Berkshire Hathaway: Now the Cheapest It's Been in Decades

You can't go back in time. If you could, investing in any number of cherry-picked companies would solve most people's present-day financial problems. Ah, if only.

The next best thing? Buying good companies at valuations even those with a time machine couldn't.

That's where Berkshire Hathaway (NYSE: BRK-B  ) shares sit today.           

How Berkshire should be valued is a regular matter of debate. It isn't a normal company, so some normal valuation metrics lack relevance. Many of Berkshire's investments generate no net income at all, yet still reward shareholders handsomely. Portfolio holdings such as Coca-Cola (NYSE: KO  ) and Procter & Gamble (NYSE: PG  ) generate only negligible returns on Berkshire's equity through dividend payments, yet have increased Berkshire's net worth by billions. It's that heavy reliance on capital application that makes income-based valuation metrics like the price-to-earnings ratio borderline irrelevant for Berkshire. Since the essence of owning Berkshire stock is to enjoy the compounded return of its assets, price-to-book value has always seemed like the most meaningful metric to me.

That's where things get interesting. Going off price-to-book value, Berkshire hasn't been this cheap in at least two decades:

Source: Capital IQ, a division of Standard & Poor's.

Berkshire's price-to-book ratio is actually lower now than it was in March 2009, when the global economy was coming apart at the seams and some (irrationally) wondered whether Berkshire's derivative bets might actually bankrupt the company.

And there's more relevance to today's valuation than simply calling it the lowest in years. After tumbling in recent weeks, Berkshire shares now barely hold any premium over book value, with a price-to-book ratio of just 1.1. A firm sneeze from current levels sends shares below book value for the first time in recent history. 

That's where things get really interesting.                    

Consider what Buffett has said about the relationship between Berkshire's share price and book value: "Our book value far understates Berkshire's intrinsic value, a point true because many of the businesses we control are worth much more than their carrying value." Some Berkshire assets, Buffett has claimed, are "worth fifteen to twenty times the value at which they are carried on our books."

Take GEICO, a Berkshire insurance subsidiary. GEICO's intrinsic value is substantially higher than book value because of how goodwill is accounted for. Buffett laid it out in this year's letter to shareholders (emphasis mine):

When, in 1996, we bought the 50% of GEICO we didn't already own, it cost us about $2.3 billion. That price implied a value of $4.6 billion for 100%. GEICO then had tangible net worth of $1.9 billion.

The excess over tangible net worth of the implied value -- $2.7 billion -- was what we estimated GEICO's "goodwill" to be worth at that time. That goodwill represented the economic value of the policyholders who were then doing business with GEICO. In 1995, those customers had paid the company $2.8 billion in premiums. Consequently, we were valuing GEICO's customers at about 97% (2.7/2.8) of what they were annually paying the company. By industry standards, that was a very high price. But GEICO was no ordinary insurer: Because of the company's low costs, its policyholders were consistently profitable and unusually loyal.

Today, premium volume is $14.3 billion and growing. Yet we carry the goodwill of GEICO on our books at only $1.4 billion, an amount that will remain unchanged no matter how much the value of GEICO increases. (Under accounting rules, you write down the carrying value of goodwill if its economic value decreases, but leave it unchanged if economic value increases.) Using the 97%-of-premium-volume yardstick we applied to our 1996 purchase, the real value today of GEICO's economic goodwill is about $14 billion. And this value is likely to be much higher ten and twenty years from now. GEICO -- off to a strong start in 2011 -- is the gift that keeps giving.

GEICO might be an extreme example, but it's hardly unique. The cornerstone of Buffett's career has been acquiring high-quality businesses -- ones whose intrinsic value will far exceed the carrying value assigned to Berkshire's balance sheet over time. This is one reason Berkshire shares usually command a heavy premium to book value.

