Warren Buffett, Book Value and How to Value Berkshire Hathaway

Warren Buffett needs no introduction; his value-oriented, long-term investing approach is legendary. But does his Berkshire Hathaway holding company still offer value to investors? Three contributors to MoneyShow.com discuss the stock and its valuation. Ben Reynolds, Sure Dividend Berkshire Hathaway traces its roots all the way back to 1839 as a textile manufacturer. Warren Buffett began acquiring its stock in 1962, eventually taking control of the company. Since that time Buffett and Vice Chairman Charlie Munger have turned the business into one of the largest companies in the world. The $502 billion market cap company trades under two classes, an 'A' shares and a 'B' shares, which are pegged at 1/1,500th of an A share. On Feb. 23, 2019 Berkshire released fourth-quarter and full-year results for the period ending Dec. 31, 2018. Operating earnings for the quarter totaled $5.72 billion ($2.32 per share) against $3.34 billion ($1.35) in Q4 of 2017. For the year operating earnings totaled $24.78 billion ($10.05) against $14.46 billion ($5.86) in 2017. Previously, Warren Buffett had suggested that book value provided a reasonable, albeit imperfect, measure of Berkshire's value over time. As such, we had been using this metric as a valuation yardstick for the security. However, as of the most recent annual report, Buffett said that it was now time to abandon that practice. Given this stance, we have reverted to looking at operating earnings per share, excluding the impact of equity gyrations. With the scores of operating businesses under Berkshire's umbrella spanning the economy, along with a model of retaining all earnings coupled with a significant cash hoard that can fund future growth, we have projected mid-single digit improvements on the bottom line. While Berkshire is exceptionally valuable, the security is not especially straight forward to value. Looking at the P/E ratio alone only tells half of the story. As such, here's how we think about Berkshire's valuation. The company is composed of five main types of assets, highlighted in the overview above. We combine three of those parts -- insurance subsidiaries, non-insurance subsidiaries and shared control businesses -- as one valuation component. This portion of the business provided operating earnings of $24.8 billion last year or $10.05 per share. If you apply a conservative valuation to that number, say 14 times earnings which incorporates both the idea of solid profitability mixed with some difficulty growing at the current size, you reach about $347 billion or around $141 per share. Next up is the collection of marketable investments, including American Express , Apple , Bank of America , Coca-Cola , Wells Fargo and many more, which are independent from the operating businesses. Those investments have a market value of $173 billion at the end of 2018. If the entire position was liquidated, the tax owed would total about $14.7 billion, bringing the value down to $158 billion or so. On a per-share basis, that works out to roughly $64 per share. Finally, you have Berkshire's cash position, which totaled $112 billion, plus another $20 billion in fixed-income instruments. Buffett has indicated that $20 billion is untouchable to guard against extreme calamities. The remainder is not required to operate the business and will aid in future growth via buying wholly owned or partially owned businesses or repurchasing stock. For our purposes we ignore the fixed-income assets and take out an additional $20 billion to get to $92 billion or roughly $37 per share in available cash. Collectively these three components add up to a fair value estimate of $242 per share, which is the number we have used in our calculations above. Berkshire's competitive advantage has been Warren Buffett and Charlie Munger for over 50 years. However, even without these two the business will still possess a significant advantage in the dozens of wholly owned businesses spanning the economy, along with the other two legs of the company. While size makes growth difficult, the diversified set of assets also allows capital to flow toward promising areas. Moreover, without a dividend payment, funds are allowed to compound internally and add to the safety of firm. Berkshire Hathaway has an exceptional collection of assets. We believe the current valuation looks compelling when you look at the assets collectively. Berkshire Hathaway is a borderline buy or strong hold at current prices. Shawn Allen, Internet Wealth Builder The assets at Berkshire Hathaway include vast holdings of cash, stocks and bonds as well as 74 operating companies, some of which in turn have many subsidiaries. But Buffett advises focusing on the forest rather