Intrinsic Value Examples From Charlie Munger

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Includes: BRK.A, BRK.B
by: Eric Sprague

Introduction

The 1997 to 1999 annual reports available at Wesco Financial show that Charlie Munger calculated intrinsic value for shareholders. This was done by adding a fraction of the "Deferred tax liabilities, relating to appreciation of investments" number from the Notes to Financial Statements to the "Total shareholders' equity" number from the balance sheet. Charlie Munger is also the Vice Chairman of Berkshire Hathaway (BRK.A, BRK.B).

Background

I recently finished reading Damn Right by Janet Lowe and it was packed with information including details on intrinsic value:

Just to keep everyone's thinking straight, Munger departs from the philosophy of Berkshire Hathaway and in the annual report he calculates Wesco's intrinsic value for shareholders.

[page 162]

Looking at Wesco's website, reports are made available from 1997 to 2009. Intrinsic value is calculated from 1997 to 1999. We'll go through these 3 years to look at the details.

1999 Details

A footnote on the first page of the 1999 letter to shareholders tells us the number of shares outstanding.

Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents.

We'll start by focusing on a key number from the balance sheet:

1,895,372,000 = 1999 Total shareholders' equity

Here is the balance sheet for reference.

Click to enlarge

The first paragraph in the Consolidated Balance Sheet and Related Discussion part of the letter explains book value.

As indicated in the accompanying financial statements, Wesco's net worth decreased, as accountants compute it under their conventions, to $1.90 billion ($266 per Wesco share) at year-end 1999 from $2.22 billion ($312 per Wesco share) at yearend 1998.

The Notes to Financial Statements give us a "loan" number.

705,343,000 = 1999 Deferred tax liabilities, relating to appreciation of investments

Here is the note for income taxes.

Click to enlarge

Mr. Munger talks about the impact of this interest-free "loan" number.

However, some day, perhaps soon, major parts of the interest-free "loan" must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $99 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $99 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free "loan" was probably about $20 per Wesco share at yearend 1999.

99 = 705,343,000/7,119,807

Next we get to the intrinsic value explanation.

Thus, if the value of the advantage from the interest-free tax-deferral "loan" was $20 per Wesco share at yearend 1999, and after-tax liquidating value was then about $266 per share (figures that seem rational to the writer), Wesco's intrinsic value per share would become about $286 per share at yearend 1999, down 16% from intrinsic value as guessed in a similar calculation at the end of 1998.

1999 Summary

The details behind the $266 per share net worth number are as follows:

$266 = 1,895,372,000/7,119,807

The details behind the $99 per share interest-free "loan" from the government are as follows:

$99 = 705,343,000/7,119,807

Mr. Munger says the present value of this "loan" is about $20 per share.

$286 is the estimated intrinsic value per share and it is simply the $266 above plus the $20 above.

Mr. Munger then explains that the Berkshire Hathaway intrinsic value is different.

Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, been widening in favor of Berkshire Hathaway.

All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations.

1998 Details

Again, we have 7,119,807 shares.

We'll start by focusing on a key number from the balance sheet:

2,223,756,000 = 1998 Total shareholders' equity

The above number can be seen by going to the 1998 column of the 1999 balance sheet in the 1999 Details section.

The first paragraph in the Consolidated Balance Sheet and Related Discussion part of the letter explains book value.

As indicated in the accompanying financial statements, Wesco's net worth increased, as accountants compute it under their conventions, to $2.22 billion ($312 per Wesco share) at yearend 1998 from $1.76 billion ($248 per Wesco share) at yearend 1997.

The Notes to Financial Statements give us the "loan" number.

906,736,000 = 1998 Deferred tax liabilities, relating to appreciation of investments

The above number can be seen by going to the 1998 column of the Income Taxes note in the 1999 Details section.

Mr. Munger talks about the impact of this interest-free "loan" number.

However, some day, perhaps soon, major parts of the interest-free "loan'' must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $127 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $127 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free ""loan'' was probably about $30 per Wesco share at yearend 1998.

127 = 906,736,000/7,119,807

Next we get the intrinsic value explanation.

Thus, if the value of the advantage from the interest-free tax-deferral "loan'' present was $30 per Wesco share at yearend 1998, and after-tax liquidating value was then about $312 per share (figures that seem rational to the writer), Wesco's intrinsic value per share would become about $342 per share at yearend 1998, up 25% from intrinsic value as guessed in a similar calculation at the end of 1997.

1998 Summary

The details behind the $312 per share net worth number are as follows:

$312 = 2,223,756,000/7,119,807

The details behind the $127 per share interest-free "loan" from the government are as follows:

$127 = 906,376,000/7,119,807

Mr. Munger says the present value of this "loan" is about $30 per share.

$342 is the estimated intrinsic value per share and it is simply the $312 above plus the $30 above.

1997 Details

Again, we have 7,119,807 shares.

We'll start by focusing on a key number from the balance sheet:

1,764,292,000 = 1997 Total shareholders' equity

Here is the balance sheet for reference.

Click to enlarge

The first paragraph in the Consolidated Balance Sheet and Related Discussion part of the letter explains book value.

As indicated in the accompanying financial statements, Wesco's net worth increased, as accountants compute it under their conventions, to $1.76 billion ($248 per Wesco share) at yearend 1997 from $1.25 billion ($176 per Wesco share) at year-end 1996.

The Notes to Financial Statements give us the "loan" number.

729,012,000 = 1997 Deferred tax liabilities, relating to appreciation of investments

Here is the note for income taxes.

Click to enlarge

Mr. Munger talks about the impact of the interest-free "loan" number.

However, some day, perhaps soon, major parts of the interest-free "loan'' must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $102 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $102 per Wesco share. In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free "loan'' was probably about $25 per Wesco share at yearend 1997.

102 = 729,012,000/7,119,807

Next we get the intrinsic value explanation.

Thus, if the value of the advantage from the interest-free tax-deferral "loan'' present was $25 per Wesco share at yearend 1997, and after-tax liquidating value was then about $248 per share (figures that seem rational to the writer), Wesco's intrinsic value per share would become about $273 per share at yearend 1997, up 39% from intrinsic value as guessed in a similar calculation at the end of 1996.

1997 Summary

The details behind the $273 per share net worth number are as follows:

$248 = 1,764,292,000/7,119,807

The details behind the $102 per share interest-free "loan" from the government are as follows:

$102 = 729,012,000/7,119,807

Mr. Munger says the present value of this "loan" is about $25 per share.

$273 is the estimated intrinsic value per share and it is simply the $248 above plus the $25 above.

Conclusion

It is interesting to see how Mr. Munger values this particular company. However, we have to be careful about making assumptions about his methods for valuing other companies. He said Berkshire is a different animal - this same valuation logic wouldn't work for them.

Disclosure: I am long BRK.A, BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Any material in this article should not be relied on as a formal investment recommendation.