Since the release of Berkshire Hathaway’s (BRK.A) annual letter, posts have been flying out there as to Berkshire’s actual value vs. today’s current $133,000 a share price.
Before we get started and Buffett folks assume some things, let me say this:
– Buffett is the greatest investor of all time
– Berkshire is a one of a kind company
According to Buffett”
“Finally, our insurance business – the cornerstone of Berkshire – had an excellent year. Part of the reason is that we have the best collection of insurance managers in the business – more about them later. But we also were very lucky in 2007, the second year in a row free of major insured catastrophes.
That party is over. It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise. Even if the U.S. has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so. If the winds roar or the earth trembles, results could be far worse. So be prepared for lower insurance earnings during the next few years.”
For all the contributions of the near 70 businesses Berkshire owns, it is in its essence an insurance company. The unit produced a $3.3 billion (down from $3.8 in 2006) of the company’s $13 billion in earnings in 2007. Further, $37 billion of the company’s reported $44 billion in cash and cash equivalents belong to insurance.
Let’s just forget about Berkshire for a minute and say it is company “A”. Company A’s main business had operated under perfect conditions for the past two year and its stock has reacted accordingly with it reaching an all time high just 4 months ago and despite the current market environment, sits only 16% below that. Here is the odd thing about company A’s business, when it is perfect, the prices it can charge for its services falls. It’s margins actually begin to shrink. Then, invariably, there is a shock that causes a large disruption to the business and earnings fall, at times dramatically. Thus is the insurance business……
Berkshire, currently trading at 15 times earnings (down from over 18 at its high) seems to reflect some of this expected insurance deterioration. We may get a hurricane (or a series of them) in 2008, or not. Either way, insurance results will deteriorate and in concert so should Berkshire’s as a whole. If they do not fall, one would expect them to stagnate.
If you were going to buy shares in any company, would you expect to find true value when its principle business line has operated under perfect conditions? Of course not. One would argue that a conservative valuation of the company would under those conditions would be a “fair valuation” not “value”.
I would argue that Berkshire is fairly valued for its current business environment. The last time Berkshire represented “value” was exactly 8 years ago in March 2000 at the height of the dot.com bubble. Since then its share price has risen 256% even after the current drop.
Does this mean today Berkshire buyers will not make money? No. They assuredly will. It does mean that the out-sized gains investors in 2000 have seen will escape them.
Disclosure (“none” means no position):None
2 replies on “Berkshire Hathaway A "Value"?”
Todd, I almost always agree with you in particular your long thesis on Sears (btw – the stores i check keep getting better), but as for your valuation of Berkshire, I disagree. 8 years from now I suspect Berkshire holders will have enjoyed another bout of triple digit gains. Nobody understands compounding like Buffet and all I can say is everything under the Berk umbrella will continue to compound, ie dividends from its equity portfolio, earnings from its companies, and returns from its other investment activities in bonds, put options etc.
In response to the previous comment, I personally am more on the side of Todd on this one. Berkshire Hathaway is no longer the same kind of company it was years ago. I.E. a fledgling conglomerate which also had the added benefit of having a very large, return generating equity portfolio. Outsized gains came from multiple expansion on its valuation, the addition of strong growthy businesses and the oracle of omaha managing a huge cash hoard.
These days, Berkshire Hathaway is much too large for the stock portfolio to generate outsized returns relative to size. Many of the acquisitions over the past 50 years are maturing into simply cash generating businesses – i.e. See’s Candies, the Insurance Businesses, etc. – and as a result Warren Buffett has had to look for growth outside of these business lines and in acquisitions. Once again, the size of the company makes it difficult to find suitable acquisitions that offer the kind of “homerun” explosive potential that it might have before. That is not to say that these businesses won’t continue to provide good growth in earnings and solid cash flow, but it does mean that it is becoming increasingly difficult for Berkshire to provide the kind of outsized returns it has in the past. In fact, Warren Buffett acknowledged this in his shareholder letter this year. I don’t think that in another 8 years we’ll be seeing Berkshire valuation increasing yet another 256%. I mean, yes, if Warren Buffett and Charlie Munger stay at the helm, investors will probably continue to see more than suitable return for their investment. But, the days of compound annual return in excess of 25% a year are probably long gone. For comparison’s sake, BRKA has earned investors about 14% a year annualized from 1997 to the end of 2007. In the decade before that, 1987-1997, investors were rewarded with in excess of 30% annualized return. In the decade before that (1977-1987), in excess of 40%.