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Berkshire Hathaway
That Illusive Intrinsic Value

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By mungofitch
August 10, 2009

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I spend a lot of time pondering intrinsic value (IV), and the myriad ways of estimating it.

One confounding factor is market valuations; they don't really matter, but it is the conventional way of valuing Berkshire's equity portfolio  and we tend not to question this approach. Obviously it overestimates IV at times of broad market over-valuation and vice versa. These effects average out over the long run, but distort the short run. It's in the short run that we have to make investment decisions.

So, my thought is this: If you were to estimate the intrinsic value of Berkshire by adding up your best well-informed estimates of the medium-to-long view intrinsic value estimates of all its portfolio companies public and private, rather than using market valuations, do you think the intrinsic  value of Berkshire is higher, lower, or around the same as it was in  late 2007 when the market price of Berkshire stock was so memorably high?

My thought is that true intrinsic value has changed very little. Market prices are obviously much lower, but that doesn't matter at all.

So, what are the key drivers of true IV in either direction?

To the down side--- The aggregate future earnings power of the franchises of several subsidiaries and investors is truly lower due to the market displacement and lower anticipated aggregate profits in the next 25 years. I think that many will resume their old growth slopes, but at a lower parallel level after  a one-time several-year modest displacement downward. Think of it as four really, really bad hurricane seasons in a row: no real change in the operation of the machine, just a one-time kink downward.

To the up side--- Offsetting this is simply the fact of another 1.7 years of earnings since November or December of 2007, plus the conversion of many dollars of "2007 cash" with "2007 IV" of one dollar each into 2009 investments with clearly higher intrinsic values. Goldman would be a prime example.

So, my contention would be that these factors are of very roughly comparable orders of magnitude, so true intrinsic value hasn't really changed much. It was probably a bit lower than it seemed back then, and probably a big higher than it seems now. Thus, to a first approximation we can think of the meltdown as a  roughly one to two year flat spot in the long run unknowable "true"  intrinsic value curve, and the IV about the same as it was in late 2007.

Thoughts?

�You may be wondering why I raise this issue. As in 2007, I believe that there will arrive a market price at which lightening up on my position will make sense. Last time around I thought the price was getting rich and started selling at $132,200 and had sold about half my total position when the price hit $147,500. So, having backed up the truck (and borrowed another truck to fill up too), I have begun to think about the future---at what price would lightening up a bit become as sensible an alternative as holding? If intrinsic value is largely unchanged since the last peak, then there is no reason for me to use a markedly different set of milestones next time.

Of course, a lot has happened to the stock, the company, and the world since then. But in the end, just like those innocent days of yore, I don't want to hold a large quantity of overvalued Berkshire stock if it happens again.

Jim

PS: One nice thing about this whole crisis. At least we don't hear much nagging any more from folks screaming about the huge useless cash hoard. From a post of mine in Dec 2007 with the S&P at 1472, from whence it went on to drop -54.7%: I think a "cash his king" moment will probably come around soon enough. We're not anywhere near it yet, by my reckoning. Maybe dollar crashes, emergency raising of interest rates to defend the dollar, credit crunch that makes this summer look like a passing cloud on a beautiful summer's day... No, I don't think it will happen. Even stranger things will.

Ha! Too bad I wasn't reading more carefully what I was writing.