BERKSHIRE HATHAWAY BRK.A
August 23, 2016 - 2:09pm EST by
Den1200
2016 2017
Price: 223,460.00 EPS 0 0
Shares Out. (in M): 1,643K P/E 0 0
Market Cap (in $M): 367,144 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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Description

I recommend the purchase of BRK (and shorting out downside risk using IWM).

Back in 2004 at a talk at Columbia by Bill Ruane, people were skeptical when Ruane stressed he was sure WEB could compound investments and business earnings at a 12% or higher compound rate for some time. Man was he right. Here are some BRK numbers.

-          Pre-tax, non-insurance, business earnings per share have increase at a compound annual rate of 21.0% for 40 years. From 1970 to 1980 it was 20.8%, from 1980 to 1990 it was 18.4%, from 1990 to 2000 it was 24.5% and from 2000 to 2010 it was 20.5%. These numbers are just amazing.

-          Or look at the net earnings per A share. In 2011 the earnings were $6,215 per A share, in 2015 they were $14,656. The majority of these net earnings were based on business earnings per share including underwriting profit for the insurance businesses, and only a small part was investment, dividend and interest income. That is a compound rate of 23.5%. Again quite amazing numbers.

So what might be driving this unique performance? I think it is not just WEB’s investing acumen which is pretty much unparalleled. (I know others have great performance as well, but none have done it with the vast amounts of money WEB has.) The key also I think is the unique corporate culture that exists at BRK. I keep hearing about Trump’s business brand, but the guy with the real business brand that is vastly more valuable is WEB. Here is an example, a friend of mine brokers commercial insurance for a large insurance brokerage, basically any form of insurance a business might need. When talking about BRK he mentioned how hard it is to place business with them. Basically he said, they choose who they want to insure. He said they are expensive and only pick the best risks. Other BRK businesses profit from this too. There is a reason why BRK has been attaching the BRK name to its businesses.

In addition I believe that being bought by BRK upgrades the performance of many of the businesses. First the managers are shielded from Wall Street’s need for earnings management and told to increase the size of the moat. The managers also get access to large pool of needed growth capex capital and so they can do what they always wanted to do but felt they couldn’t sell to Wall Street. No wonder some of these businesses have shown such attractive growth rates.

Anyway, I think BRK is an amazing business with a unique culture. I also believe that we will still see good performance of the underlying businesses for some time after WEB goes away. First there is a quality board that understands what the business is about. And on the other hand if you slow down the fast pace of growth capex within a short period of time earnings will increase markedly as they normalize to the level of a slower growing business. In short, we will have continued momentum from past growth capex.

So now to the numbers. At the end of 2015, per equivalent A share, BRK had $159,794 in investments and cash. Also we had about $38,421 per share in deferred tax liabilities. Now we are not paying this tax liability today. Actually BRK has been accumulating this tax liability for many years now. The present value of that payment is much lower than the $38,421 per A share that is on the books. It is highly likely that this tax liability will continue to grow. So instead of taking the whole amount I will take 50% into account, or $19,211 per A share. That gives me a net value for investment and cash ex 50% of the deferred tax liability of $140,583 per A share.

In addition net business earnings per A share were $12,304 in 2015. (FYI. This number excludes income from investments, but does include the insurance underwriting income.) In the past WEB has inferred he thinks BRK’s business earnings should be worth about 17 times net earnings. Now it has been a while that WEB has made this inference and BRK is a lot larger now. So in order to adjust for that I will take a multiple of 15 times which gets me a value of the net business earnings of $184,560 per A share.

The sum of $140,583 in investment plus cash ex the 50% of the deferred tax liability per A share and $184,560 in net business income value per A share equals $325,143 per A share in intrinsic value at the end of 2015. ($216.76 per B share)

Now this all refers to 2015, but what about the future for BRK. I think it is highly likely that growth will sustain itself at a decent level. Maybe given the current size of BRK, we cannot assume the 20% plus compound growth rate we have seen for more than 40 years, but 10% seems to be a reasonably number. If I assume 10% compound growth through the end of 2017 we end up with net business earnings of $14,888 per A share. Btw, based on the latest 10K net earnings for Precision Castparts are $912 per BRK A share, so we are already 1/3rd the way to $14,888 using the Precision Castparts purchase.

