I was rereading Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) 1994 annual meeting transcripts today and, to my great surprise and delight, bumped into a comment from a shareholder who mentioned that Charlie Munger (Trades, Portfolio) had calculated the intrinsic value of Wesco Financial Corp. in its 1994 annual report. Out of curiosity, I immediately read the annual report and found Munger’s detailed calculation, which is described as follows:
"As indicated in the accompanying financial statements, Wesco increased its net worth, as accountants compute it under their conventions, to $678.1 million at year-end 1994, or about $95 per Wesco share, from $626.1 million at year-end 1993.
The foregoing $95 per share book value approximates liquidation value assumption that all Wesco’s non-security assets would liquidate, after taxes, at book value. Probably, this assumption is too conservative. But our computation of liquidation value is unlikely to be too low by more than a couple of dollars per Wesco share, because (1) the liquidation value of Wesco’s consolidated real estate holdings (where interesting potentials now lie almost entirely in Wesco’s equity in its office property in Pasadena is now far below its former high, and (2) unrealized appreciation of other assets (primarily Precision Steel) cannot be large enough, in relation to Wesco’s overall size, to change very much the overall computation of after-tax liquidating value.
Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in effect, an interest-free loan from the government equal to its deferred income taxes on unrealized gains, subtracted in determining its net worth. This interest-free 'loan' from the government is at this moment working for Wesco shareholders and amounted to about $27 per Wesco share at year-end 1994.
However, some day, perhaps soon, major parts of this interest-free 'loan' must be paid as assets are sold. Therefore, Wesco’s shareholders have no perpetual advantages creating value from them of $27 per Wesco share. Instead, the present value of Wesco’s shareholder’s advantage must logically be much lower than $27 per Wesco share. In the writer’s judgment, the value of Wesco’s advantage from its temporary, interest-rate free 'loan' was probably about $9 per Wesco share at year-end 1994.
Thus, if the value of the advantage from the interest-free tax-deferral 'loan' present was $9 per Wesco share at year-end 1994, and after-tax liquidation value was then about $95 per share (figures that seem plenty high to the writer), Wesco’s intrinsic value per share would become only about $104 per share at year-end 1994, up 4% from intrinsic value as guessed in a similar calculation at the end of 1993.
And finally, this reasonable-to-this-writer, $104-per-share figure for intrinsic value per share value of Wesco stock should be compared with the $115.12 per share price at which Wesco stock was selling on Dec. 31, 1994. This comparison indicates that Wesco stock was selling about 11% above intrinsic value.
Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway."
It’s extraordinary that Munger warned the market price of Wesco’s stock was above its intrinsic value. I have never heard it from other corporations’ executives before. Incidentally, during either 2014 or 2015’s Daily Journal (DJCO, Financial) shareholder meeting, Munger again hinted that he thought the market price of Daily Journal was too high compared to its intrinsic value.
While it would be great if this simple intrinsic value calculation technique could be applied to all businesses, it’s impractical to think so. During the 1994 Berkshire Hathaway shareholder meeting, Warren Buffett (Trades, Portfolio) also explained when Munger’s method of calculating intrinsic value is applicable:
"It just isn’t that complicated because there aren’t a number of businesses there that have values different than carrying values, or where they are, they’re all footnoted, in terms of numbers.
So it would be almost impossible to come up with numbers that are significantly different than the number Charlie put in there.
Berkshire has assets that, number one of which would be the insurance business, that it’s clear have very significant excess values, but one person might estimate those at maybe three times what somebody else would estimate them at. That’s less true of our other businesses, but it’s still true in a way, so that Berkshire’s range would be somewhat greater.
And as Charlie — we basically — we don’t want to disappoint people, but we also don’t want to disappoint ourselves. But we have our own yardsticks for what we think is doable.
We try to convey that as well as we can to the people who are partners in the business, and I think that we saw some things being published about Wesco that simply might have led to, and probably did lead to, some expectations that simply weren’t consonant with our own personal expectations. And that leaves us uncomfortable."
Read more here:
- Ă‚ Value Investing Might Be Dead?
- Key Takeaways From the Berkshire System Summit
- Notes From Tony Nicely's Talk, Part II
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