Is Berkshire Hathaway a Buy?

In December 2007, Barron's published an article titled "Sorry, Warren, Your Stock's Too Pricey." The writers argued that Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) was overvalued for several reasons: It was trading above its historical price-to-book multiple. It was questionable whether Buffett would ever land his "elephant" investment, making a meaningful dent in Berkshire's growing cash hoard. And insurance pricing, a pillar of Berkshire's business, was crumbling. Nothing looked good.

Most of the article was prescient. Berkshire stock peaked a week before publication, and it still remains about a third below those levels. (Other parts of the article weren't as lucky, with painful predictions such as "our bet is that financial companies like AIG ... will do even better [than Berkshire].")

But today, Berkshire investors couldn't be staring at a more different world. Historical valuations are about as low as they've ever been. The elephant acquisition, Burlington Northern, has already been bagged. And there's reason to believe insurance pricing could stage a rebound. All of this leads me to believe Berkshire Hathaway is a buy.

Valuation
Let's start with valuation. I've rambled on this topic more than a few times, so my apologies if this is repetitive.

The most reasonable way to value Berkshire is the price-to-book ratio. Why? For most companies, using discounted cash flow or price-to-earnings multiples is what you'd focus on. That's the agreed-upon yardstick. But Berkshire is a different animal. Rather than cranking out profits and cash flow, Berkshire has a portfolio consisting largely of investments where price appreciation is the goal.

Take BYD, a Chinese electric-car company that Berkshire purchased a 10% stake in two years ago. At the end of 2009, Berkshire's original $232 million investment was worth $2 billion. How much income and cash flow has this investment produced? Exactly zero dollars. Yet the return to shareholders is obvious in terms of Berkshire's book value.

Looking at Berkshire's historical price-to-book value going back to 1994 shows an average multiple of 1.85 and a five-year average of 1.5. When Barron's ran its article in 2007, the five-year average was 1.6, while Berkshire's then-current multiple was 1.8 -- hence the overvaluation worries.

Today, shares trade at about 1.3 times book value. That's below the five-year average, and it's considerably below the long-term average. I'm comfortable calling that considerably cheap.

Elephant hunting
To be fair, plenty have argued that Berkshire's valuation premiums deserve to shrink as the company grows. The idea is that size will shackle returns as Buffett is forced to buy massive investments to move the needle on Berkshire's ever-growing balance sheet.

Ominously, the loudest bell-ringer of this threat has been Buffett himself. In 1995 he warned, "The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good big ideas."

No doubt, Berkshire has settled for lower-returning ideas. But the good news is that Buffett has had no problem finding big ideas. It started with the $22 billion purchase of General Re in 1998, and it built momentum as the years progressed. There's the $5 billion Iscar investment in 2006, the $4.5 billion purchase of Marmon in 2007, the $8 billion combined savior investments in Goldman Sachs (NYSE: GS  ) and General Electric (NYSE: GE  ) in 2008, and the Big Kahuna $44 billion purchase of Burlington Northern last year.

If anything, finding big ideas has become easier as Berkshire's reputation as a nurturing parent to privately owned businesses gains credibility. Berkshire's ability to not just grow, but to do so at attractive rates, hasn't missed a beat. That's a major plus for long-term investors who thought the company had hit a plateau.

Insurance pricing
Berkshire is a mess of businesses from almost every industry imaginable -- from underpants to credit default swaps. Insurance, however, is the largest focus by far, accounting for roughly one-third of revenue.

That's been a thorn of worry for many years as underwriting pricing has marched steadily downward. Insurance underwriting is typically either extremely profitable, or a hard-to-watch money sink. The last few years have been more of the latter.

But these things move in cycles. Insurance pricing can't, and won't, drop forever. And if you want a good place to start looking for a rebound, today's seeds of a budding economic recovery offer a good place to start. There's so much pessimism in the insurance-pricing market, and valuations are so thoroughly pricing that pessimism in, that even a small positive surprise could be a serious boon to insurance-company shareholders.  

