I'm not going to give Berkshire Hathaway any special consideration here. When you buy a stock, you are essentially becoming a silent partner in the business. Partner because you become an owner. Silent because you have little or no say over the daily operations of the business.
While I would love to be a partner with Warren Buffett and the brilliant minds with which he surrounds himself, I have to realize that I want to hold my business forever. A wonderful business can grow regardless of management. So, can Berkshire do that when Buffett and his pal Charlie Munger are no longer at the helm?
Berkshire's Net Worth
Shareholder Equity for Berkshire has grown roughly 8.8% a year over the past ten years. If Berkshire were to close its doors tomorrow and sell off its individual pieces, as a silent partner, you'd be entitled to your fair share of its $108.4 billion net worth—and that is the basis for our calculation.
The Value As An Ongoing Business
No business can survive long if it can't generate excess cash. In the case of Berkshire, free cash flow has been growing at about 21.4% a year for the past ten years. Remember: We can't judge a business based on single-year performance. Instead, we have to focus on multi-year timeframes.
We don't expect Berkshire to close up shop tomorrow. Instead, we expect it to stay in business for twenty or more years. As such, as an ongoing business, Berkshire is worth more than its $108.4 billion net worth. As a silent partner, you are also entitled to any excess cash that it can generate—cash that can be paid out to partners or, as has been the case with BRK, plowed back into the business for growth.
Is Management Rational?
Berkshire only generates about $0.04 of cash for every dollar invested in the business. This is due largely in part to the size of its swelling asset base. We know that Buffett and Munger are rational and can assume that any successor management they choose will also be rational. In that light, and because we know that it is a fundamental tenant of Buffett's to only carry debt when it can be used as an asset to generate cash, we can safely say that Berkshire's 4% CROIC is acceptable.
I know what you're thinking: He's cutting Berkshire some slack. I'm not. Still, I know Buffett and Munger as managers because I have become familiar with them as people through their 50 years of writing and speaking. I believe they are rational, good managers and that they will hold the same standard for their successors. But, when Joe Blow manager takes the helm at a company and I don't know anything about him and his style, I have to be more skeptical and base my decision on the raw numbers. Stick with me for a few more paragraphs.
Putting It Together
Berkshire's intrinsic value with Buffett and Munger at the wheel comes is about $245.6 billion, or roughly $159,478 a share for Class A stock (BRK.A). We know the company is jammed with great investments and subsidiaries, so there is definitely a wide moat. With a 25% discount, a purchase could be justified at $119,609.
Don't Open Your Wallet Yet
All of this assumes that it will be business as usual at Berkshire. The problem, one that is unique to this and a few other companies, is that its excess cash is tied directly to the special abilities of Buffett and/or Munger. Part of Berkshire's excess cash comes from its successes in arbitrage and trading. Will the new management have the same gambling-savvy as current management? Will they be better? Worse?
Let's assume that they're worse, and that Berkshire can only grow its excess cash at 16%—three quarters of its historical rate. (After all, the majority of the cash comes from subsidiary companies and dividends). Remember: If we're wrong and it is business as usual, we simply end up making more money.
The "New Management" Value
With free cash flow growing at 16% instead of 24.1%, Berkshire has an intrinsic value of $206 billion. With a margin of safety of 25%, the purchase price comes in at $100,387.
Do I think that Berkshire's silent partners will make money in the future? There's not a doubt in my mind. Do I think it is a fairly safe bet, even sacrificing the 25% margin of safety and settling on the 16% MOS that Berkshire is currently offering? Yep. Would I buy it? No.
When you start finding excuses to buy businesses, even though they don't meet your criteria, you become a gambler, not an investor. I have nothing but confidence in the abilities and talents of Buffett and Munger. As Buffett himself has said, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
In this case, my data does not give me the confidence I need to reasonably expect at 15% or more return for the next twenty years.
I don't know what goes on in the brilliant mind of the world's greatest investor. Still, I know that Berkshire hasn't announced that it would be repurchasing its stock. Considering that Buffett is in the business of growing money rapidly, he is likely looking for the greatest value for his silent partners' dollars... and he isn't finding it in Berkshire Hathaway stock.
So, no — I'm not cutting Buffett any slack. Then again, neither is he.
BRK.A 10-yr. chart: