Monday, March 1, 2010

Valuation Of Berkshire Hathaway: The Lower Bound For Intrinsic Value

Warren Buffett uses change in per-share book value as yardstick to measure success of Berkshire Hathaway against S&P 500 index, but clearly says that the book value in itself understates the intrinsic value of the company. He defines intrinsic value as “discounted value of the cash that can be taken out of a business during its remaining life”.

Clearly, calculating the said value is not a simple task and the outcome can be very different depending on assumptions used. In the 2009 annual report, Mr. Buffett hints that the companies Berkshire controls are worth considerably more than the values at which they are carried on books, especially the insurance businesses.

The book value of Berkshire Hathaway was stated to be $84,487 per class A share in the annual report. With share price of $119,800 price per book ratio (P/B) is 1.42. With net earnings of $5,193 per class A share the price per earnings (P/E) ratio is 23.1. Looking at these rough measures, Berkshire does not appear undervalued. In fact, looking at just the P/E one could say it may be a bit overvalued.

However, neither of these ratios commonly used for valuation can capture one of the most important aspects of the Berkshire Hathaway: the “float”. Berkshire holds huge amounts of money due to collect-now, pay-later insurance business model. Over the years, the insurance-related float has grown to amazing $62 billion. And for the last seven consecutive years, Berkshire was essentially paid to hold this money via underwriting profits. In addition, derivatives-related float was about $6.3 billion at yearend.

For getting a rough estimate of the lower bound of intrinsic value of Berkshire Hathaway without trying to estimate the future income streams from various businesses, I took a look at the balance sheet. I consolidated the balance sheet a bit further as in the annual report assets and liabilities are listed per business group.


Roughly half of the total assets ($156,9 billion) are in cash or in investments. These make $101,118 per A share and $67.41 per B share. If you add Property, plant and equipment then you arrive to valuation of $203,5 billion ($131,195 per A share or $87.46 per B share).


The book value of Berkshire is pretty much same as the "BRK shareholder equity" in the above excel sheet. I used the stated average number of 1,551,174 class A shares to count all per share figures. "Per B share" amounts are divided by 1500.

The total "float" of $68.3 billion is derived from the liabilities. From my point of view this float represents additional value (almost free leverage in hands of an extraordinary investor) to me and therefore I would count it as part of my lower bound of intrinsic value. Adding together BRK shareholder equity and the stated total float I get $199,4 billion. That is $128,548 per A share and $85.70 per B share.

My conclusion from looking at the balance sheets is that the lower bound of intrinsic value is roughly in the same ballpark as the current share price. Therefore, in my eyes Berkshire Hathaway is probably undervalued.

No comments:

Post a Comment