Chart 1 below tracks Berkshire's "Adjusted Munger Value" quarterly since 1996 based on a simple method Charlie Munger referred to in his 1999 letter to Wesco shareholders. Charlie's method was simply book value plus one fifth of deferred taxes. Munger mentioned that each dollar of book value was much more valuable at Berkshire than a similar dollar at Wesco, but he did not say how much more valuable.
Munger explained how deferred tax could be thought of as an interest-free loan from the government that needed to be "repaid" only if Wesco sold investments and realised gains. Munger described his method as a guess but he did not explain fully why he thought one fifth was the right proportion.
So, Chart 1 tracks Berkshire's book value plus one fifth of float and deferred taxes, and multiplies the result by a premium that gets smaller as Berkshire grows relative to total US GDP. We call the resulting figure "Adjusted Munger Value" or AMV.
AMV matches pretty well with market price since 1996 showing four periods of over-valuation of 20% or more and five periods of under-valuation of 15% or more.
But there are those unanswered questions about how much a dollar of book value is really worth at Berkshire, and how much value accrues to shareholders from float and deferred taxes. So here is another approach.
Another Approach: Using Free Money
The point here is that Berkshire's $442bn of assets are partly funded by $49bn of deferred taxes, $73bn of insurance float and $122bn of other liabilities which are deducted to give book value of $198bn. This is correct accounting but does not reveal the underlying economics. Until they are "paid back", the deferred taxes and insurance float are earning returns for Berkshire. And the longer they earn money for Berkshire, the more they are worth to Berkshire's shareholders. (If you could get an interest free loan from your bank of a hundred thousand dollars repayable in a hundred years' time, how much would that hundred thousand dollars be worth to you and how much would it be worth to your bank?)
So it is really important to estimate how long Berkshire gets to use the deferred taxes and insurance float.
Berkshire's deferred tax liability arises mostly from unrealised gains on its investments and other property. The liability represents the tax that Berkshire would have to pay if it sold those assets. But so long as Berkshire does not sell, there is no tax to pay and Berkshire can leave it all invested in income-producing assets.
Buffett's preferred holding period is "forever" and Berkshire's deferred tax liability has grown more than eightfold over the past seventeen years. Nevertheless, Berkshire does occasionally need to sell assets, and the amount of deferred tax also changes with fluctuations in the prices of the stocks Berkshire owns. I guess that perhaps 85% can be considered very long-term funds.
The growth of insurance float has been much more stable but could yet dip in a bad year. Insurance float represents premiums paid to Berkshire by its customers that Berkshire expects to pay out later to settle claims. Some claims get settled quickly, but provided the overall level of float does not fall, Berkshire gains from investing billions of dollars at a zero cost of capital.
In fact, Berkshire's insurance subsidiaries make an underwriting profit most years. That means they get paid to hold the float, giving a cost of capital even less than zero! Buffett said in the latest annual report that he expected some increase in float in 2013 but that further gains would be tough to achieve. However, if there was any decline in float in the future, Buffett expected it would be very gradual.
So Berkshire should get to use the float for a long time.
Buffett also pointed out that the $73bn of float came at a "price" of $16bn of goodwill that is included in book value as an asset. So we should perhaps make a corresponding downwards adjustment here but let us keep things simple and guess that 85% of float can also be considered long term funds. (By counting only 85% of float and deferred taxes we are already deducting $18bn. A further deduction for the $16bn of goodwill would reduce the calculated value of Berkshire by a bit more than 4%.)
Sustainable Assets Long Term - SALT
Chart 2 below plots the sum of equity plus 85% of float and deferred taxes against market price, a measure we call SALT.
There is a strong correlation between SALT and market price (R2 = 0.88) that I think is more than just coincidence. Berkshire's equity, together with 85% of its float and deferred taxes, can all be thought of as very long-term, non-interest bearing capital available for Berkshire to invest in what might be termed Sustainable Assets Long-Term or SALT. So long as Berkshire can deploy this capital at average rates of return, each dollar invested has a dollar of economic value.
This greatly simplifies the valuation. We do not need to guess what an average rate of return should be, nor make a host of other estimates that are prone to error. Instead we just need to think about Berkshire's businesses and investments. Can they do averagely well in future?
One point to bear in mind is that $49bn of Berkshire's assets are cash or equivalents earning low returns in US Treasury bonds. We have already set aside $18bn, in case of a bad year for insurance pay-outs, by counting only 85% of float and deferred taxes. But the other $31bn of cash, waiting to be deployed at above-average rates in the next acquisition, is a chunk of SALT currently earning well below average. (But how little can $31bn of cash be worth?)
So what do you think? Is Berkshire's array of above average businesses likely to prosper averagely well in the future? (Including the "…eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies.") Are they worth their SALT? If so, Thursday's closing price of $117.07 for the B shares ($175,441 for the A's) would seem to indicate that Berkshire was priced close to intrinsic value. And if Berkshire's businesses continue to beat the average, we would then have a margin of safety provided by the prospect of above-average future growth. That is what I think.