There could be something else going on here. The chart clearly shows Berkshire's price-to-book multiple has been on a downward trajectory for years. This might have to do with Buffett's age -- the "Buffett premium" may be dwindling as his mortality comes into focus. But with the price-to-book multiple now approaching one, whatever Buffett premium shares held in the past is effectively gone. The market is pricing Berkshire as an average company when history -- and common sense -- shows it is anything but.

This isn't unusual, but it's a treat when it occurs. As Buffett himself once said, "Market price and intrinsic value often follow very different paths -- sometimes for extended periods -- but eventually they meet."

Fool contributor Morgan Housel owns shares of Berkshire and Procter & Gamble. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Coca-Cola and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Coca-Cola, Berkshire Hathaway, and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 13, 2011, at 3:26 PM, EquityBull wrote:

    I sold half my Berkshire position about 2 weeks ago and swapped the cash to add to my apple.

    My rationale is that Berkshire's day's with Buffet are coming to an end no matter how you slice it. This is priced in and will remain so. Nobody believes Berkshire will be the same when Warren is gone. Warren is Bekrshire.

    Another reason is that climate change is increasing the exposure for insurance companies. Berkshire among others are slammed this year with the tsunami, hurricanes, tornadoes and other disasters that are a few standard deviations out. Additionally big insurance co's are looking at La Nina weather to potentially bring the most disruptive disasters we have seen in 100 years. This is historically worse then El Nino by orders of magnitude. Berkshire is not where you want to be if these predictions are even 50% true.

    Last you have to look at what other investment options you have available for your money. Berkshire's growth days are over. Buffett wont' look at technology which may be the last place he can get enough growth to move the needle on a company so large as Berk.

    I compared Apple trading at < 10 times next years earnings growing at 100% with 70 billion in cash versus berkshire growing at 10% or less, less cash on the balance sheet and still a higher forward PE then apple. How would anybody buy Berkshire over Apple would amaze me. While Berk got cheap apple just went ludicrous cheap.

    Finally Warren doesn't see enough value in his own shares yet to buy them back. At book value and with most companies worth much more then the carrying cost why isn't he buying back his own shares? One would think he knows his company better then any of them and at some point your capital might be best deployed buying back your own shares. However he has not voted with a buyback even at today's price.

    I still hold half my position in Berkshire nonetheless because you gotta have a little Berk no matter what. It never pays to completely bet against the Oracle but as I said there are much faster horses to put your money on.

  • Report this Comment On June 13, 2011, at 3:31 PM, TMFHousel wrote:

    <<Nobody believes Berkshire will be the same when Warren is gone. Warren is Bekrshire.>>

    I tend to disagree with that. Future acquisitions will change, that's for sure. But GEICO's policyholder growth won't change at all. Coke's sales won't fall. Iscar's business won't be affected whatsoever. Burlington's freight per mile won't decrease a hair. A lot of Warren's gift to Berkshire will be enduring.

  • Report this Comment On June 13, 2011, at 3:50 PM, TheDumbMoney wrote:

    I agree with Mr. Housel. As usual, people are freaking out. Additionally, Buffett could easily live ten more years and still be managing the thing at ninety-one. The average 80-year old (Buffett's like 81) has around 8.7 years of remaining life-expectancy, or thereabouts. That's because if ya get that old, you have survived or not gotten the cancers and heart disease that nail so many people betwen the ages of about 65-75. From an actuarial standpoint, which Buffett would appreciate, it's a pretty good bet that Buffett will still be alive and kicking and running that company for at least five more years. Thus, even though BRK will probably drop 10% on the day he dies (no matter HOW cheap it is the day before), it's likely much better to buy than to wait for that day. After he dies, we shall see how the next capital allocator does; if not well, I can say with fairly high confidence that rather than watch some future CIO drain value,that is one board that will either: 1) start returning a ton of dividends; or 2) break apart the company, including selling Geico for what it is worth, etc.

