Berkshire Hathaway Stock at Least 20% Undervalued

Source: HomeServicesAmerica

Every year, I value Berkshire Hathaway (NYSE: BRK-B  ) (NYSE: BRK-A  ) using the "two-column" approach (if you're not familiar with this approach, don't worry, I'll explain it). About a year ago, I found it to be at least 20% undervalued at $107 per B-share. Fast-forward to 2014, and the B-shares have advanced 8% to $116. So I figured it was time to sharpen up my pencil and re-estimate 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 Buffett 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.

Read on to see my math and assumptions. You're free to use this two-column-approach methodology to create your own valuation.

1. Investments per share
As of the end of 2013, Berkshire held $129,253 per A-share in investments (or about $86 per B-share). That's an increase of 14% during the year. The portfolio of investments includes debt and stock in quite a few companies, but the "big four" are American Express, Coca-Cola, IBM, and Wells Fargo. Most of these investments are liquid with reliable market prices. Thus, I simply value the investment portfolio at $86 per B-share.

2. Operating earnings per share
During 2013, Berkshire's operating businesses generated $9,116 per A-share in pre-tax earnings (or $6.08 per B-Share). This represents 13% growth over the previous year. So what's $6.08 per B-share worth? The S&P 500 trades at 20 times after-tax earnings, or 13 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 overpriced 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 $61 per B-share.

Foolish bottom line
If I sum up $86 per B-share in investments and $61 per B-share for the operating businesses, that gives me a grand total of $147 per B-share. With the stock trading at about $116 per B-share, it's more than 20% undervalued, even using a very conservative set of assumptions. 

The wisdom of Warren
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  • Report this Comment On March 06, 2014, at 11:09 PM, Funwithmon wrote:

    Hi - I get your calculations that this is an undervalued stock, but I don't get why it was referred to as an "outstanding" stock with the reports of 2013 returns of 18%. So, that's a fine number and everything, but in my hopeful mind, "outstanding" annual returns is a bigger number.

    I'm wondering about the stocks with 100% returns over two years, and etc. What word would you use to describe them?

    I think I just want to see a chart with columns labeled poor, good, outstanding and spectacular, just buy the spectacular ones and a few outstanding ones, you know, to be safe, and then eat a snack and then enjoy the rest of my day.

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