Berkshire Hathaway's Operating Businesses Currently Priced Under 2X Earnings

Aug. 4.11 | About: Berkshire Hathaway (BRK.A)
I occasionally fail to follow my better judgment and find myself watching one of the business news channels, with a steady stream of talking heads, each of whom is willing to supply answers to questions that they have no business attempting to answer. It is dangerous listening to advice from people who don’t know how to say “I don’t know."
Also dangerous is not being aware that the best thing to ever happen to these networks was the financial panic of 2008. For them, fear equals ratings. And that is why every single day on each of these networks viewers are kept up to speed on the “crisis” of the moment.
Think about 2011 alone. We started the year worried about massive municipal bond defaults. Then the turmoil in the Middle East accompanied with a flashing memo on the television about an oil crisis. Then we moved to the natural disaster of Japan and the nuclear accident which was supposedly going to cripple the global economy. After that we had an extended focus on Greece and the European debt crisis. After a couple of months, that slipped away and was immediately replaced by the debt ceiling 24/7 coverage as we waited breathlessly for politicians to successfully do something that had been done over 100 times in the past to no fanfare. And then just a day after the debt ceiling issue was addressed, the crisis of the day was again a looming double dip recession.
Tough to keep up, isn’t it? I’m sure I even missed a few from the past six months. My point is that the world isn’t changing at the speed these financial networks make it out to be, and thinking that it does will negatively impact your investment performance. Yes, there are things to be concerned about and there always will be. But if you are an investor who had his heart in his throat over the debt ceiling or is selling today over fears of a double dip recession, I think you may not have the proper stomach for buying and selling stocks for your own portfolio.
The recipe for success is simple. Find a company that you can value reasonably well. If the stock market is valuing that company significantly under what you think it is worth, you buy some. Put it away and let market forces bring out that value over time. Then look for another company to do the same thing with.
The value of a business does not fluctuate on a day-to-day or even month-to-month basis very often. The fact that the stock market revalues a business every second is what creates the opportunity for investors. There are a lot of people making buy and sell decisions about the stocks you own every day without knowing anything about the company or its business.
If you don’t have the ability to follow this recipe, or if you don’t have the stomach to ignore Mr. Market’s often silly fluctuations, then turning your money over to someone who does is likely the right move. And right now you can turn your money over to the greatest investor of all time, Warren Buffett, and get exposure to the incredible company he has assembled at a fantastic price.
Getting to the Point
Berkshire Hathaway (NYSE:BRK.A) of course is Buffett’s investment vehicle and right now it is on sale. And right now might be the most attractively priced the company has ever been.
Berkshire Hathaway is made up of two parts. Part one is the investment portfolio, which each year actually shrinks in significance for Berkshire as Buffett continues spending most of his cash hoard on buying entire businesses. But the investment portfolio is still huge. At the end of Q1, Berkshire has over $97,000 per Berkshire share in investments (cash, equities, fixed income).
Part two is made up of the operating businesses that Berkshire owns wholly. In 2010, pre-tax earnings per share from these operating units was $7,200.
Now if you are at all familiar with Berkshire and know what the current stock price is, I think bells should go off as soon as you see these two numbers. Consider the following: The current Berkshire share price $110,000; less the value of investment portfolio per share ($97,000), that equals $13,000 per share.
If you back out the investment portfolio as I have, that means you are essentially paying $13,000 per share for the operating businesses that in 2010 generated $7,200 of pre-tax earnings per share. That is a multiple of 1.8 times pre-tax earnings for a group of rock solid businesses carefully selected by the greatest investor of all time -- quite a deal.
To come up with a more appropriate valuation, you can pick what you think is a more appropriate multiple for this high quality group of operating businesses. Whitney Tilson of T2 partners suggests 10 is appropriate in this presentation, which he updates frequently. That results in a valuation for Berkshire that looks like this:
Investments per share - $97,000
Value operating businesses (10 x $7,200) - $72,000
Estimate of value per Berkshire share - $169,000
Current share price - $110,000
I think this is obviously incredibly attractive and as close to risk-free as an equity investment can be, given the quality of Berkshire’s balance sheet. The kicker for me is that right now large-cap high quality stocks like Coca-Cola (NYSE:KO), Wells Fargo (NYSE:WFC) and American Express (NYSE:AXP) are also very attractively priced. And the Berkshire portfolio is loaded with those, which may mean the investment per share figure is going to grow considerably in the coming years.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BRK.A over the next 72 hours.