About a year ago, I attempted to value Berkshire Hathaway (NYSE:BRK-B), and I found it to be at least 20% undervalued at $82 per B-share. Fast forward just over a year, and the B-shares have advanced 30% to almost $107. So, I figured it was time to sharpen up my pencil and reestimate the value.
My conclusion: It is just as undervalued, even at today's higher prices.
My valuation approach
Berkshire is a huge company, and notoriously difficult to value. Fortunately, Warren provides a pretty good framework for evaluating the intrinsic value. He laid it all out in his 2010 letter to shareholders. Basically, the value of Berkshire Hathaway shares comes down to two quantitative factors:
- Investments per share
- Operating earnings per share
I've shown my math (and assumptions) below, and you're free to use this methodology, also known as the two-column approach, to create your own valuation.
1. Investments per share
As of the end of 2012, Berkshire held $113,786 per A-share in investments (or about $76 per B-share). That's an increase of 16% during the year. The portfolio of investments includes debt and stock in quite a few companies, but the "big four" are American Express (NYSE:AXP), Coca-Cola (NYSE:KO), IBM (NYSE:IBM), and Well Fargo (NYSE:WFC). Most of these investments are liquid with reliable market prices. Thus, I simply value the investment portfolio at $76 per B-share.
2. Operating earnings per share
During 2012, Berkshire's operating businesses generated $8,085 per A-share in pre-tax earnings (or $5.39 per B-Share). This represents 16% growth over the previous year. So what's $5.39 per B-share worth? The S&P 500 trades at 18 times after-tax earnings, or 12 times pre-tax earnings if you assume a 33% tax rate. Some might argue that since Berkshire's collection of businesses are higher-quality than the index, they deserve a premium. Some might also argue that the index is over-priced at the moment. I won't delve into that debate, which is highly subjective by nature. I'll just be conservative and assume Berkshire's operating businesses are worth at least 10 times pre-tax earnings, or $54 per B-share.
Foolish bottom line
If I sum up $76 per B-share in investments and $54 per B-share for the operating businesses, that gives me a grand total of $130 per B-share. With the stock trading at about $107 per B-share, it's still about 20% undervalued, even using a very conservative set of assumptions.
Heading to Omaha
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