than these individual trees, which he says range in size from twigs to redwoods. In order not to get lost in mind-numbing details, Buffett suggests that the Berkshire forest be thought of as consisting of five major groves. These are: 1) Its non-insurance operating companies (railroad, utilities, and manufacturing, service & retailing) 2) Equity investments 3) Shared-control businesses -- most notably Kraft Heinz 3) Cash and Treasury bills 5) Insurance operations where a primary goal is to fund much of the other four with low- or cost-free funds. In 2018, operating earnings soared 71%. This was boosted substantially by President Trump's reduction in the federal corporate income tax rate from 35% to 21%. Pre-tax earnings in its non-insurance operating businesses were up 24% and its insurance operations returned to an underwriting profit from the rare loss that occurred in 2017. GAAP earnings, however, were down 91% due to a huge income tax gain in 2017 and due to market value losses on investments in 2018 as well as a partial write-down on its Kraft Heinz investment. While the highly volatile GAAP earnings figures make for scary headlines, they are basically meaningless in evaluating Berkshire's underlying earnings and value. The price-to-book value ratio seems reasonable at 1.43. For Berkshire's normalized adjusted earnings, I assume it will earn 10% of book value on the basis that book value per share has grown at an average of almost 12% in the past ten years after reflecting investment gains. On this basis, the adjusted P/E is reasonably attractive at 14.3. However, the trailing P/E based on operating earnings (which excludes any gains or losses on investments) is not attractive, although lower than typical, at 20.1. It seems likely that Berkshire will continue to grow its intrinsic value and earnings at an acceptable rate in the future. However, this would likely be in the range of perhaps 10% per year and not the huge growth of bygone years. In conclusion, I believe Berkshire is trading at a sensible price given Buffett's recent comments on its valuation as well as his share buy backs and based on my analysis in the value ratios section above. Ultimately, to buy Berkshire is to place trust in Buffett and to trust that he has built the company to thrive after he is no longer CEO. Building Berkshire to thrive for the long term has been Buffett's life work. I rate the stock a buy. Tony Daltorio, Investors Alley Premium Digest It is sad to see the end of an investing era. I'm speaking, of course, of the end of value investing. One of the last adherents to it -- the legendary Warren Buffett -- has thrown in the towel and adopted the modern Wall Street model of momentum and share price appreciation. For nearly 30 years, Buffett used book value as the benchmark for the value Berkshire Hathaway created each year -- but no more. It is hard to overstate what a change this is for Buffett, who in his early years, discovered the investment writings of Benjamin Graham, the father of value investing. Graham had been scarred, like most of his era, by the stock market collapse between 1929 and 1932. So Graham developed an investing style that focused on retaining capital. One of the ways through which Graham sought to do this was through measuring a business' book value, which is defined as the cash left after a business' assets are liquidated and liabilities paid off. If you could find a stock trading below this figure, at a price-to-book of less than 1, then it was a relatively safe investment. However, book value has always had its limitations. It fails to capture intangible assets, such as brand value or intellectual property. That's why it's become less relevant as the global economy becomes increasingly more de-industrialized, digitized and service-oriented, reducing the need for businesses to hold real assets such as factories, real estate and machinery. I believe the removal of emphasis on book value is simply a way of allowing more financial engineering to occur at Berkshire Hathaway via stock buybacks. Previously, Buffett had put a limit of only buying back stock if the shares were trading at 1.2 times book value or lower. As of Dec. 31, Berkshire Hathaway's A shares had a book value per share of $212,503. Its share price is U.S. $303,000, creating a gap of over $90 billion between book and market values. It's little wonder then that Buffett now prefers the market price over book value as a guide to his value creation. And now, the barn door is open to buying back stock at any price. I thought I would never see that at Berkshire Hathaway.

Warren Buffett, Book Value and How to Value Berkshire Hathaway

Does Berkshire Hathaway still offer value for investors?

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