If you ever go looking for the best businesses around the world you will definitely bump into a fully or partially owned subsidiary of Berkshire Hathaway (BRK.A), (BRK.B). Created by the living legend of investing, Warren Buffett and his partner, Charles Munger, BRK is the biggest collection of wonderful businesses around the world.
Those businesses share some common characteristics that make them extremely profitable and low-risk investments. These characteristics are:
- A strong and durable competitive advantage
- Good and shareholder-friendly management
- Long-term growth prospects
Berkshire Hathaway has shown for many decades extreme profitability, growth and always maintained a stellar, unleveraged balance sheet. Today it has $194 billion market value at $78.29 per class B share (each Class A share equals to 1,500 B shares in terms of valuation and earning distribution). BRK gives no dividend.
The book value of the company is at $169 billion or $68.27 per share. Valuing Berkshire though this metric its actual value is widely misunderstood. Although management uses book value to track the growth of the business the actual net asset value is a lot greater due to the way Berkshire's Insurance Operations work.
You see the insurance segment produces a lot of float, which is the money collected as insurance premiums and waiting to be paid to insurance holders when needed. Here though lies the strength of the insurance companies BRK has bought. They manage to stay profitable enough so that they can serve the needs of their customers without touching the float at all, giving them the ability to use float as an asset and invest that money for the long term and for their own benefit.
Float for 2011 was $70.6 billion as you can read in Buffett's Annual Letter to shareholders (pdf). If you add float to book value as an asset you'll end up with an actual value of $239.5 billion or $96.77 per share which is 23.6% above market price.
The other place we can find hidden value at Berkshire is its earnings and cash flow statements. For the previous year, 2011, BRK had earnings of $10.25 billion or $4.14 per share and a P/E ratio of 19. But for Berkshire this number is also misleading because the available cash for the company to reinvest is a lot more. FCF for BRK was $20.5 billion or $8.28 per share meaning a P/FCF ratio of just 9.4!
To sum up, the float-adjusted book value of BRK and the P/FCF ratio implies a fair-value range of $82-$97 per share, making Berkshire a great opportunity below $82 per share, not only because it's undervalued but also because you buy its growth prospects for free.
You can find the latest annual report (for 2011) here (pdf).