What Does Berkshire’s Management Think?
Warren Buffett and his business partner, Charlie Munger, never mention a specific value for Berkshire Hathaway (BRK.A), but they do give us clues from time to time.
Chart 1 below tracks Berkshire’s “intrinsic 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 was talking about Wesco’s value and mentioned that each dollar of book value was much more valuable at Berkshire than a similar dollar at Wesco, but he didn't 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 realized gains. Munger described his method as a guess but he didn't 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. Let’s call the resulting figure “Adjusted Munger Value” or AMV.
click to enlarge
AMV matches pretty well with market price since 1996, showing four periods of over-valuation of 20% or more and four periods of under-valuation of 15% or more, including right now.
Despite the good correlation between the change in AMV and market price (R2 = 0.84), 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’s another approach.
Another Approach - SALT
The point here is that Berkshire’s $376bn of assets are partly funded by $36bn of deferred taxes, $69bn of insurance float and $111bn of other liabilities, which are deducted to give book value of $160bn. This is correct accounting, but does not reveal the underlying economics. Until they’re “paid back”, the deferred taxes and insurance float are working for Berkshire. And the longer they work for Berkshire, the more they’re worth to Berkshire’s shareholders. (If you lend me $100 for a hundred years, interest free, how much is that $100 worth to each of us?)
So it’s really important to estimate how long Berkshire gets to use the deferred taxes and insurance float.
Berkshire’s deferred tax liability has grown more than six fold over the past fifteen years, consistent with Buffett’s preferred holding period for stocks: “forever”. Nevertheless, Berkshire does occasionally need to realize gains, and the deferred tax liability has dipped a few times. My guess is that perhaps 85% of it 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. However, there is good reason to believe that float is unlikely to shrink permanently for a very long time yet (never say never but….). For example, on 20 January 2010, the morning of the special shareholders meeting to approve the purchase of Burlington Northern, Buffett announced “…to my knowledge… the largest insurance contract ever written” that over time would “…probably result in perhaps $50 billion of premiums.” Well, let’s keep it simple and guess that 85% of float can also be considered very long-term funds (which leaves a buffer of $10bn and change for that possible bad year).
The reason I think it is meaningful is the same reason for lumping equity together with float and deferred taxes: they 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. The question then becomes whether Berkshire can deploy this investible long-term capital at average rates of return. If it can, each dollar invested has a dollar of economic value, more if Berkshire achieves a higher than average rate of return and less if it can only invest at a lower than average rate.
More simplicity: we don’t need to figure out what rate of return is appropriate. We needn’t discuss risk-free rates, equity risk premiums or betas. Nor need we make other fine judgments that can have a coarse effect on calculated value.
We don’t need to guess who’ll be doing the investing in 50 years’ time.
We just need to think whether Berkshire’s businesses and investments can do an average job in future.
One point to bear in mind is that $41bn of Berkshire’s assets are cash or equivalents, earning next to nothing in US Treasury bonds. We’ve already set aside $10bn of that cash, in case of a bad year for insurance pay-outs, by counting only 85% of float. But the other $31bn of cash, waiting to be deployed at above-average rates in the next mouth-watering opportunity, is a chunk of SALT that’s 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 to the future? Are they worth their SALT? If so, last week’s closing price of $77.05 for the B shares ($115,750 for the As) would seem to indicate a margin of safety of more than 20%. And if Berkshire’s businesses continue to beat the average, we then have the prospect of substantial further upside thrown in for free: we have a double margin. That’s what I think.