Shoot me down, Fools
Add it all up, and I think Berkshire is a buy. Disagree? No sweat. Just show me where I'm wrong in the comments section below.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway, and so does The Motley Fool. Berkshire Hathaway is also a recommendation of Motley Fool Inside Value and Motley Fool Stock Advisor selection. The Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (71)

Comments from our Foolish Readers

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  • Report this Comment On June 18, 2010, at 2:03 PM, ToddFinances1 wrote:

    I generally agree with what you're saying but you could have written this article any time last year at much lower BRKA prices, $100k and below. To wait until BRKA is close to $120k to write this article is somewhat late. I'm a BRK bull and I have most of my networth in it but I won't buy any shares above $74 per BRKB share. I think BRK will face headwinds in investments per share over the coming years but I also think that operating earnings stand to rebound quite well over the same time frame, including the reinsurance market as you mention. All in all I think BRKA is worth around $130k/share as it stands now. At current prices I'm neither a buyer or a seller.

    Todd

  • Report this Comment On June 18, 2010, at 2:04 PM, gilsh wrote:

    couldn't agree more. and for small investors, the recent split has enabled putting your leg on berkshire's boat, without locking yourself to one stock.

  • Report this Comment On June 18, 2010, at 2:44 PM, jwk13 wrote:

    This statement seems misrepresent brk's earnings:

    "Rather than cranking out profits and cash flow, Berkshire has a portfolio consisting largely of investments where price appreciation is the goal."

    Your statement makes it seem that BRK's profits are afterthoughts at best. It's a cash generating machine. The sentence should have read, "In addition to cranking out profits...." I understand that your next paragraph focus is on the appreciation of securities, but i just think it someone didn't know anything about BRK and read this article they would be shocked that it makes billions in profits.

  • Report this Comment On June 18, 2010, at 3:06 PM, Champ4870 wrote:

    I hae been a long term bull of BRK_ . Right now I am neither a buyer or seller of the stock. I think we are in a Bear trap situation in the market and am fearful that thee market will be headed down soon. I would be a buyer at $72 or 108,000. a major concern that has not been discussed is the falling amount of rail traffic as result of reduced trade with China. Burlington Northern's profitability next quarter is lickly to be down substancially inspite of their efforts to take market share from their competitors while their market share increases due to reduced traffic. The comments made by others regarding the insurance business profitability are reasonable.

  • Report this Comment On June 18, 2010, at 8:40 PM, tshk1221 wrote:

    HSY: 15 x stockholder's equity

    AAPL: 6.3 x stockholder's equity

    PM: 17 x stockholder's equity

    KFT: 1.5 x stockholder's equity

    AXP: 3.6 x stockholder's equity

    KO: 4.8 x stockholder's equity

    PG: 2.6 x stockholder's equity

    DIS: 1.8 x stockholder's equity

    UNP: 2.2 x stockholder's equity

    BRK-A: 1.35 x stockholder's equity

    Average: 5.6 x stockholder's equity

    Without assessing average multiples of all US companies being publicly traded, we can't really determine whether BRK-A/B is expensive or cheap. However, a glimpse of the sample multiples and their average above clearly show that BRK-A/B is, indeed, one of the cheapest stocks in the US now.

  • Report this Comment On June 18, 2010, at 10:04 PM, susan400 wrote:

    BYD will soon crash, etc.

    Owing over priced stks nd calling that book value ?

    come on.

  • Report this Comment On June 19, 2010, at 9:39 AM, Reddrummer wrote:

    tshk1221:

    That is a misleading way to look at it. This is because BRK-A is required to account for most of their assets using the fair value method of accounting which means that their shareholders equity figure is actually close to accurate where for KO or PG, many valuable assets such as their brand name cannot be quantified.

  • Report this Comment On June 19, 2010, at 10:56 AM, gmconway1953 wrote:

    Agree.....BRKA is undervalued. Fair Value is $130,000.

  • Report this Comment On June 19, 2010, at 9:12 PM, makarstar wrote:

    Could Berkshire B shares ever reach the same share price as the Class A shares? And why are the Class A shares worth so much?

  • Report this Comment On June 20, 2010, at 12:12 AM, miteycasey wrote:

    B prices can not reach the same price as A because there are millions more shares.

    A is so much because of supply and demand. There are only ~1.6 million shares of A stock outstanding. Yet they have a market cap of ~$200Billion.

