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Saturday, August 13, 2011

Berkshire Hathaway looks cheap: operations have a 3.3X implied multiple

Originally, I wrote a post about Berkshire's valuation and made a very stupid mistake (double counted.) I would like to thank that reader for quickly pointing out my mistake, you know who you are.

I have decided to give the Berkshire valuation another shot. This time  with the help of Augustin Chieh of Chieh Capital. Augustin probably has the most extensive Berkshire valuation of anyone I know and I was lucky to have his help. Augustin definitely did help me on this, yet any mistakes in this analysis are all my own.

Berkshire Hathaway's Value: = Investments + Operations
  • Investments = 153.18B¹
  • Operations  [insurance underwriting operations] + [non-insurance operations] = [1.4B*12] + [5.93B * 15] = 105.75B² 
  • Equivalent class A shares outstanding: 1,651,284, as of July 28, 2011
  • Currently, the Berkshire A's go for 107,600 - the Berkshire B's go for 71.52
153.18B + 105.75B = 258.93 Intrinsic Value.  That's 156,805 per A share or 104.53 per B share
Market’s current implied multiple on the operating business when backing out investments is 3.3X.
            
([market cap] – [investments]) / [operations earnings] = ([178B] – [153.18B]) / [7.33] = 3.3  =   current implied multiple for Berkshire’s Operating Businesses          

Conclusion: Berkshire is currently selling at a reasonable value. There are a few possible catalysts. First, Berkshire Insurance subsidiaries have excess capital in order to generate new float which if written conservatively can translate to an instant increase of Berkshire's value. The second, Berkshire's investment portfolio is filled with blue chip companies which are selling at historical lows; if blue chip stocks start to rise, Berkshire’s portfolio will rise with it. Thirdly, about a billion dollars in housing earnings has disappeared since 2006 – which will eventually come back.
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[Notes]
 ¹ I am assuming the major investments Berkshire holds will not be sold, leaving no capital gains tax This is of course, very debatable. I am also assuming 1 dollar of no cost float equates to 1 dollar of equity.  

² The 15 multiple for Berkshire’s non-insurance operations since Berkshire’s operating subsidiaries are handpicked by Buffett himself and a multiple close to the long term average S&P 500 multiple seems reasonable.. The 12 multiple is for the insurance underwriting operations. Although Buffett’s insurance operations have continued to grow float intelligently and at low costs, most insurance business don’t have a competitive advantage and are highly susceptible to market forces.  Operation numbers come from the annual report page 67, results from operations. The underwriting profit is the normalized underwriting profit from 02’-08’to include a full insurance pricing cycle. The underwriting profit also excludes 9/11 since policies now exclude 9/11 type costs, unless customers explicitly pay for them.  

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