Also it seems that cash and investment per share are doing quite well too. If one looks at the deferred tax liability for Q2 2016, one will see it has already grown from $63,126 in Q4 2015 to $72,180 in Q2 2016. Most of that deferred tax liability is the increased value of investments. In short, it seems the investment portfolio has been doing just fine in 2016.

So how much is BRK worth at the end of 2017? Well if we take $14,888 per A share in net business earnings and take a 15 multiple on that then we get a value for the businesses of $223,320 per A share. If we also assume that by the end of 2017 cash and investment goes up by 10%, then we get a value of $175,733 in cash and investments per A share. Adjust that for the projected deferred tax liability at the same time I get a value of $154,642 in cash and investments ex 50% of the deferred tax liability per A share.

$223,320 plus $154,642 makes $377,962 per A share in intrinsic value at the end of 2017.

So what about the downside? Well a serious economic downturn would impact the investments per A share. Also net business earnings per A share would be impacted. On the other hand with the massive amounts of cash WEB has available he would be able to invest large amounts of cash at attractive returns. It is hard to predict what will happen, but there is plenty of worrisome stuff out there. For example,

·         The chance of a new recession goes up exponentially every year you get farther away from the last recession. And in the US the last recession ended 7 years and 2 months ago in June 2009. Since the Great Depression we have had three period where the time between recessions were longer than 7 years and 2 months. With the 1969 recession we went 8 years and 10 months, in the 1990 recession we had gone 7 years and 8 months and with the tech bubble we had gone 10 years.

·         China’s economy is clearly not growing at 6%. The Chinese economy seems to be struggling to maintain momentum. The logical release to that would be a currency devaluation. A 20% devaluation would have a large impact on the global economy. Kyle Bass makes this case and it is quite convincing.

·         Europe is still struggling. Its banking system is clearly still in bad shape. According to the WSJ if Europe would stress test its banks using the US metrics, European banks would have to raise $125 billion. Little chance they could do so in the current environment in private capital markets. The Euro crisis is only one step/recession away from flaring up. The only reason why things have died down is the ECB and European governments increasing deficit spending again. What happens when China devalues and Europe ends up with another recession and tax receipts fall of a cliff again? Also what happens to the banking system in Italy in that instance? Don’t even mention Greece where more than half of all loans are in default. Europe really is only one recession away from disaster.

 

Anyway, if you believe that the same risks are out there I would suggest that you own safe assets on the long side, like BRK, and that you short out the IWM. I wrote up IWM not too long ago. It is valued to perfection, and a recession or Chinese devaluation or European collapse would send the IWM down to much lower regions. That way you are hedged and when things are low enough to cover the IWM short, WEB will be right there buying businesses and growing the value of BRK shares.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued growth

 

    sort by    

    Description

    I recommend the purchase of BRK (and shorting out downside risk using IWM).

    Back in 2004 at a talk at Columbia by Bill Ruane, people were skeptical when Ruane stressed he was sure WEB could compound investments and business earnings at a 12% or higher compound rate for some time. Man was he right. Here are some BRK numbers.

    -          Pre-tax, non-insurance, business earnings per share have increase at a compound annual rate of 21.0% for 40 years. From 1970 to 1980 it was 20.8%, from 1980 to 1990 it was 18.4%, from 1990 to 2000 it was 24.5% and from 2000 to 2010 it was 20.5%. These numbers are just amazing.

    -          Or look at the net earnings per A share. In 2011 the earnings were $6,215 per A share, in 2015 they were $14,656. The majority of these net earnings were based on business earnings per share including underwriting profit for the insurance businesses, and only a small part was investment, dividend and interest income. That is a compound rate of 23.5%. Again quite amazing numbers.

    So what might be driving this unique performance? I think it is not just WEB’s investing acumen which is pretty much unparalleled. (I know others have great performance as well, but none have done it with the vast amounts of money WEB has.) The key also I think is the unique corporate culture that exists at BRK. I keep hearing about Trump’s business brand, but the guy with the real business brand that is vastly more valuable is WEB. Here is an example, a friend of mine brokers commercial insurance for a large insurance brokerage, basically any form of insurance a business might need. When talking about BRK he mentioned how hard it is to place business with them. Basically he said, they choose who they want to insure. He said they are expensive and only pick the best risks. Other BRK businesses profit from this too. There is a reason why BRK has been attaching the BRK name to its businesses.

