Tode on Tilson on Berkshire
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By Tode
March 16, 2007

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Let me begin by saying that Berkshire has always been one of the most misunderstood and under-appreciated companies on Wall Street. So in a way, it is nice to have an articulate guy like Whitney Tilson getting some face time on national TV and delivering a few sound bites about how cheap Berkshire's stock is, despite its being "one of the fastest growing large businesses in the world." Even if there is some hyperbole in what Whitney says, it also has an element of rough justice given our history of mistreatment.

The interviewer, by the way, was priceless. It was as if she has been told before the interview, "Hey, we are going to have a little fun today. We want you to do a parody of the typical airhead interviewer. You will have only three minutes, maybe enough time to interrupt your guest once or twice, so don't be firing any blanks. Each question must be carefully crafted to demonstrate to your audience that you have no clue whatsoever. I'm telling you, this will be hilarious."

Whitney starts by saying Berkshire had a spectacular year. She interrupts him with "but weren't their fourth quarter earnings down 30%?" And later on when Whitney notes that WEB's multi-year currency bet against the dollar had made profits of over $2 billion, she jumped in a second time and noted that the trade had lost money this last year.
Great stuff, and she pulled it off with a perfect dead-pan delivery. Bravo.

Now let me turn to Whitney.

He asserts: "The core operating businesses grew their earnings 38% last year, finishing a ten-year run of growing earnings per share of the operating businesses at 31.7% compounded. It's one of the fastest growing large businesses in the world."

Again, maybe we should all just sit quietly when Berkshire's virtues are exaggerated publicly, and accept it is long overdue reparations for past mistreatment by Wall Street. But I will go ahead and give my two cents worth anyway.

It is clear that Whitney is talking about the earnings in "Column Two" when he says that Berkshire's operating businesses are growing at 32% compounded for the last ten years. As discussed in several posts last week, this is, in my opinion, a very misleading thing to say, because Berkshire as a whole is not growing at anything approaching that rate.

I think there are much better metrics to guide us when assessing the overall growth rate of Berkshire.

1. Book Value.

This is still the metric that WEB leads with every year. Over the past 11 years, the growth rate has been 15.5% compounded ($14,425 in 1995; $70,281 in 2006).

2. Combined Two Columns Growth.

Simply add the two columns, after multiplying Column Two by whatever multiple you think those businesses in the aggregate deserve. If you use 10x, you start with $23,567 in 1995 and end with $116,886 in 2006, which computes to 15.7% compounded growth--very close to the book value growth.

If you think the businesses in Column Two are worth more, say 12x, the beginning value is $23,917 and ending value is $124,136, which gives you a growth rate of 16.2%. Not that huge a difference.

3. Assets Per Share

This metric gives another perspective which I believe is important to consider, because it reflects the leverage that WEB is adding to the balance sheet. The assets per share in 1995 were $21,667. In 2006 they were $161,134, which computes to 20.0% compounded growth. That is very impressive. Much of this is due to the addition of the utilities and finance businesses, which are financed by debt. In 1995, we had $1.50 of assets for every dollar of net worth. Today it is $2.30. I will not be surprised to see the ratio increase further in the years to come. We are still a long way from the kind of leverage GE has on its balance sheet, but clearly we have added significant leverage--the "safe variety" as WEB would say. And he wants to grow these areas more, so I believe the ratio will continue to creep up in the years to come.

So how fast is Berkshire Really growing? Over the last 11 years, assets at 20%, net worth about 15.5%, "Two Columns" around 16%. That's quite remarkable, especially for a company this large. But no matter how you slice or dice it, the business enterprise in its totality is not growing at anything close to 32%.

Whitney says Berkshire is easily worth $140K-150K per A share. That would be just over twice book value. (It also would be valuing Column Two at about $65K a share, which would be 18x pre-tax or about 28x after-tax.) Granted, there have been some times when Berkshire sold for twice book, but it's been a long, long time. I recognize that one could argue that if Berkshire is evolving into a GE-type balance sheet, why shouldn't it get a GE-type book multiple (over 3x). This makes for an interesting debate. In theory at least, as Column Two (the non-insurance businesses) keeps growing faster than Column One (investments held mostly by the insurance businesses), at some point the P/Book ratio "should" increase, assuming the businesses comprising Column Two continue to earn better than average returns on their invested capital.

But back in the real world, I think WEB would "say something" if the stock ever hit 2x book again during his lifetime. He does not want the stock to be trading in nosebleed territory, when his successors take over. He does not want his new partners paying way more than he and CM would pay for a share of the business--a price that reflects too many unhatched chickens. It's not that the chickens won't come--they almost certainly will. He just prefers that we pay as they arrive. Whitney is a very smart guy and I bet he would agree with me that if the stock got up to his asserted IV range, Charlie would start to twitch.

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