Tilson Explains the Increase in Berkshire Hathaway's Intrinsic Value Estimate

Morningstar recently interviewed T2 Partners Founder Whitney Tilson regarding his views on Berkshire Hathaway’s (BRK.A) intrinsic value. Mr. Tilson has increased his estimate of Berkshire’s intrinsic value from $110,000 to the mid $130,000 range due to a recovery in the market value of Berkshire’s investment holdings:

Today, Berkshire’s stock portfolio has rallied, the outlook for the economy and so forth, so that’s reflected now in a higher estimate of intrinsic value, in the mid-$130,000 range. The stock’s just above $100,000, so we think you’re buying a $0.75 dollar, 25% discount to intrinsic value [for] the world’s strongest balance sheet run by the world’s greatest capital allocator with decent growth prospects going forward. So it’s just the kind of safe, conservative stock–you sleep well at night–in an environment where we’re nervous.

Mr. Tilson is asked about his valuation methodology for Berkshire Hathaway:

Berkshire is a very large, complex conglomerate, but in valuing it, it’s actually fairly simple. You have cash and investments that you value at market-to-market. Cash is worth cash. The stocks are worth whatever the stock price is.

Then you have 75 operating businesses that are generating substantial earnings. You take the cash and investments, put a multiple on the earnings, and just add the two together.

This is a variation of the two-column valuation method that Warren Buffett has implicitly endorsed in his annual letters. The result of using this method is that the intrinsic value estimate is very sensitive to market quotations. This has benefits and limitations. By anchoring the intrinsic value estimate to market prices of Berkshire’s investments, there is an element of conservatism when market prices decline, but also a potential for an overly aggressive estimate if market prices of investments rise rapidly.

I found Mr. Tilson’s comments regarding the valuation of the operating businesses very interesting. It seems that he was using a 12 times multiple on pre-tax earnings in 2007 but is using a 8 times multiple today. Along with the decline in market prices for Berkshire’s investments since 2007, the contraction in the earnings multiple for the operating businesses resulted in lowering his valuation:

The main reason our intrinsic value estimate declined is we stopped putting a 12 multiple, which was a fair multiple back when the market was doing OK. The average company in the S&P 500, we were applying a market multiple.

Well, today the market multiple’s a lot lower, so we’re now applying an eight multiple to pre-tax earnings, not a 12 multiple. That brings the intrinsic value down substantially, but we try and be conservative.

This strikes me as well justified. If the environment in which an investor can purchase private and public companies has changed, this must be reflected in the intrinsic value of a holding company such as Berkshire Hathaway as well. Otherwise, the valuation ignores the principle of opportunity cost. It makes little sense to value Berkshire’s operating companies at an earnings multiple far higher than the valuation these companies would command in the market for a private buyer today.

My view is that multiple models should be used to arrive at intrinsic value estimates whenever possible. In addition to the two-column approach, many analysts have used “float-based” valuations to come up with intrinsic value estimates. These float-based models attempt to arrive at a present value for cash flows that can be expected from earnings on Berkshire’s large insurance float over long periods of time. The valuation of the operating companies is then added to come up with an intrinsic value estimate.

The float-based model was discussed here in February in more detail. In general, the float-based model comes up with higher intrinsic value estimates than the two-column method. I generally consider the two-column method as the lower bound for intrinsic value and the float-model as the upper bound.

Disclosure: The author owns shares of Berkshire Hathaway.

Comments

[TonyCinTX:]

I own a LOT of BRK-B, and I would buy more (and did recently) but I hate to have more than 50% of my net in one stock no matter what it is. Anyway I agree with Tilson; BRK-B is at 75% or 80% and is worth $4200 to $4500. It is trading at $3400. The market is insane, instead of betting on working companies it is speculating on getting rich off of bailouts and health care "reform" and Ponzi schemes. That might work for them, but I'm afraid I'll just have to hold on to companies actually earning a profit by making customers happy, and leave the political and financial criminal profiteers to their own ways.

Sep 23 09:51 AM

[jbert:]

I too have well over 100K in BRK. The reality is that BRK is like a mutual fund, or more correctly, a closed-end fund. As such, it will almost always trade at a discount to the underlying value. If it goes over for any extended period of time, management should issue stock instead of cash for acquisitions, bringing the value back into alignment and taking advantage of Mr. Market.

Unfortunately, there's no easy way to get it "up to" correct value..

Sep 23 12:18 PM

[long term v...:]

Question about the valuation of Berkshire Hathaway. Tilson explains this is is a fairly straightforward exercise where you take the cash, marketable securities and the valuation of operating subsidiaries applying a conservative multiple of 8 to the operating earnings. The sum of the 3 equals the intrinsic value of Berkshire conservatively calculated. What about the debt on Berkshire's balance sheet? Is there any downward adjustment made to the IV of the company to reflect the value of debt or is this accounted for by using a conservative P/E multiple?

Sep 23 01:16 PM

[Graham and ...:]

I think that Tilson includes the debt in the operating businesses (as opposed to the corporate level) and just uses conservative multiple of operating earnings.

I would instead, use enterprise value to EBITDA and back out the debt. What's more, what if the debt is at the corporate level? Then you'd still need to back out the debt.

Fortunately, Berkshire's debt is not large. A larger item is insurance reserves, or "float," which is part of the insurance operation.

But I don't subtract this, because Berkshire's underwriting is so good that the cost of "float" is practically zero (on a net present value basis).


On Sep 23 01:16 PM User 490422 wrote:

>
> Question about the valuation of Berkshire Hathaway. Tilson explains
> this is is a fairly straightforward exercise where you take the cash,
> marketable securities and the valuation of operating subsidiaries
> applying a conservative multiple of 8 to the operating earnings.
> The sum of the 3 equals the intrinsic value of Berkshire conservatively
> calculated. What about the debt on Berkshire's balance sheet? Is
> there any downward adjustment made to the IV of the company to reflect
> the value of debt or is this accounted for by using a conservative
> P/E multiple?

Sep 23 04:17 PM