    Also, Buffett thinks the company is undervalued, and has said so; he just probably thinks there are other assets that are more undervalued. Plus, buying back shares would add to book value per share more linearly, whearas buying more Geicos adds to it potentially more exponentially.

  • Report this Comment On June 13, 2011, at 4:03 PM, catoismymotor wrote:

    I can't deny that BRK has enjoyed a fantasic run and a well deserved reputation. I do have concerns about its size. How much annual growth can it really achieve when it is already $183 billion?

  • Report this Comment On June 13, 2011, at 5:40 PM, beechtree1 wrote:

    We admire Berkshire Hathaway and so we should. What's it like being Charlie and Warren; I wander. Both extraordinarily intelligent people. Ordinary minds boggle at the breadth of their knowledge and their ability to translate it to outstanding pieces of modern corporate literature in Berkshire's annual reports. As I perceive Mr Munger to be the more cerebral of the two I very much feel these

    annual reports are more Mr Munger's work, his influence, his direction. I won't forget Blanche DuBois' pathetic famous words, made victorious

    as they are used with Churchillian intend in Berkshire's finest hour of recent years ( see 2009 Annual Report,

    page 4, What We Don't Do, para 2 ).

    Those two are writing corporate history

    in our time. Literally and otherwise.

    And they know it.

  • Report this Comment On June 13, 2011, at 5:53 PM, jgod42 wrote:

    @EquityBull: You mention Buffett's mortality, but you fail to mention the health of Steve Jobs. What do you think of Apple's prospects without Jobs at the helm?

    Jobs replacement will need to be an innovator and leader. Buffett's replacement will need to wisely invest income and float from Berk's many businesses. To me the latter seems less risky.

  • Report this Comment On June 13, 2011, at 7:01 PM, DrHsu wrote:

    Plus if you look at Berkshire's equuity porfolio, there are many tha are unvalued too. Hence Bekshire is definitely below its intrinsic value.

  • Report this Comment On June 13, 2011, at 10:40 PM, plange01 wrote:

    buffet had to stop using inside information and is now like everyone else!

  • Report this Comment On June 13, 2011, at 11:11 PM, TheDumbMoney wrote:

    DrHsu, yeah, you could argue WFC is quite undervalued, for example. I doubt that KO is undervalued though, at least it isn't by my DCF analysis, and that if I recall is the biggest equity holding. Of course my DCF analysis depends upon using a 10-to-12% discount rate for coast of equity, which is higher than Buffett would use (I think he uses the so-called risk-free rate, a 30-year Treasury, on any business he deems sufficiently moaty), so maybe he would say even that is undervalued.

  • Report this Comment On June 14, 2011, at 4:50 AM, dividendgrowth wrote:

    It's not only Berkshire Hathaway, most high quality large caps are trading at their cheapest in decades.

  • Report this Comment On June 14, 2011, at 1:49 PM, jekoslosky wrote:

    Both Berkshire and Apple could be suffering right now due to worry over how long the CEOs will be around. I believe both will succeed beyond their current leaders.

    That makes them both buys, in my book. I'm adding to my holdings in both this week.

    stocksnovice.blogspot.com

  • Report this Comment On June 17, 2011, at 1:02 PM, whyaduck1128 wrote:

    Could the folks at MF slobber and drool over the "Oracle of Omaha" just a little more? This reminds me of 13-year-old girls going bonkers over the latest (interchangeable and talentless) teen boy singer. Buffett is a fantastic investor, yes, but that does not mean he's infallible.

    I'm not convinced that Berkshire is the perfect investment, or that we should all worship at the altar of the Oracle. And just in case I'm wrong, yes, I have some Berkshire stock.

  • Report this Comment On June 20, 2011, at 8:54 AM, gudabg wrote:

    I don't understand. Net tangible asset for Berkshire is 108 B$. Value of BRK-A + BRK-B is 300 B$. So P/B is 3 not 1.1

    Where am I wrong?

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