Buffett's Berkshire Is Still 20% Undervalued

About a year ago, I attempted to value Berkshire Hathaway (NYSE: BRK-B  ) , and I found it to be at least 20% undervalued at $82 per B-share. Fast forward just over a year, and the B-shares have advanced 30% to almost $107. So, I figured it was time to sharpen up my pencil and reestimate the value.

My conclusion: It is just as undervalued, even at today's higher prices.

My valuation approach
Berkshire is a huge company, and notoriously difficult to value. Fortunately, Warren provides a pretty good framework for evaluating the intrinsic value. He laid it all out in his 2010 letter to shareholders. Basically, the value of Berkshire Hathaway shares comes down to two quantitative factors:

  1. Investments per share
  2. Operating earnings per share

I've shown my math (and assumptions) below, and you're free to use this methodology, also known as the two-column approach, to create your own valuation.

1. Investments per share
As of the end of 2012, Berkshire held $113,786 per A-share in investments (or about $76 per B-share). That's an increase of 16% during the year. The portfolio of investments includes debt and stock in quite a few companies, but the "big four" are American Express (NYSE: AXP  ) , Coca-Cola (NYSE: KO  ) , IBM (NYSE: IBM  ) , and Well Fargo (NYSE: WFC  ) . Most of these investments are liquid with reliable market prices. Thus, I simply value the investment portfolio at $76 per B-share.

2. Operating earnings per share
During 2012, Berkshire's operating businesses generated $8,085 per A-share in pre-tax earnings (or $5.39 per B-Share). This represents 16% growth over the previous year. So what's $5.39 per B-share worth? The S&P 500 trades at 18 times after-tax earnings, or 12 times pre-tax earnings if you assume a 33% tax rate. Some might argue that since Berkshire's collection of businesses are higher-quality than the index, they deserve a premium. Some might also argue that the index is over-priced at the moment. I won't delve into that debate, which is highly subjective by nature. I'll just be conservative and assume Berkshire's operating businesses are worth at least 10 times pre-tax earnings, or $54 per B-share.

Foolish bottom line
If I sum up $76 per B-share in investments and $54 per B-share for the operating businesses, that gives me a grand total of $130 per B-share. With the stock trading at about $107 per B-share, it's still about 20% undervalued, even using a very conservative set of assumptions. 

Heading to Omaha
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Read/Post Comments (8) | Recommend This Article (12)

Comments from our Foolish Readers

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  • Report this Comment On May 02, 2013, at 1:33 PM, Seanickson wrote:

    I dont think its a conservative set of assumptions. Berkshires equity investments should be discounted by maybe 15% or so because although they are long term investments at some point in the future they will be sold and incur taxes of 35% and in the meantime dividends are taxed at 10%. I think its reasonable to exclude all underwriting earnings as i think indefinite cost free float is a good enough outcome to hope for. Berkshire earned close to $12 billion excluding underwriting gains last year and had look through earnings of about $3.4 billion(after about a 15% haircut). $15.4 billion at 15x earnings would be about $231 billion (93.33/B share). However berkshire does have about $25 billion in cash( half of this tied up in the heinz acquisition now) and equivalents above whats needed for insurance reasons generating only a pittance and about $15 billion in other investments(warrants,etc.) not generating income. Its a little aggressive but fairly reasonable to add these back into the valuation which would bring the total b share valuation up to about $109.50, only slightly above todays levels. The main difference is how investments are counted, i think its better to account for income instead of investments per share(especially considering the haircut that would be necessary due to taxes).

  • Report this Comment On May 02, 2013, at 3:17 PM, jjf3851 wrote:

    How are dividends paid by long-term holdings handled in this estimate? Are they baked into the $113,786 / share value? Or should the dividends be valued with a multiple, like the Operating Earnings?

  • Report this Comment On May 03, 2013, at 11:45 AM, Mega wrote:

    Seanickson,

    I agree with some of your adjustments. But on the other hand I think the float is worth something. I wouldn't pay much above book value for an independent National Indemnity or General Re, but I'd pay well above book value for GEICO because they've built a strong consumer brand, that will drive underwriting returns for decades.

    Also a 13x multiple on the operating businesses sounds more fair to me than 10x. So after all my adjustments I'm probably back to $130 or so.

  • Report this Comment On May 03, 2013, at 1:14 PM, TMFWillSommers wrote:

    Hi Seannickson -

    Thanks for reading the article and providing a thoughtful response. It looks like we're using different valuation methods, which is fine -- each investor is entitled to their own approach. I happen to like the two-column approach because it makes sense to me, is very simple, and of course, that's how WEB thinks about it.

    Other than using different methods, our only point of difference seems to be valuing the investments with regard to taxes. You could be right on taking a haircut. I choose not to because most of the positions with the largest tax bill (e.g. KO, AXP) will never be sold. I don't think that tax bill will every be paid. Also, why are you using a 35% rate? Perhaps, this is my lack of knowledge of corporate tax policy, but I'd assume any sales (which I don't will happen) will be taxed at the long-term cap gains rate.

    Fool on,

    Brendan

  • Report this Comment On May 03, 2013, at 1:16 PM, TMFWillSommers wrote:

    Hi jif3851

    Dividends from investments are baked into the $114k/A-share or $76/B-share value. No need to apply a multiply.

    Regards,

    Brendan

  • Report this Comment On May 03, 2013, at 2:44 PM, jjf3851 wrote:

    TMFWillSommers,

    Thanks for the clarification.

    Jeremy

  • Report this Comment On May 03, 2013, at 5:47 PM, Seanickson wrote:

    TMFWillSommers,

    Theres no doubt these positions have extraordinarily long durations. I think the main reason to discount investments per share is because Berkshire has to pay a 10% tax on any dividends it receives. As far as the 35% tax rate, Berkshire will have to treat any capital gains as ordinary income and subject to the 35% rate, probably much of the reason why he didn't sell coca cola when it was trading at 40-50x earnings.

  • Report this Comment On May 03, 2013, at 6:03 PM, Seanickson wrote:

    oh and the float is definitely worth a lot. Although, I decided to exclude insurance underwriting, the float is certainly not valueless. Its the $73 billion in float that makes many of Berkshire's investments possible. And it may be that this is too conservative an assumption. In whitney tilson's analysis he uses half of normalized insurance earnings, that may be more reasonable. I try to use pretty conservative assumptions, but its definitely possible to be too conservative as well.

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