Berkshire Hathaway's Valuation: Credit Suisse or Common Sense?

The following shows how to value Berkshire Hathaway (BRK.A) correctly, and questions the valuation proposed in a recent Credit Suisse report which was carried by Barron’s in an article titled “Berkshire Facing Question of the Ages” published on May 9th, 2007.

The Credit Suisse research report on which the Barron’s article was based, stated that their “12-month price target remains $110,000, equal to 1.9 times estimated Dec. 31, 2007, tangible book value per share of about $56,956; alternatively, about 1.7 times forward tangible book value of the insurance business and 16 times the earnings of these other businesses. We consider the stock fully priced.”

Let’s see if we can arrive at a better way to value this company. There are two components to correctly valuing Berkshire Hathaway: operating earnings and per share investments. Our imaginary scenario plays out something like this:

Hurt by the measly 110k twelve month price target put on his revered company, Warren decides to sell everything owned by Berkshire and return all the cash thus generated to his shareholders. He begins with cash and investments. As per the 2006 annual report, Berkshire has per share investments (including cash) of $80,636. We know that there has been an increase in the share prices of most of the investments since end 2006, but let’s be very conservative. Since some of these investments were purchased long ago at very low prices, there will be taxes due. Let’s assume that all of these investments were purchased at zero, thus creating the greatest possible tax liability. Then 15% long term capital gains on $80,636 comes to $12,095, leaving $68,540 available to be paid out per share. Next, Warren puts his operating businesses on the block. There is a flurry of activity amongst competing business owners and the private equity big wigs to buy gems such as Dairy Queen, MidAmerican, Geico and Iscar.

Based on the Credit Suisse per share estimate for 2007 operating earnings of $5,800 and a multiple of only 10 times earnings; Warren is able to dispose his operating businesses for $58,000 per share. This holds true even if expect the insurance earnings component to go down periodically due to disasters, as the strong brand names and low cost float of these insurance subsidiaries make them very valuable to any outside buyer. In summary, by liquidating all investments and selling all operating businesses, Warren is able to give each shareholder $126,540-the sum of per share investments of $68,540 and per share operating business proceeds of $58,000. This figure is the minimum valuation. Per share investments have gone up substantially since end 2006 and the tax liability is nowhere as great as we assumed. Also, the operating businesses should probably sell at a premium to the market multiple instead of just 10 times as we assumed.

What is the true value of a company? Should it based on some multiple of tangible book value or other such accounting construct or should it be based on the logic of what the business is worth to another buyer under the most conservative of estimates? I believe that it is the latter. That makes me a buyer at $110,000 or to be accurate at $3,650 for the B share. Who said there weren’t any bargains around?

Disclosure: Author has a position in Berkshire Hathaway

BRK.A 1-yr chart

Comments

[Tim Eriksen:]

Are you certain that there is a LT cap gains rate of 15% that is applicable to corporations? It is my understanding that capital gains are generally taxed as ordinary income for corporations.

2007 May 17 11:21 AM

[Sandeep Gill:]

Thank you Tim. I stand corrected. One workaround may possibly be for the corporation to distribute the shares it holds in other corporates amongst its own shareholders who may then be liable for the individual long term capital gains tax rate. A good tax lawyer would probably know more about this.

BTW -- You run Cedar Creek Partners right?

2007 May 17 02:10 PM

[Grant Lawson:]

Have you accounted for debt?

2007 May 17 08:50 PM

[Sandeep Gill:]

Good question Grant. I should probably have clarified this in the article itself.
The answer is yes. Specifically, in per share investments have excluded those investments that our held
in their finance operation because these are largely offset by borrowings.
See methodology in page 3 of 2005 annual report at berkshirehathaway.com/...

2007 May 17 11:02 PM

[Grant Lawson:]

Thanks for the reply and the link. Going to look into it more and depending on the outcome maybe I'll see you at the shareholder meeting next year.

2007 May 18 07:38 PM

[FIG trader_:]

Somebody has to start screening this stuff; You can't keep on allowing ignornace about finance, accounting and stock valuations to be disseminated so easily. Do you know where the $80636 in Berkshire investments (as per your commentary) came from and what purpose they servce?????? They are backing up a considerable amount of insurance liabilities (you look up the exact number) the difference being some number close to shareholder equity (minus the equity in other businesses). It can't all be distributed and much is under insurance subsidiaries; the capital ion those books is called statutory capital, levels of which are regulated and controlled by state regulators; You guys are dangerous to your own financial health if you proceed on current path

2007 May 19 08:13 AM

[Sandeep Gill:]

Mr FIG trader,

Perhaps screening postings made under the cloak of anonymity, would lead to better dialogue.

I would urge you to read the annual reports where all the information is clearly stated. Here is a link to the 2006 annual report: www.berkshirehathaway....
The per share investments exclude those that are backed up by debt in their finance operations.Also, Berkshire generates zero cost float through exercising underwriting discipline.
My article stated that this was an imaginary scenario of liquidating/selling everything. Selling Bekshire's insurance operations to other financially strong insurance companies would hardly violate any state regulations, else one would never see any insurance industry acquisitions/mergers.

This is not a stock that can be played for quick gains but over a long time period it should do better than the market. Hope this helps.

Sandeep

2007 May 19 10:50 AM