Just a few days before Berkshire's (NYSE:BRK.A) general shareholders' meeting, it seems appropriate to implement a valuation exercise of the company and assess just how close or distant the company's intrinsic value is to the market value it holds today.
But before going into detail, I would like to share the following information with my readers:
- I am a shareholder of the company ever since I opened my first brokerage account in 2007. Buffett surely does not know I'm his business partner -- first, because I'm a profoundly minority holder and, second, because my shares are under the Street's name and not my own.
- I admire Buffett as an investor and businessman but am not blindly devoted -- a trait that I have seen in many other followers.
- I have read a lot about him and Benjamin Graham, in addition to the fact that I am currently rereading his letters to shareholders from 1965 to date. Thus, several concepts that he has wanted to convey to his shareholders throughout the years linger fresh in my mind.
- I will continue to be a shareholder in the near future, although I am concerned about what will become of the company in the post-Buffett era.
Additionally, I would like to share with you the fact that I have sent two questions to the three journalists who were selected to ask questions during next Saturday's annual meeting; they are the same two questions for the three journalists in order to increase the chances of them being asked. I assume that at least one of these questions has been asked by many others who, like me, are wondering why he failed to answer it directly himself in this year's shareholder's letter.
These questions are:
- You've stated several times in the past that if management (you) wasn't capable of delivering a better return than the index, then management wasn't doing the job. Then you said that the yardstick should be any five-year period, and you've just missed your first five-year period comparison. Why didn't you even tackle the issue on your annual shareholders letter? Are you changing the yardstick? What's next?
- You and Charlie are good observers of the past and human biases, but it looks as if you think that history and human biases do not affect Berkshire or its management. I can't stop thinking that you are being overoptimistic and are also denying the many possible future negative outcomes without you at the helm. Why don't you start a dividend policy before you are no longer at the helm? And more so now that life has proven that at this size, even you can lose to an index for a period of five years -- your own yardstick, by the way.
Regarding the annual meeting and the questions I sent, I may add that I was present in Omaha in 2008 during that year's shareholders' meeting, where I attended an event that is no longer being carried out -- a "meet and greet" for foreign visitors. This was an event in which Buffett and Munger signed autographs for visitors who came from abroad, which turned out to be kind of a disappointment because when I read "meet and greet" I had assumed I would get the chance to exchange some words with him and Munger -- not that I would be escorted to a table by a security guard where a few seconds later he and Munger would sign a book I happened to have with me.
Back to the annual meeting and my questions: I know that the format has changed since then and that analysts and journalists add value, but when I was there most of the questions asked were not so constructive business- and investment-wise, and the few valuable questions were not answered in depth. Besides, Buffett has an incredible skill to answer without answering, a phenomenon that people such as Doug Kass experimented with in his role as bear in the last annual meeting.
It is difficult to place Buffett in a complicated situation, very difficult. It is maybe even more difficult to prove he was wrong, but the hardest thing of all is to get him to directly answer certain questions that offer information of real interest to his investors and not ambiguously or with some analogy that makes him look good without compromising himself.
However, Buffett is Buffett precisely because of that, because he has that great mastery to tell Coca-Cola (NYSE:KO) directors that they are not making decisions considering their shareholders the way they should, without being instructive or showing inconformity in public. Above all, he had the ability to pave the way for them so they could correct the mistake, letting them realize that if they buy back enough stock they would have used a corrective measure able to repair the damage. Even when this would be equivalent to recovering a fumble play and not score a touchdown, just as Buffett had previously said.
Well, having set up this introduction, I will now continue directly to the company's intrinsic value analysis. Much has been recently said about whether Buffett, at his age, should represent a "Premium" or a "Discount" to the value of the company. It is my opinion that he should represent a "Discount" regardless of his age and state of health.
The reason is simple: As long as there are no clear signals that the company will be able to keep growing at a satisfactory rate without Buffett as head, I assume that the future, just as the past, will depend on one great player, the best player, the Michael Jordan of the finance world, Mr. Warren Buffett. Unfortunately the Bulls, even with great players in their lineups and a great coach, stopped being the Bulls once their star player retired.
Buffett is a star among stars -- he is the sun of the financial market solar system -- and the fact that this great star is not showing us that he has designed a system capable of continuing with success without him having to brighten up the heavens concerns me rather than comforts me, as I see it does many other shareholders. Quoting Peter Bevelin in Seeking Wisdom: "In Against the Gods, Peter Bernstein refers to a 1703 letter written by German mathematician Gottfried Wilhelm von Leibniz to the Swiss scientist and mathematician Jacob Bernoulli referring to mortality rates: 'New illnesses flood the human race, so that no matter how many experiments you have done on corpses, you have not thereby imposed a limit to the nature of events so that in the future they could not vary.'"
That said, I believe that no matter how much effort Buffett puts into convincing us and himself and no matter how much preparation he does, if while still present today he is unable to show us that the company's future may be similar to the past, or at least satisfactory enough, without him as head, the chances of something going wrong exceed by far the chances of something going well. And my concerns don't end there, as I also ask myself what will happen to so many other smaller stars who head Berkshire subsidiary companies and who still, at a great percentage, continue to be those who lead those businesses to reap big rewards.
Would those stars want to work under another CEO other than Buffett? Would they continue to have that unstoppable desire to conquer the world and go to work every day to send more money to Omaha? What will happen in the passing of the torch that will no doubt take place in several of these subsidiary companies in upcoming years? Will they all have a perfect outcome and will the new relays do an equal or better job than those leaving?
Unfortunately, these questions have no smart answer at this moment because, as Sam Goldwyn said, "Forecasts are dangerous, particularly those about the future."
Estimating the intrinsic value of a company is a task for artists and not for scientists, as rightfully said by Buffett, it does not require Greek letters or complicated equations, but it does require the assumption of certain things that if they turn out differently to what was assumed, they will yield a result that may be very different from reality. For the purposes of my analysis, these are the assumptions that are being considered:
- Everything that is reported by Berkshire is highly reliable.
- I see no additional risks to those previously mentioned, as the company participates in a wide range of industries and its strength in the insurance sector is unparalleled in the world.
- I have decided not to provision anything for PP&E additions, even when this last category has widely exceeded what has been discounted under Amortization and Depreciation in the last several years.
- A multiplier 12 to 15 times the company's earnings after taxes seems appropriate as an applying range for a company that is so solid.
- I have used two Models for my intrinsic value calculation. In Model 1 I have taken the earnings average of the past eight years brought to current value considering an arbitrary 3% annual inflation, even when the reported figure stood below and I have excluded 2008 and 2009, years of crisis.
- I have decided to leave earnings and losses from derivative contracts for the estimation of profits.
- For the proportional part of non-reported profit by Berkshire in relation to companies in which Berkshire is a minority shareholder, I have decided to consider the total of such earnings -- "Economic Earnings" as Buffett used to call them -- and apply a 33% tax rate.
- For such non-reported profits, I have decided to also consider a multiplier of 12 to 15 times the net earnings.
- For Model 2 I have used the same criteria but have considered only earnings from last year, instead of the average from several years.
Model 1 (3 Stages)
Average earnings per share from the last eight years, excluding 2008 and 2009 (brought to present value), 2013, 2012, 2011, 2010, 2007, 2006 ($11,850, $9,382, $6,828, 8,663, $10,207, $8,786): $9,286.
12-15 Multiplying range. Range of value per share from Stage 1: $111,432 - $139,290.
Earnings per share after taxes derived from earnings withheld by companies in which Berkshire is minority shareholder (according to information collected from Yahoo Finance or the company's website or www.sec.gov, and considering only the latest report): $2,130.*
12-15 Multiplying range. Range of value per share from Stage 2: $25,560 - $31,950.
*Estimate. As Keynes rightly said: "I would rather be vaguely right than precisely wrong."
Model 1 range of intrinsic value per share. (Stage 1 + Stage 2): $136,992 to $171,240.
Model 2 (Same 3 Stages)
But considering only the most recent year (2013) rather than the last eight-year average.
Model 2 range of intrinsic value per share: $167,760 to $209,700.
The share value increase during the last 18 months exceeds the company's intrinsic value increase, no matter how impressive the latter has also been. The company's book value is close to $135,000 per share (surely even a bit more today) or what practically equals the low part of the estimated range in the analysis of Model 1.
Considering earnings from the most recent year as basis for such estimation (Model 2), then the low part of the range equals +/- 125% the book value, or what in simple numbers is practically the floor of what Buffett has stated he would be willing to pay to repurchase shares.
I am convinced that Model 2 is closer to reality than what Berkshire is today, as Model 1 considers a past where Berkshire didn't have some new subsidiaries such as Heinz, BNSF and Lubrizol, in addition to holding a lower stake in Marmon and ISCAR and a less robust MidAmerican, among other significant additions and minority investments in other public companies.
Count me in as an investor who is interested in increasing my stake at any price below $167,000 per share, provided Buffett starts to place a tangible and real plan into motion for the company to continue down the same path without him at the front. Something we will eventually have to see, unless as he rightly says: "If enjoying work prolongs life, then Methuselah's record is in danger."
By the way, and in closure to this brief and not too scientific analysis that will surely not be read by Buffett -- and if he happens to, it will only result in a brief chuckle -- I would like you to ponder that Berkshire currently produces net earnings (yes, net, after taxes and boy oh boy, many taxes) of $23-$24 billion a year, approximately 90+ times more than Amazon (NASDAQ:AMZN) and two times more then Google (NASDAQ:GOOG). How about that for never having been considered a growth stock?
Disclosure: I am long BRK.A. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.