I once read somewhere that if you don’t understand the business, you can’t value it. And if you can’t value it, you have no business investing in it.
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) is a company that can be understood and pretty accurately valued.
Investors start with a leg up when the CEO writes to shareholders and basically walks them through how to come up with the company’s intrinsic value.
Over the weekend, Berkshire Hathaway released their 2015 annual report and letter to shareholders.
On the first page, Warren Buffett (Trades, Portfolio) told shareholders where he would be a buyer of the stock. Due to accounting rules, Buffett said that intrinsic value of Berkshire far exceeds its book value. He further wrote that he would be “delighted to repurchase” shares if they should sell as low as 120% of book value.
Let’s figure out what that stock price would be.
Berkshire’s book value as of Dec. 31, 2015 was $155,501, making Buffett’s buy target (120% of book value) $186,601. Translating that to class B shares, which are 1/1500th of class A shares, it would come out to $103.67 book value and $124.40 for Buffett’s buy target.
By establishing a low ball price, Buffett basically put a floor under Berkshire’s stock price. Keep in mind that Buffett is the ultimate value investor, and he only wants to pay a dirt cheap price. So his valuation of 120% of book value would be a bargain price.
Now that everyone knows Buffett’s buy price, I highly doubt we will trade at or below that price unless we have a full blown market panic.
By doing a little math, however, we too can come up with another very simple valuation for Berkshire.
On page nine of the letter to shareholders, Buffett spells out two key numbers that investors need in order to calculate intrinsic value. While this is only an estimate, it pays to recall that, “it is better to be roughly right than precisely wrong.”
As of Dec. 31, 2015, per-share cash was $159,794. This number includes cash, stock investments, and other investments that Berkshire holds on its books.
The second key number is the operating businesses that Berkshire owns, including insurance underwriting income, which was pre-tax earnings of $12,304 per share.
If we apply a 10x multiple to those earnings, which in our estimation is a steal, since many of the businesses the generated those earnings are world class companies, it would give us a valuation of $123,040.
Back of the envelope calculation of Berkshire’s intrinsic value as of Dec. 31, 2015:
Per-share cash and investments: $159,794
Pre-tax earnings (10x): $123,040
Intrinsic value: $282,834
As of Feb. 26, BRK.A closed at $198,190 per share, or roughly 43% below our back of the envelope calculation of Berkshire’s intrinsic value. Class B shares closed at $131.92 and the intrinsic value would be $188.56 (1/1500th of $282,834).
If we use the floor of 120% of book value, or $124.40 for class B shares, as the downside price, and our estimate of intrinsic value of $188.56 as fully valued, the current share price of $131.92 is a very attractive price.
When you are able to figure out a ballpark price of a company’s intrinsic value, you set yourself apart from most investors who have no clue of the company’s intrinsic value.
Anyway you slice it, Mr. Market is offering investors an attractive price for a world-class company.