    In addition I believe that being bought by BRK upgrades the performance of many of the businesses. First the managers are shielded from Wall Street’s need for earnings management and told to increase the size of the moat. The managers also get access to large pool of needed growth capex capital and so they can do what they always wanted to do but felt they couldn’t sell to Wall Street. No wonder some of these businesses have shown such attractive growth rates.

    Anyway, I think BRK is an amazing business with a unique culture. I also believe that we will still see good performance of the underlying businesses for some time after WEB goes away. First there is a quality board that understands what the business is about. And on the other hand if you slow down the fast pace of growth capex within a short period of time earnings will increase markedly as they normalize to the level of a slower growing business. In short, we will have continued momentum from past growth capex.

    So now to the numbers. At the end of 2015, per equivalent A share, BRK had $159,794 in investments and cash. Also we had about $38,421 per share in deferred tax liabilities. Now we are not paying this tax liability today. Actually BRK has been accumulating this tax liability for many years now. The present value of that payment is much lower than the $38,421 per A share that is on the books. It is highly likely that this tax liability will continue to grow. So instead of taking the whole amount I will take 50% into account, or $19,211 per A share. That gives me a net value for investment and cash ex 50% of the deferred tax liability of $140,583 per A share.

    In addition net business earnings per A share were $12,304 in 2015. (FYI. This number excludes income from investments, but does include the insurance underwriting income.) In the past WEB has inferred he thinks BRK’s business earnings should be worth about 17 times net earnings. Now it has been a while that WEB has made this inference and BRK is a lot larger now. So in order to adjust for that I will take a multiple of 15 times which gets me a value of the net business earnings of $184,560 per A share.

    The sum of $140,583 in investment plus cash ex the 50% of the deferred tax liability per A share and $184,560 in net business income value per A share equals $325,143 per A share in intrinsic value at the end of 2015. ($216.76 per B share)

    Now this all refers to 2015, but what about the future for BRK. I think it is highly likely that growth will sustain itself at a decent level. Maybe given the current size of BRK, we cannot assume the 20% plus compound growth rate we have seen for more than 40 years, but 10% seems to be a reasonably number. If I assume 10% compound growth through the end of 2017 we end up with net business earnings of $14,888 per A share. Btw, based on the latest 10K net earnings for Precision Castparts are $912 per BRK A share, so we are already 1/3rd the way to $14,888 using the Precision Castparts purchase.

    Also it seems that cash and investment per share are doing quite well too. If one looks at the deferred tax liability for Q2 2016, one will see it has already grown from $63,126 in Q4 2015 to $72,180 in Q2 2016. Most of that deferred tax liability is the increased value of investments. In short, it seems the investment portfolio has been doing just fine in 2016.

    So how much is BRK worth at the end of 2017? Well if we take $14,888 per A share in net business earnings and take a 15 multiple on that then we get a value for the businesses of $223,320 per A share. If we also assume that by the end of 2017 cash and investment goes up by 10%, then we get a value of $175,733 in cash and investments per A share. Adjust that for the projected deferred tax liability at the same time I get a value of $154,642 in cash and investments ex 50% of the deferred tax liability per A share.

    $223,320 plus $154,642 makes $377,962 per A share in intrinsic value at the end of 2017.

    So what about the downside? Well a serious economic downturn would impact the investments per A share. Also net business earnings per A share would be impacted. On the other hand with the massive amounts of cash WEB has available he would be able to invest large amounts of cash at attractive returns. It is hard to predict what will happen, but there is plenty of worrisome stuff out there. For example,

    ·         The chance of a new recession goes up exponentially every year you get farther away from the last recession. And in the US the last recession ended 7 years and 2 months ago in June 2009. Since the Great Depression we have had three period where the time between recessions were longer than 7 years and 2 months. With the 1969 recession we went 8 years and 10 months, in the 1990 recession we had gone 7 years and 8 months and with the tech bubble we had gone 10 years.

    ·         China’s economy is clearly not growing at 6%. The Chinese economy seems to be struggling to maintain momentum. The logical release to that would be a currency devaluation. A 20% devaluation would have a large impact on the global economy. Kyle Bass makes this case and it is quite convincing.

    ·         Europe is still struggling. Its banking system is clearly still in bad shape. According to the WSJ if Europe would stress test its banks using the US metrics, European banks would have to raise $125 billion. Little chance they could do so in the current environment in private capital markets. The Euro crisis is only one step/recession away from flaring up. The only reason why things have died down is the ECB and European governments increasing deficit spending again. What happens when China devalues and Europe ends up with another recession and tax receipts fall of a cliff again? Also what happens to the banking system in Italy in that instance? Don’t even mention Greece where more than half of all loans are in default. Europe really is only one recession away from disaster.

