goldman Sachs, Wrigley, Dow Chemical and General Electric, those are with the fair value of around $17 billion. This table below will illustrate it better:
| USD billion | Jun-11 |
| Fixed maturity securities | 35.8 |
| Equities | 67.5 |
| Preferred | 17 |
| Total | 120.3 |
So the fair value of all Berkshire Hathaway investment at the end of June 2011 worth $120.3 billion, already 67% of the company’s market capitalization now.
Value of the insurance business
One of the main operations in Berkshire Hathaway is the insurance business, which produce a lot of float. The float is the amount of money that Berkshire doesn’t own; just temporarily hold it to pay out in claims. If the insurance underwriting breaks even, meaning that the premiums company receives equal the losses and expenses it incurs, the float will be “free”.
At the end of 2010, it is reported that Berkshire Hathaway got the float of around $65 billion, and dated back in 1970, where it just had $39 million in float, it has experienced fantastic float growth during the last 40 years, 20.4% annual compounded growth. In the earning side, if conservatively the growth of float is assumed to be 5% to infinity, only a fifth of its historical record and Berkshire Hathaway only generated only 10% on its float, so it would be $6.5 billion on $65 billion float, and using 10% discount rate. So the value of its insurance business can be calculated using the Gordon Growth model:
| Annual earning | 6.5 |
| Growth in earning | 5% |
| Discount rate | 10% |
| Terminal value | 136.5 |
So with the earning power that we can very conservatively estimated at 10% on its float, float growth is only 5%, and the required rate of return is at 10%, the value of its insurance business stays at $136.5 billion.
Operating companies
The insurance floats have funded Berkshire into the investment into equities, debts, preferred securities as well as buying businesses. Currently, Berkshire is having 68 operating businesses in different segments. In the shareholder letter of Warren Buffett, he divided into three main segments: Manufacturing, Services and Retail; Regulated, Capital intensive Businesses (which has MidAmerican and BNSF); and Finance and Financial Products.
Over three years in 2008, 2009 and 2010, those operating companies total earn the average earnings of $14.3 billion, at the earning yield of conservative 10%, the value of the operating companies would be worth $143 billion.
Enterprise value
At the end of June 2011, Berkshire Hathaway got nearly $48 billion in cash and cash equivalent for all of the company. And total notes payable and borrowing from different segments has totalled $56 billion. So with the market capitalization of nearly $180 billion, enterprise of Berkshire Hathaway stays at $188 billion.
Valuation of Berkshire Hathaway
So the valuation of Berkshire Hathaway is equal the sum of the value in the operating companies plus the value of the investment it has made. The operating companies have been estimated to worth $143 billion, and the fair value of its investment stands at $120.3 billion. However, with its float on hand, if we expect the float would grow at 5% to infinity and Berkshire keeps earning 10% on its float, the value of the insurance business would be $136 billion. So fundamentally Berkshire Hathaway should be worth around $263 – $279 billion. At the enterprise value of $188 billion, it is trading at around 70% off its intrinsic value.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.
