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Berkshire Hathaway (BRK.A), (BRK.B) ("Berkshire") is the company controlled by famous investor Warren Buffett. In the span of almost five decades Mr. Buffett has transformed the textile company he purchased with that name into a holding company worth $285 Bln today. He created the company through corporate acquisitions and open market purchases of stock. In this article, I will use observable market multiples to estimate the value of Berkshire.

The company reports results in the following categories:

  1. Insurance (underwriting and investing)
  2. Railroad
  3. Utilities and Energy
  4. Manufacturing, service and retailing
  5. Finance and financial products
  6. Investment derivatives gains/losses

With the exception of the last category (which is a portfolio of derivative contracts) each category is a subsidiary or group of subsidiaries that operate as standalone businesses. These subsidiaries don't have any functions performed by company headquarters and run their operations the same way they did prior to being acquired by Berkshire. Staff at headquarters is very low (about 24 people). Mr. Buffett allows his managers to run their businesses without interference. He says that only a handful of people report to him on a daily basis. Since there are no apparent synergies at work, we can attempt to value the company by estimating each category´s standalone value and then adding the results.

I will skip the insurance group for now. I will assume that there is negative value in the derivatives portfolio. This portfolio consists of credit default swaps and put options sold by Berkshire and as such are liabilities on the balance sheet. Some contracts will produce payouts upon expiration and others, hopefully most, will not. Since it is impossible to know today, I will use Berkshire´s fair value booking of these liabilities which is $6.0Bln (see note 15 on 10-Q filed with the SEC).

So I will start with the Railroad unit (the earnings information, to September 2013 is taken from the 10-Q as well).

Railroad:

Berkshire owns Burlington Northern Santa Fe (BNSF), which is the largest railroad in North America. There are other large railroads that can serve as comparable businesses; I have chosen the following list:

Company

Ticker

Share Price

EPS (TTM)

P/E

Union Pacific

UNP

$168

$9.07

18.5

Canadian National

CNI

$57

$3.09

18.4

CSX Corp

CSX

$29

$1.86

15.6

Average PE

17.5

BNSF had earnings for the first nine months of the year ending September 2013 of $2.7 Bln, an annualized rate of $3.6 Bln for the full year (full year 2013 information has not yet been reported). Using the average P/E above we can estimate the market cap of BNSF would be $63 Bln ($3.6Bln x 17.5) if it were a publicly traded company.

Utilities and Energy:

Berkshire owns about 90% of MidAmerica which is a utility holding company owning and operating a collection of regulated distribution companies, generation assets and pipelines. The two utilities in the table below have similar characteristics:

Company

Ticker

Share Price

EPS

P/E

Duke Energy

DUK

$68

$3.41

20.0

American Electric Power

AEP

$46

$2.38

19.3

Average PE

19.7

MidAmerica had earnings attributable to Berkshire for the first nine months of the year ending September 2013 of $1.1 Bln, an annualized rate of $1.5 Bln. Therefore the value I would expect for Berkshire's stake in MidAmerica is about $30 Bln ($1.5Bln x 19.7)

Manufacturing, service and retailing:

This category is made up of a very diverse group of businesses. There are chemical companies, retailers and manufacturing and services subsidiaries. Grouped here are Lubrizol, MiTek, Iscar, Flight Safety, Marmon and many others. Given the diversity of the group, I will simplify the analysis by using a market multiple of 17, which is the P/E on the SPDR ETF (a fund tracking the S&P 500 index).

This group had earnings for the first nine months of the year ending September 2013 of $3.2 Bln, an annualized rate of $4.3 Bln. Its value would be around $73Bln ($4.3Bln x 17).

Finance and financial products:

This is a smaller category that groups furniture and equipment rental businesses, Clayton Homes (a prefabricated home builder that provides financing) and other subsidiaries. I will use the P/E on a financial focused ETF, XLF, as comparable.

Finance and financial products had earnings for the first nine months of the year ending September 2013 of $0.4 Bln, an annualized rate of $0.5 Bln. XLF has a P/E of 12.5, which yields a category value of $6Bln.

The following table summarizes the estimated valuations of all categories excluding insurance:

Berkshire unit

Estimated Value ($Bln)

Railroad

$63

Utilities and Energy

$30

Manufacturing, service and retailing

$73

Finance and financial products

$6

Investment in derivatives

($6)

Total excluding Insurance

$166

Insurance:

The group of insurance and reinsurance subsidiaries are used by Buffett as a warehouse for stock holdings accumulated throughout the years. These subsidiaries also create "float", defined as the timing difference between collection of premium and payouts on expected claims, a source of funds Buffett uses for investing (float was approximately $77Bln to September 2013). Cash from subsidiaries is the other source of funds (no cash leaves Berkshire, it has never paid out a dividend). The resulting portfolio of investments, almost $200Bln in size as of September 2013, is distributed as follows:

Asset Class

Value on 10-Q as of Sept 2013 ($Bln)

Equity

$105

Cash and Equivalents

$35

Fixed Income

$29

Other Investments (Heinz Holding is about half of this)

$27

Total Portfolio

$196

Calculating earnings from this unit is difficult for two reasons. First, the underwriting results are extremely volatile. Second, the equity portion of the portfolio creates under-reporting of "economic earnings" because accounting rules do not allow Berkshire to book the proportion of earnings represented by the shares it owns. As a quick illustration, if Coca-Cola (KO), a long time Berkshire holding, earns $2 per share and distributes $1 per share, Berkshire books $1 in income, not $2. Alternatively, if Berkshire owned 100% of Coca-Cola it would be able to book the $2. Because more than half of the portfolio is in stock we can't accurately measure the true earnings being generated.

An alternative way of valuing the insurance activity is to look at the group's book value and book value multiples in the market. The insurance category lists assets of $302Bln and liabilities of $123 Bln, implying a book value of $179 Bln. Berkshire breaks out balance sheet in categories to facilitate this type of analysis. Insurance and reinsurance comps Travelers (TRV) and Everest Re (RE) trade for about 1.2x BV, which would imply a valuation of $215 Bln for Berkshire's insurance group.

Putting it all together, the "breakup value" or "sum of the parts analysis" results in a valuation of $381 Bln for Berkshire, about 33% higher than its current market cap.

Berkshire unit

Estimated Value ($Bln)

Railroad

$63

Utilities and Energy

$30

Manufacturing, service and retailing

$73

Finance and financial products

$6

Investment in derivatives

($6)

Insurance

$215

Total

$381

This is difficult to understand. Perhaps some valuation penalty is justified due to the uncertainty around Buffett´s succession…but almost $100Bln discount is a very large amount and should provide adequate margin of safety.

Source: Berkshire Hathaway: Sum Of The Parts Suggests $100B Discount