In times of market turmoil, it's always interesting when a company insider -- either an executive or director -- buys a large amount of stock. And it's doubly interesting when a big insider buy occurs at Berkshire Hathaway (BRK.A -0.36%) (BRK.B -0.35%), Warren Buffett's massive conglomerate.
It has rarely been a bad idea to purchase more shares of Berkshire, given that the company has compounded value at a stunning 19.8% rate over 57 years through 2022. But is this insider purchase an indication the conglomerate's shares are especially cheap, or was the purchase more of a requirement?
Abel buys $25 million, an increase of 30%
Last week, it was reported that Greg Abel, who currently heads the Berkshire Hathaway Energy division and is also a vice chairman of the company, purchased $24.6 million in Berkshire stock, increasing his stake in the Buffett-led giant by about 30%.
For those who haven't been following Berkshire closely over the past few years, Abel is one of a handful of key Berkshire executives outside of Buffett and partner Charlie Munger. In 2018, Abel was named vice chairman, a title on par with Munger, along with Ajit Jain, who heads Berkshire's insurance operations. At the outset of the pandemic in May 2020, Buffett hosted Berkshire's annual meeting in an empty auditorium, with only Abel by his side. And one year later, Buffett confirmed that if something were to happen to him, it would be Abel who would succeed Buffett in running Berkshire's sprawling operations.
While some may have raised an eyebrow at Abel increasing his personal bet on Berkshire shares by 30%, there may be another reason Buffett's would-be successor bought shares.
A new requirement
In this year's proxy statement, Buffett added a new stipulation for Berkshire's board of directors. The prior qualifications included somewhat amorphous and qualitative measures, including "business savvy," "high integrity," and "deep genuine interest in Berkshire."
However, this year, Buffett added another more quantitative criteria: All directors must have a "significant investment in Berkshire shares relative to their resources for at least three years."
Abel himself had just netted a windfall from the sale of his shares of Berkshire Hathaway Energy (BHE). While Berkshire counts BHE as one of its subsidiaries, it doesn't actually own 100% of BHE but rather 92% of the company. Last year, Abel actually sold the 1% of BHE he owned back to Berkshire for $870 million.
Needless to say, Abel's net worth greatly increased, but his exposure to Berkshire's businesses declined as a result of the sale. With Abel the heir apparent to the CEO role and a board member, he likely needed to increase his stake to meet Buffett's new guidelines.
Warren Buffett added a new shareholding requirement for Berkshire directors. Image source: The Motley Fool.
But Berkshire is likely a buy anyway
While Abel certainly was looking to increase his stake, there were likely no hard and fast rules as to when and how to increase that stake. Of note, Abel bought shares during the market swoon in reaction to the recent regional banking crisis. Berkshire's stock declined in the mid-single digits along with the market as that crisis unfolded, so Abel's average buy of A shares was made near $447,000, about 5% off Berkshire's recent highs.
It's rarely a bad time to buy Berkshire, but were shares especially cheap then?
Valuing Berkshire today
Berkshire is a bit hard to value, as it has several different businesses encompassing insurance, railroads, utilities, manufacturing, industrials, and other businesses. The value is also skewed higher by Berkshire's giant equity portfolio into which Buffett and his team invest the insurance float perpetually coming into the company.
Ex-hedge fund manager Whitney Tilson has a method for calculating the intrinsic value of Berkshire that is relatively simple and close to how I would think about it as well.
Basically, the method separates out the operating businesses from the cash and stock investments but with one caveat: Since the insurance subsidiaries incorporate the dividend income from Berkshire's equity portfolio as part of the insurance income, Tilson doesn't count the insurance income as part of Berkshire's operating income but rather replaces the insurance profit with the average underwriting profit over the past decade, which is $1.4 billion. By subtracting the investment income and underwriting loss in 2022 and replacing it with $1.4 billion in profits, Tilson calculates an "underlying" Berkshire operating profit of $28.5 billion in 2022. Tilson then puts an 11 multiple on those pre-tax operating earnings to value the operating businesses.
Tilson then values Berkshire's excess cash and its stock investments at face value. These totaled $490.6 billion at the end of 2022. Tilson then adjusts the equity portfolio for the small 3.6% gain the market has made in 2022, adjusting that figure up to $501.7 billion.
Using 1.46 million shares, Tilson derives a value of $562,000 per A share and $375 per B share, around a market cap of $820 billion and about 22% above today's share price.
However, I'd make a few adjustments to Tilson's estimates. First, the stock portfolio currently has a lot of capital gains tax liabilities associated with Buffett's massive gains in stocks that Berkshire has held for years but not yet sold. As of Dec. 31, those deferred capital gains taxes totaled about $41.1 billion. In addition, Tilson also includes about $3.6 billion in cash at the railroad, utilities, and energy division. However, I'd probably ignore that as "extra" cash, as those divisions run with a lot of net debt tied to their assets, and that cash is probably used to run those debt-heavy businesses and not available for deployment.
With those adjustments, Tilson's method would yield a market cap of around $775 billion, still about 17% higher than today's market price.
But Berkshire still may be worth more than that
On the other hand, it's also likely Tilson's 11 multiple for the operating businesses is probably conservative. After all, the major U.S. railroads tend to trade between a mid-teens to high-20s price-to-earnings (P/E) ratio. Meanwhile, The Utilities Select Sector SPDR Fund, an exchange-traded fund (ETF) that tracks the utility sector, trades at an average P/E ratio of 22.8. Berkshire also has another category that it calls "other controlled businesses." A lot of that is in industrials, such as Marmon and Precision Castparts. The industrial sector as measured by the Industrial Select Sector SPDR Fund trades at an average P/E ratio of 20.8.
So, while insurance and consumer-facing businesses trade at relatively low multiples today, a majority of Berkshire's controlled businesses are in industries that should likely garner a higher multiple of operating earnings than 11.
As proof Berkshire may be materially undervalued, investors should also look to whether or not Berkshire is repurchasing stock. The answer is yes; Berkshire has consistently been repurchasing its own shares over the past few years. In 2022, the company retired 1.2% of shares outstanding and was a buyer of its own stock through the fourth quarter as well, with repurchases occurring in each of the last three months.
Buffett and his team likely have a rigorous method for calculating the intrinsic value of Berkshire, and Buffett wouldn't be repurchasing stock if he didn't think shares were undervalued to some extent. Therefore, this also seems to confirm Berkshire stock may be a steal at these prices.
Follow Abel into Berkshire
While Abel's purchase of Berkshire may be the result of new requirements for directors and especially the future Berkshire CEO, shares still look like a good value today by several measures. While Berkshire probably won't compound value at 19.8% per year going forward, as it's far too large now to grow that fast, it's a safe stock that has a good shot at outperforming the market in general. Its current undervaluation certainly bolsters the case for including it in anyone's portfolio today.