     

    Anyway, if you believe that the same risks are out there I would suggest that you own safe assets on the long side, like BRK, and that you short out the IWM. I wrote up IWM not too long ago. It is valued to perfection, and a recession or Chinese devaluation or European collapse would send the IWM down to much lower regions. That way you are hedged and when things are low enough to cover the IWM short, WEB will be right there buying businesses and growing the value of BRK shares.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Continued growth

     

    Messages


    SubjectPrice target
    Entry08/23/2016 06:05 PM
    Membervalueinvestor03

    Thanks for write up. I agree that BRK at the current price is a good idea. I think your price targets at over 2x current bv/ps are a bit high. I don't believe the stock has traded at such levels in a very long time and I know WEB has warned against paying that price for the stock.


    Subjectwhere's the beef?
    Entry08/23/2016 06:07 PM
    Membersocratesplus

    is it just me, or am i right that the rigor of VIC pitches has gone rather soft.

    this is not a question or being right or wrong.  brk is a fine idea today and tomorrow, in addition to yesterday. for all i know, this pitch may be the most rewarding one of all posted recently.

    but what do i know about brk now after reading this ptich that i didnt know before?

    now, i dont want to be a prick, and perhaps it is too late for that, but i would have thought a brk pitch would have told me something that i didnt know.

     


    SubjectRe: where's the beef?
    Entry08/23/2016 07:22 PM
    Memberbowd57

     

    Hi, SocratesPlus --

    > i would have thought a brk pitch would have told me something that i didnt know

     

    I've been buying NWLI lately. I have absolutely nothing new or interesting to say about it. Surely the point is, "Best Idea", not, "Most Sophisticated Pitch"?

     

    That having been said, Den1200, could you engage with some of the sell-side research that has a much lower valuation than yours, and explain where they're wrong?

     

    Yours,

    Chrs

     

     

     


    SubjectRe: Re: where's the beef?
    Entry08/25/2016 09:02 AM
    MemberMSLM28

    Speaking of NWLI, how do you see DoL affecting them over the next few years?  Thank you kindly in advance


    SubjectRe: Re: Re: where's the beef?
    Entry08/26/2016 09:33 AM
    MemberBiffins

    This would have been a great idea in the 70s, 80s and 90s. Not so much since then. He's pretty much flat versus the S&P500 with an incredibly high correlation with the S&P500.

    Infact his entire recent performance has been caused by a re-rating of the multiple for BRK and not an appreciation of the book value. This has led Buffett, who has always touted gains in book value to be the best metric to judge him by, to start reporting gains in the Berkshire Hathaway share price instead. 

    http://qz.com/353399/after-50-years-warren-buffett-is-suddenly-shifting-his-target-metric/

     

    So now suddenly, instead of paying on absolute performance of his portfolio, we are paying for a re-rating of the fully owned enterprises instead. Which should be an ok proposition since entities like BSNF or Precision Castparts or the insurance business deserve to be re-rated if their competitors have re-rated. But then you're in the re-rating game, and this can de-rate as well since now you're trading well above Book Value, and 1.1 P/B is the level Buffett has publicly declared he'll step in to buy back his own shares. And now he's changed that metric to 1.2 P/B. And infact in May 2016 he said he might loosen that metric more to 1.3 P/B or even higher since he has so much cash "burning a hole in his pocket". So even his own criteria have been drifting as he's getting bulled up on this bull market. 

    So this explains why BRK has traded in line with S&P500. BRK has a large portfolio of diverse American businesses. As S&P500 has re-rated, so has BRK. That makes sense. BRK versus S&P500 is flat for a decade. 

    Well I know another portfolio that is even more diverse than BRK, has also benefitted from the re-rating in equities, is even more liquid, and has historically performed in-line with BRK over the last decade............ and that's S&P500 itself. So buy that instead. 

