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Every year, I value Berkshire Hathaway (NYSE:BRK-B) (NYSE:BRK-A) using the "two-column" approach (if you're not familiar with this approach, don't worry, I'll explain it). About a year ago, I found it to be at least 20% undervalued at $116 per B-share. Fast-forward to 2015, and the B-shares have advanced 22% to $142. So I figured it was time to sharpen up my pencil and reestimate the value.
My conclusion: The stock 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 Buffett 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
Read on to see my math and assumptions, and feel free to use this two-column methodology to create your own valuation.
1. Investments per share
As of the end of 2013, Berkshire held $140,123 per A-share in investments (about $93 per B-share). That was an increase of 8% during the year. The portfolio of investments includes debt and stock in quite a few companies, but the "big four" are American Express, Coca-Cola, IBM, and Wells Fargo. Most of these investments are liquid with reliable market prices. Thus, I simply value the investment portfolio at $93 per B-share.
2. Operating earnings per share
During 2014, Berkshire's operating businesses generated $10,847 per A-share in pre-tax earnings (or $7.23 per B-share). This represented 19% growth over the previous year.
So, what is $7.23 in pre-tax earnings per B-share worth? The S&P 500 trades at 20 times after-tax earnings, or 13 times pre-tax earnings if you assume a 33% tax rate. Some might argue that since Berkshire's collection of businesses are of higher quality than the index's, they deserve a premium. Some might also argue the index is overpriced 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 $72 per B-share.
If I sum up $93 per B-share in investments and $72 per B-share for the operating businesses, that gives me a grand total of $165 per B-share. That's 16% more than the current trading price of $142 per B-share. That tells me Berkshire Hathaway still looks attractive, even if I calculate the value with a very conservative set of assumptions.