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By gdefelice
March 15, 2005

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I did a post in early December of 2004 suggesting that 2004 was a Great Year. Really, the post turned out to be a comparison between Berkshire at year-end 1999 (when Buffett considered making repurchases at $45,000) and Q3 '04. I went through the Buffett method of calculating investments per share and pre-tax operating earnings per share. Here's that post.

After reading through this year's annual a few times now, I feel even more comfortable suggesting that Berkshire is as cheap now as it was then.

Before going on, I'd like to say that I feel that to date Gen Re has been a disappointment and earnings from Flight Services (and NetJet's in particular) have not materialized as expected. Of course, 9/11 was particularly hard on both of these business units. Nevertheless, and despite the disappointment, Berkshire's Intrinsic Value has greatly increased since year-end 1999.

At the end of 1999, float was $25.238 billion and as of year-end 2004 float is at $46.1 billion for an increase of 80%.

In 1999, investments were $73.57 billion or $48,344 per share.

At that time, the difference between the assets of the Financial products division and the liabilities was a net positive of $2 billion.

I'm going to adjust the 1999 figures and add this net asset to total "investments". With that $2 billion, total investments were $75.57 billion in 1999 or $49,650 per share.

In 1999, the pre-tax operating earnings from non-insurance businesses were generated from the following subsidiaries: Buffalo News, Flight Services, Home Furnishings, International Dairy Queen, Jewelry, Scott Fetzer Companies, See's Candies and Shoe Group. The total operating profit before tax for this set of subsidiaries was $704 million...or $463 per share.

It might be useful to consider that at the time, there were no earnings from Mid-American, as only the commitment to invest in Mid-American had been made in October of 1999 -- no money had been invested. As well, at the time, Buffett didn't consider any "earnings" from the Financial Products division to be worthy of being included within the non-insurance businesses I outlined above. (As of today, this is no longer true).

Fast forward to today. As I said before, float has nearly doubled.

Investments total about $103 billion or about $67,000 per share. However, I am going to make the adjustment I made above to factor in the current net value of the Financial Products investments, which are $9.6 billion. Adding $9.6 billion to $103 gets us to $112.5 billion or about $72,836 per share. This is just below a 50% increase from 1999. (This may be a faulty analysis but Buffett has shown the ability to consistently produce large returns from the trading portion of this division and imbedded in this number at the as yet unrealized gains from the currency investments. However, I think it makes some sense especially as this does not factor in the operating businesses now within this segment [Clayton, CORT and XTRA]). At least, that is not how I understand it.

For the calculation of pre-tax operating earnings from the non-insurance subsidiaries, I'm going to make an adjustment. I'm going to present MidAmerican on an operating earnings before tax basis.

Here are the major non-insurance operating subsidiaries/categories: Apparel, Building products, Finance and Financial products (which include the ongoing earnings from Clayton, CORT and XTRA and none of the trading or currency or other gains from the oddball pastimes of Buffett), Flight services, McLane Company, Retail, Shaw, Other businesses. The total pre-tax earnings from this group of businesses is $3.065 billion. Before going on, it is useful to remember that Flight services earned $225 million in 1999 and only $191 million in 2004. As well, the operating segment of Financial products included here earned only $584 million in 2004 but as much as $726 million just a few years ago.

MidAmerican earned $816 million before taxes and write-offs in 2004. Our economic interest in MidAmerican is about 84%. So, our pre-tax earnings for this subsidiary were about $685 million.

Add that $685 million to $3.065 billion above for a total of pre-tax operating earnings from non-insurance subsidiaries of $3.751 billion or $2440 per share versus $463 per share from 1999.

The non-insurance operating subsidiaries are earning more than 5.25 times (pre-tax) what they were earning just 5 years ago. This is with a woeful performance from Flight Services and doesn't include the fact that Clayton's earnings should be much larger next year. I think Clayton could earn $800 million pre-tax by itself next year.

An important consideration is the proper multiple to put on the pre-tax earnings of the non-insurance subs. Since these businesses appear to be superb businesses with the ability to earn substantial returns on tangible equity (as described by Buffett), it seems a reasonable fair-value for them might be 13 times pre-tax earnings.

So, in 1999, I figure net investments were $75.57 billion or $49,650 per share and since pre-tax per share earnings (from non-insurance subs.) were $463, if we put a 13 multiple on them, then the subsidiaries were worth just over $6 billion for a grand total of $81.57 billion or $53,593 per share.

Today, I figured net investments were $112.5 billion or $73,161 per share and since pre-tax per share earnings were $2440, if we put a 13 multiple on them, then the subsidiaries are now worth $31.7 billion for a grand total of $144.2 billion or $93,770 per share.

I realize that this number is not quite double what it was in 1999. However, I have left out a very, very significant piece of the puzzle, which I discussed in the other post. Namely, I didn't include any under-writing gains or, alternatively, any increased value of the insurance subsidiaries (our largest business) for future float growth they will produce. GEICO is far, far more valuable than it was in 1999 and so are BHRG and Other Primary. It might be fair to argue that Gen Re's value has not increased but you must consider that it's float is about 50% larger than it was in 1999. As well, every year we move away from 1998, I feel better that the future of Gen Re should be better than its recent past. Are these value increases worth another $16 billion, which would get us to about double where we were in 1999?

I think so. Float us up 80% from 5 years ago and earned insurance premiums are up 50%. The insurance subsidiaries now have much greater capacity for higher dollar underwriting gains (even if combined ratios do not improve...) simply because float is so much larger now. And, while growth prospects are not as good as they were in recent years, prospects for improved underwriting results from Gen Re appear likely. Recall, as well, that we earned over $1 billion in underwriting gains in the worst natural disaster year ever. Underwriting gains could have been $2 billion in a non-catastrophic year and, if you back out retro-contracts, over $2.5 billion. Gain's like this were simply not possible in 1999 -- the businesses just weren't this large.

As well, as discussed in the last post, Coke's value was over $11 billion in 1999 and it is under $8.5 billion today (and yet, its intrinsic value has increased each of the last 5 years). It is definitely much cheaper than it was then. American Express is just about at the same value as it was in 1999 and its IV has increased quite a lot since then. Before the P&G buyout, Gillette hadn't moved much either and our P&G gain will be included in the Q1's release.

All in all, again, I see Berkshire as a totally different monster than it was in 1999.

Should the dollar fall another 20% from where it ended the year, we'll tack on another $4 billion plus, we've got $40 billion in cash as a huge cushion.

I would be shocked if Berkshire weren't at least twice as intrinsically valuable as it was in 1999 by no later than the end of this year. I'd be shocked if it weren't already true.

I suspect that the insurance scandal is weighing heavily on the stock. Depending on how it breaks, it might provide either an amazing chance to buy Berkshire at levels below the relative value available in 1999 or this might be the last chance to pick up Berkshire for a song. The clock is ticking on this valuation.


gdefelice


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