In this article last year, I presented a simple way to value Berkshire Hathaway (BRK.A, BRK.B) based on a multiple of book value. The beauty of this approach is that it requires just a few figures and assumptions, and accounts for all manner of accounting distortions that affect reported earnings at the company.
Update on valuation
In Berkshire's results for 2016, we find that book value has grown to $172,108 per A share, equivalent to $115 per B share, growing 10.7% over the previous year. This is higher than the 8% growth that I had posited on a normalized level in my prior article. The S&P 500 was up 12% last year (with dividends), and many of Berkshire's holdings got a big boost after the presidential election. So I would say that 2016 was better than normal.
The two year average, during which the market was up 6.7% annualized, is 8.5%. Using this as the basis for expected growth going forward, and an expected 6% return from an investment, I would say that the multiple of book value representing fair value for Berkshire's shares would be 8.5/6 = 1.42.
One additional refinement I am going to make is to roll the valuation ahead by a year by basing it on expected book value at the end of 2017. So the multiple on trailing book value would be 1.42 * 1.085 = 1.54x. Multiplied by book value, this would indicate that the fair value for Berkshire's B shares would be $177, not far from their current $171 market price. I should add that this isn't meant to provide a precise figure for the valuation, but rather to provide an estimate and a framework with which the reader can arrive at their own figure.
In his annual letter, Buffett emphasizes the disconnect between his shares' intrinsic and book values. However, I would point out that this should be reflected in faster than normal growth in book value, which is the case, but not by much.
It is increasingly hard for the company to find sensibly priced acquisitions on which the business was built. The company arguably overpaid for its acquisition of Precision Castparts last year. The last large investment in the public markets — IBM (NYSE:IBM) — has not produced any value. Last year was great for Berkshire's investment holdings in financial stocks, and yet the growth in book value underperformed the gain in the S&P 500. The curse of size is real.
The company is authorized to buy back shares below 120% of book value, and this should provide a floor on the stock, although like Buffett I believe the stock is worth much more. Absent a market crisis, the stock is unlikely to trade at this level for long.
Berkshire is one of the best-managed companies in America, and you won't find it doing something stupid on the capital allocation front, reducing the agency cost of holding the stock. Even so, this is largely reflected in the market price of the stock, with not much upside.
If you own the stock, hold on to it. Sell some upside calls (maybe at the $180 strike price on the B shares) to generate some income. If you don't own the stock, but would like to, wait for a 5%-10% pull-back as a better entry point. Sell the $150 strike puts to generate some income while you wait.
Disclosure: I am/we are short BRK.B OPTIONS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.