     

     


    SubjectRe: Re: Re: Re: Re: where's the beef?
    Entry08/26/2016 02:25 PM
    MemberBiffins

    "I think it's pretty clear that the quality of businesses inside of Berkshire is superior to that of the market as a whole"

    I have no idea why you think, or would assume that, or indeed hold it to be self-evident. You particularly like the aviation cycle with Precision Castparts? I don't. Or think BNSF earnings are going to take off on another crude-by-rail/sand volume bonanza? I don't. Or really like where insurance businesses are trading in a collapsing interest rate environment? I don't. Or really like the portfolio full of klunkers like IBM, KO, AXP, WMT, DE (I am short all 5!) which are 5 of top 7 biggest positions. I don't. I don't like PSX either. Or really like the lack of any tech giants or infotech companies that are structural long-term winners? I don't. 

    I am pretty sure, S&P500 will spank BRK over next 5 years. Lets see.


    SubjectBuffett's returns
    Entry08/26/2016 03:21 PM
    Memberzzz007

    Even prior to the past 10-15 years, there has been a relatively solid case made that Buffett's investment returns relative to the market (on an apples-to-apples basis) were nothing special. AQR did a study that parsed the contributors to his returns, and concluded that the "success" of his equity investment strategy historically could be explained almost fully by BRK's use of stable, cheap financing (free insurance float) to lever up returns roughly 1.6x. To his (Buffett's) credit, his historical focus on relatively low beta names (consumer) helped things. Also to his credit, he has never tried to hide the fact that his access to cheap float is a competitive advantage. However, the study does implicitly knock holes in any assumption that the underlying businesses in BRK are by nature of higher quality than the market writ large.

    A summary of the paper can be found here:

    http://www.economist.com/node/21563735

     

    The full study is available on scribd:

    https://www.scribd.com/document/186456207/Buffett-s-Alpha-Frazzini-Kabiller-and-Pedersen

     


    SubjectRe: Re: where's the beef?
    Entry08/27/2016 04:14 AM
    MemberDen1200

    In general I do not read sell side research. I think about things myself and then form my own conclusions.


    SubjectRe: where's the beef?
    Entry08/27/2016 04:27 AM
    MemberDen1200

    The thought was to point out that you might be better off being long BRK and short IWM in this economic environment. I for one would have wanted to own BRK long - IWM short in 2008. Yes BRK went down, but all along the way I knew it would come out on the other end. And being hedged at that time would have helped a lot.

    Also the beef is that the BRK business outperform the general economy by quite a margin and I think that is because of corporate culture, not just WEBs investment accumen. How often I have heard that "this time WEB paid too much" and three years later you wonder why that business' earnings doubled and it turns out the price was pretty reasonable after all. Each time the same story ... it is too large and can't generate much growth and then oops a few years later I wonder how in gods name they grew earnings faster than I thought possible.

    Also who cares how one makes money. The VIC is not a board developed so we can tell each other novel stories with "many things we don't know". From hearing it from JG himself, this board is to give people an idea as to why you think something is cheap so the reader can go back and start work himself. 


    SubjectRe: Re: Re: Re: where's the beef?
    Entry08/27/2016 04:32 AM
    MemberDen1200

    The chart helps my thesis ... and why BRK is cheap. The stock price has not kept pace with the business performance. The investment side is becoming less important and the owned business performance is getting more important over time and that section continues to grow at a fast clip.

     


    SubjectRe: three dumb questions
    Entry08/27/2016 04:38 AM
    MemberDen1200

    I do believe that the board will be able to maintain the culture for some time. Also slowed down growth capex will turn up in continued earnings growth. WEB not being there will make it harder acquiring businesses that I agree with. So it should slow things down, but it is not going to be a hard stop.

    I think most of WEB's relatives died into their nineties and in good mental health.

    I agree with you on the PtoB valuation. The IV is clearly higher than the book value. I keep hearing people say it ain't worth two times book, but then a second later they tell me its normal for some shitty bank to be bought out at 2 times book. The business performance and ROE clearly justifies a higher PtoB. And my experience over the years has been that I systemically under estimated the growth and business performance of BRK.


    SubjectRe: Re: Re: Re: Re: where's the beef?
    Entry08/27/2016 04:40 AM
    MemberDen1200

    trev62 - Couldn't have said it better.


    SubjectRe: Re: Re: Re: Re: Re: where's the beef?
    Entry08/27/2016 05:00 AM
    MemberDen1200

    The runway for Precision Castparts is decades long and there is a shitload of marketshare to be had.

    You really think you could replace the transport volume that BNSF has. Shut down BNSF and the United States economy would grind to a halt. There is a reasonable chance of a renewed boom in crude shipping btw. if you go through the capex budgets of non opec countries/companies it is highly likely we will see oil shoot up again in price of oil. Don't worry, we shall drill again in large volumes in shale.

