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Calculating BRK's Intrinsic Value
Board: Berkshire Hathaway

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By happ8714
March 9, 2007

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There are many ways to calculate IV. Our venerable Chairman seems to prefer column 1 and column 2 which at 10 times pre tax for non insurance earnings, roughly 15 X after tax, gives us a value of $116,850, say $117,000.

I prefer a float/earnings model which I calculated an IV of $131,300 which is $600 less than J Kish's Conservative IV at year end. Now I think my float/earnings model give a truer value than our leader's. However I have noted for a long time that BRK is strong buy at 80% of this IV $105,000; and a buy at 90% of this IV or $118,000. Voila 90% of IV is more or less the same value that Buffett's col 1 & 2 give to begin buying BRK.

(My $131,300 breaks down to $44,300 per share for non insurance, and $87,000 Insurance. This is an average of 17.5 X $3,900 after tax income, or $2,529 per share for non insurance.)

Another of many ways to calculate IV is put some multiple on BRK total "pro forma" earnings. This begs the question what is BRK "normalized" earnings today?

Let's add up the earnings.
1) Look thru -- Look through as I have calculated are $1,569 per share for 2007. I'm calling this $1,600. New investment will offset any decrease in earnings or increase in dividends.
2) Non insurance -- I used $3,900 m for my float/earning model but looking out quarter by quarter I got $4,100 m, or $2,650 per share. This is a 9.4% increase. Most of this increase is built in with full year from acquisitions and the acquisition that closes in January. I would think actual earnings would beat this estimate.
3) Investment - Investment income last year was $3,120 m last year. I'm estimating it at $3,600 m or $2,300 per share. The $900 m for the 4th quarter was multiplied by 4. In other words, this does not assume neither any natural increase in dividends nor any Equitas float money.
4) Capital Gains -- One of the problems with most models is ignoring capital gains. I can not remember a year when BRK did not have positive capital gains. Last year, reversing the Gillette gain, BRK had the smallest capital gains in 8 year. Over the last 5 years capital gains have averaged $981 m per share; over 6 years it is $918 m; over 7 years it has been $1,044 m.

I think $1,000 per share is a reasonable accrual going forward for capital gains.
5) Insurance -- BRK business is disasters. Now they have a large auto division, but it is the re-insurance that locates greatly. To say that this year insurance made an underwriting profit of $3,800 m and last year squeaked out $53 m is a mistake. Adjusting for disasters, i.e., taking out the disasters in 2005, give $3,453 m for 2005 and $3,838 m for 2006. In other words despite all the headlines, if there were no disasters both years underwriting profit went up 11%, which is still quite good.
IMO the way to handle insurance is take out disasters in years when they occur, and put them in years where they do not occur. I have been using $600 per share after taxes. That's $1.5 b before taxes.
Taking out $600 per share and using a 3 years average of underwriting profits before disasters give us $800 per share of underwriting profit. This $800 is a pro forma number obviously. But for the last 4 years BRK has produced underwriting profits.
6) Investing cash - The last piece of the puzzle is what would BRK look like if it invested all of its cash? Let's take buying something at 20 times earnings, a 5% cash yield. Now Warren often pays less, but let's assume he pay up for an investment using $37 billion. This produces $1,200 per share.

Now we know that he will keep some cash on hand, maybe as much as $10 b, but remember this is 2007 projection and there will be about $10 cash flow this year. Plus he could borrow some, so please no questions about bringing the cash balance to zero.

Adding these 6 items and we have "normalized" earnings of $9,550 per share. Last year at this time, doing this same exercise I got $8,200 per share.

What do you think these earnings would be worth? I say 15 times or $143,000. If you prefer a lower multiple, please feel free to use it.

Now I think one could argue that $143,000 is a reasonable IV for BRK. Naturally a value investor tries to buy under IV. At today's close of $108,990, that means BRK is selling for 11.4 forward earnings. Now that is quite a modest number in my opinion.

happ


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