Spring is a wonderful time of year: Birds sing and flowers bloom -- and Warren Buffett, chairman and CEO of Berkshire Hathaway
Today, Buffett is having trouble finding investment opportunities, his company is mired in AIG's accounting scandal, and there's the general thought that stocks will generate limited returns in the near future. With that in mind, I wondered whether Berkshire is a good investment at today's stock price. What follow are my calculations and thoughts.
What you pay
The market values Berkshire Hathaway at $128.6 billion, or $83,500 per Class A share and $2,785 per Class B share. Whew! That's big bucks for the price of entry.
To determine whether those prices reflect Berkshire's intrinsic value, here's a very crude estimate of the company's worth, using figures from its 2004 annual report.
| 12/31/2003 | 12/31/2004 | |
|---|---|---|
| Fixed Income Investments | $26.1 | $22.8 |
| Equity Investments | $35.3 | $37.7 |
| Other | $2.9 | $2.3 |
| MidAmerican Energy | $3.9 | $4.0 |
| Operating Businesses | $20.1 | $22.8 |
| Float | $44.2 | $46.1 |
| Notes Payable | ($9.1) | ($8.9) |
| Deferred Taxes | ($11.0) | ($12.2) |
| Value Estimate | $112.4 | $114.6 |
As you see, Berkshire trades for about $14 billion more than what it was theoretically worth five months ago. This simplified analysis makes three pretty conservative assumptions. First, everything except the operating businesses is marked to market. Since float is more valuable than cash, because it is growing and essentially cost-free, we could use considerably higher figures than $44.2 billion and $46.1 billion. After all, Berkshire is actually paid handsomely -- $1.5 billion in 2004 -- to hold float. Nonetheless, let's be conservative and stick with cash values.
Second, I've valued Berkshire's slew of operating businesses by multiplying their net income by 15 (i.e., assigning them a price-to-earnings ratio of 15). This is a reasonable number because Berkshire's businesses aren't fast growers by any stretch of the imagination. They do, however, throw off tons of cash, earn about a 21% return on net tangible assets, and are not capital intensive.
The last assumption I use is that Berkshire's deferred tax liability will come due at some point. I doubt the company's portfolio will be liquidated soon, but it bears noting that Buffett wished he had sold some of his stocks when they were overvalued. Not accounting for this liability, the value estimates would be as high as $123.4 billion and $126.8 billion for 2003 and 2004, respectively.
Trust me, I know this isn't a very technical estimate of value. Precision isn't the goal here. My estimate is certainly in the right ballpark -- one might say it's vaguely accurate rather than precisely wrong -- and I think my estimates, given their conservatism, are at the lower end of the valuation range. That's a good place for risk-averse investors.
What you get
I think most everyone is well aware that Berkshire is made up of insurers, operating businesses, and investments. But let's go one step further. The great managers who run these businesses get very little press. Everyone knows Buffett and Vice Chairman Charlie Munger. But how would you like to have Buffett and Munger, a couple of .400 hitters, serving as batting coaches to a bunch of .300 hitters? That's what you get with Berkshire. And whether they're selling insurance, energy, fractional ownership in airplanes, soft-serve ice cream, shoes, or jewelry, these world-class managers generate cash. The first thing you pay for when you buy Berkshire is a great lineup of managers who use very low-cost capital to create lots of value. That's a great recipe for success.
Berkshire's stable of investments is well-known, mainly because many investors excitedly watch to see which stocks will be added to the group. Recently, Anheuser-Busch
What you don't get
Let's go back to my estimate of value. Accounting for the deferred tax liability, new investors pay a 12% "Buffett premium" to purchase Berkshire. Excluding the tax liability, an investor is buying a stake in the great businesses that make up Berkshire and essentially getting Buffett for free. And remember, I think my estimate is very conservative. So, the market may actually be penalizing Berkshire stock right now because Buffett is running the company. That doesn't make sense. Buffett is the greatest investor of all time.
The market is assessing Berkshire based on two main factors. The first is size. As we all know, a conglomerate as big as Berkshire must make $10 billion deals to substantially affect its bottom line. That means buying companies about the size of Coach
This brings me to my second point, one that really hits home with me. I'll call it the "lemming principle" and say right off the bat that I'm guilty with a capital G. During the annual meeting, Munger argued that talented people are going into money management to become rich rather than going into science and engineering to directly affect our communities and economy. I am guilty because that's exactly what I want to do. I bailed out of engineering because the rewards for being above average in the stock market dwarf what I can make as an above-average engineer.
So, when I think about Munger's comment, relate it to my own experiences, and read this great post from The Motley Fool discussion boards, the significance really takes hold. Because there are so many fund managers with so much money combing the market for the slightest stock price inefficiency, great bargains are much more difficult to find these days. Not only are there fewer bargains, but the margin of safety and the window of opportunity to take advantage of them are shrinking. And, because Buffett has huge amounts of capital to invest, the future of the float looks dim. Just ask yourself, did Buffett get to purchase as big a stake in Budweiser as he wanted? So, maybe Berkshire doesn't deserve a Buffett premium today.
I don't buy it
That notion makes no sense to me. I'd rather take my chances with Buffett than with an index fund. His flexibility to make whatever investments he wants is alone worth the price of admission, especially given his access to the owners of great private businesses. Best of all, the market doesn't really seem to think he will do much with his $46.1 billion war chest. That's not a bet I would make.
I wanted to own Berkshire in early 2000 (when the Class A shares fell to almost $40,000), but I didn't take advantage of the opportunity because I was very happy with my portfolio. But at today's prices and in today's environment, I think Berkshire is a decent bargain that may generate market-beating returns. Of course, you could also keep your cash on the sidelines for now and scour the market for bargains flying under Buffett's radar -- sometimes it's nice to be the little guy -- in the meantime. For assistance on your journey, I recommend you make Philip Durell's Inside Valuenewsletter a part of your reading material. Philip's bargain recommendations are outperforming the market, and every issue includes lessons to help you value stocks on your own. Click here to take a free 30-day trial. It's risk-free and chock full of valuable information. Remember, Buffett's not the only one with great ideas.
Fool contributor David Meier does not own shares of any of the companies mentioned. Gap and Costco are recommendations of Motley Fool Stock Advisor. The Motley Fool has adisclosure policy.
