Chart 1 below tracks Berkshire's "Adjusted Munger 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 mentioned that each dollar of book value was much more valuable at Berkshire than a similar dollar at Wesco, but he did not say how much more valuable.
Munger explained how a 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 realised gains. Munger described his method as a guess but he did not 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. We call the resulting figure "Adjusted Munger Value" or AMV.
AMV matches pretty well with market price since 1996 showing four periods of over-valuation of 20% or more and five periods of under-valuation of 15% or more, including right now.
But 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 is another approach.
Another Approach: Using Free Money
The point here is that Berkshire's $411bn of assets are partly funded by $37bn of deferred taxes, $72bn of insurance float and $126bn of other liabilities which are deducted to give book value of $176bn. This is correct accounting but does not reveal the underlying economics. Until they are "paid back", the deferred taxes and insurance float are working for Berkshire. And the longer they work for Berkshire, the more they are worth to Berkshire's shareholders. (If I lend you one million dollars for a hundred years, interest free, how much is that one million worth to each of us?)
So it is really important to estimate how long Berkshire gets to use the deferred taxes and insurance float.
Berkshire's deferred tax liability is mostly due to unrealised profits on its investments and other property. The liability represents the tax that Berkshire would have to pay if it sold those assets. But so long as Berkshire does not sell, there is no tax to pay: the investments should grow and the deferred tax grows with them.
Buffett's preferred holding period is "forever", and Berkshire's deferred tax liability has grown more than six fold over the past sixteen years. Nevertheless, Berkshire does occasionally need to realise gains, and the deferred tax has dipped a few times. I guess that perhaps 85% 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. Insurance float represents premiums paid to Berkshire by its customers, that Berkshire expects to pay out later to settle claims. Some claims get settled quickly but, provided the overall level of float does not fall, Berkshire gains from investing billions of dollars at a zero cost of capital.
Better still, Berkshire's insurance subsidiaries make an underwriting profit most years. That means they get paid to hold the float, giving a cost of capital even less than zero! Buffett gave us a new clue about the longevity of float in the latest annual report:
Clue Number 1: "It's unlikely that our float will grow much - if at all - from its current level…Were there to be a decline in float...it would almost certainly be very gradual..." (The italics are Buffett's)
So Berkshire should get to use the float for a long time, but let us keep things simple and guess that 85% of float can also be considered long term funds.
Sustainable Assets Long Term - SALT
Chart 2 below plots the sum of equity plus 85% of float and deferred taxes against market price, a measure we call SALT.
There is a strong correlation between SALT and market price (R2 = 0.85) that I think is more than just coincidence. Berkshire's equity, together with 85% of its float and deferred taxes, 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. So long as Berkshire can deploy this capital at average rates of return, each dollar invested has a dollar of economic value.
This greatly simplifies the valuation. We do not need to guess what an average rate of return should be, nor make a host of other estimates that are prone to error. Instead we just need to think about Berkshire's businesses and investments. Can they do averagely well in future?
One point to bear in mind is that $38bn of Berkshire's assets are cash or equivalents earning next to nothing in US Treasury bonds. We have already set aside $16bn, in case of a bad year for insurance pay-outs, by counting only 85% of float and deferred taxes. But the other $22bn of cash, waiting to be deployed at above-average rates in the next acquisition, is a chunk of SALT currently earning well below average. (But how little can $22bn of cash be worth?)
So what do you think? Is Berkshire's array of above average businesses likely to prosper averagely well in the future? (Including the "eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies.") Are they worth their SALT? If so, last week's closing price of $83.83 for the B shares, $125,730 for the A's 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 is what I think.