  • Report this Comment On June 20, 2010, at 1:27 PM, Friendlysurfer wrote:

    sorry, I do not like funds and alike

  • Report this Comment On June 20, 2010, at 11:16 PM, irvingfisher wrote:

    Charlie's great, but BRK is buffet. Buffet will turn 80 at the end of august. What do you think will happen to BRK's share price if Buffet has a stroke or heart attack from all that yummy DQ food he eats?

  • Report this Comment On June 21, 2010, at 10:33 AM, surfnskate wrote:

    Just recently bought BRK/B in real life during that little dip we had. It's one of a handful of stocks that are in my retirement account (I'm 33) so it's gonna be there for 20+ years. I'm not worried about Warren stepping down. He know's how to surround himself with smart people. He's got a great lot to pick from for the next CEO.

  • Report this Comment On June 21, 2010, at 2:51 PM, tshk1221 wrote:

    Reddrummer

    Can you say that the intangible value created by a lot of brands owned by KFT is not worth as much as the brands, HSY or PM? KFT does not have any intangible brands? KFT probably is one of the US companies that carries the most number of brands, and the multiple above suggests that KFT's multiple is way too low compared to others'.

    BRK-A has a lot of brands, too, such as Tiffany, See's Candies and so on. These brands of BRK-A do not have intangible value to be realized through market cap?

    To be consistent, we just need one stick to measure wheter a company is overvalued or undervalued. Too many sticks won't get you to a consistent valuation.

  • Report this Comment On June 22, 2010, at 9:22 AM, catoismymotor wrote:

    At almost $200 billion, in my opinion, it is not worth buying. Really, how much larger can it grow?

    In my opinion FRFHF.PK, MKL or LUK may be a better fit for those looking to gain instead of maintain.

    Do your DD. Think for yourself.

  • Report this Comment On June 22, 2010, at 1:50 PM, tshk1221 wrote:

    catoismymotor

    Even if you don't like to invest in BRK-A/B, you'd better calculate the following figures first:

    1. Get the ratio based on Market cap divided by stockholder's equity.

    2. Get Certainty Percentage (stockholder's equity divided by market cap).

    3. Get the market cap rate (1/ PE ratio).

    4. Increase the market cap rate by the Certainty Percentage you got (I call this Book Cap Rate).

    5. BRK-A's book value will increase at the compounding Book Cap Rate.

    6. Market will eventually reflect the compounding annual book cap rate of 13.6%.

    As of 6/11/2010, the Book Cap Rate of BRK-A was calculated to be 13.6%, which is simply superb compared to other established companies. The average of my nine favorite companies was 9.9%.

    Do your OWN DD with objective numbers from the Book (=> financial statements) to buy one of the best companies in the world for a price better than the market to beat the market. S&P 500 has lower Certainty Percetange than 13.6% or even 9.9%.

    Don't ever guess and invest with a vague imagination that LUK will go up. It is one of the sure shots to lose your precious money.

  • Report this Comment On June 22, 2010, at 3:23 PM, catoismymotor wrote:

    tshk1221,

    It sounds like I stepped on your toes by casting some doubt on the future growth of BRK-A/B. I offer you my most humble apologies.

    On the subject of LUK; I suggest you do more homework. Perhaps your outlook will change.

    All the best,

    Cato

  • Report this Comment On June 22, 2010, at 11:29 PM, TMFBoiseKen wrote:

    I plan to buy during the weeks/days after Buffet steps aside. You want value in plain sight? That will be the time.

  • Report this Comment On June 23, 2010, at 1:59 PM, gimponthego wrote:

    Relax, Surfnskate, you chose wisely. I have a few B's stashed. At 64, I've collected B's since before the split and sleep well just knowing that. Never let the worry warts who preach the downfall of BRK when Warren steps down get to you. He's got a formula that a close knit group know well and are with him on the day to day.

    This has been going on for decades with other stocks. Other companies. When CCU was at it's height and trading at $89+ Mark Mays (who is leaving..so long my friend!) had been doing the day to day for Lowry. It's nothing that should keep you from surfin' and skatin'! Johnny/ San Antonio

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