    So BRK has business earnings growth of 20% plus for 45 years, but 2016 is the year where it all ends? Is that what you are saying? Because I wrote up BRK in 2011 and someone else inferred exactly the same.

    The BRK insurance businesses are not your run of the mill franchises. As I said in the write up, my insurance broker friend bitched that it was so hard to place insurance with BRK. This is what his exact words were: "These f......g customers want nothing but BRK insurance and f......g BRK only picks the best risks and says no to everyone else. It's f......g frustrating to have to go back and say BRK doesn't want them." 

    Man, I just wrote up SRG as a short, which WEB owns, and I am pretty nervous about WEB being long it. Instead you are shorting 5 of WEB's long ideas. What's next, shooting three pointers against Stephen Curry. Good luck on winning that bet. 


    SubjectRe: Earnings & Multiple
    Entry08/27/2016 05:06 AM
    MemberDen1200

    The 12 times Tilson refers to is pre-tax. My 15 times is post tax.

    The whole BRK business environment has more capex than depreciation. Significantly so as it is growth capex. That is part of the secret sauce, allowing the BRK managers to run the business in a way they always dreamt off. BNSF invests a lot in order to generate growth. At least that is how I feel about it.


    SubjectRe: Re: where's the beef?
    Entry08/27/2016 11:48 AM
    Membersocratesplus

    den, i appreciate your point, that the idea can be more important than the writeup, or the analysis behind the idea. but when you post an idea on brk, it seems to me that the bar is raised just a bit to require you to provide more support than simply positing a pair trade based upon buffett's historical outperformance, which as messages have pointed out is becoming more historical as time passes.  if you posted an idea that most people are unaware of, then yes i think it is incumbent on the reader to do more work after reading the writeup.  but there are brk writeups on the VIC board already, and a message on a prior posting would have gotten your point across.  i guess i am saying an idea pitch deserves more. i dont doubt many on this board may disagree.


    SubjectRe: Re: Re: where's the beef?
    Entry08/27/2016 12:30 PM
    MemberDen1200

    Socratesplus, point well taken. See I think about it the opposite way. On the more obscure stuff I feel I need to be more diligent to point out what I have learned. On BRK or IWM I feel the situation is more known and all I need to do is point out that there is value there.

    My overall point to the general crowd is that many systemically over the years have under estimated how fast BRK has grown. In 2011 earnings were $6500 per A share, in 2015 they were 14K plus per A share. And then I wanted to point out that my thinking is that this is driven mostly by the business earnings and that I believe there is a recipe there of A. protecting management from Wall Street, B. low cost of capital and C. WEB encouraging long term thinking by his managers that allows for accelerated growth of the business earnings and that the business earnings part of the business is starting to eclipse the investment part of the business.

     


    SubjectRe: Re: Earnings & Multiple
    Entry08/27/2016 05:47 PM
    Membershoobity

    FWIW I like your idea. But even maintenance capex on railroads is materially higher than depreciation because the steel, wood, etc, etc, is significantly more expensive than 20-30 years ago. Buffett has made this point as well. 

    Doesn't really matter to your hypothesis but it's maybe a helpful piece of information for you. 


    SubjectRe: Re: Re: Earnings & Multiple
    Entry08/27/2016 10:13 PM
    MemberDen1200

    Point well taken.


    SubjectRe: Re: Re: Earnings & Multiple
    Entry08/28/2016 01:59 AM
    Memberbowd57

     

    Hi, Shoobity --

    >  maintenance capex on railroads is materially higher than depreciation because the steel, wood, etc, etc, is significantly more expensive than 20-30 years ago. Buffett has made this point as well. 

    Buffet also about a decade ago (? just guessing) switched from looking to buy businesses that throw off cash to businesses that can absorb cash. If BNSF can get a semi-regulated 10% ROE on "maintenance cap-ex", I bet WB would be psyched.

    Yours,

    Bowd

     


    SubjectRe: Re: Earnings & Multiple
    Entry08/29/2016 11:10 AM
    Memberblaueskobalt

    From the 2015 AR (italics mine): "Here is an update of the two quantitative factors: In 2015 our per-share cash and investments increased 8.3% to $159,794 (with our Kraft Heinz shares stated at market value), and earnings from our many businesses – including insurance underwriting income – increased 2.1% to $12,304 per share. We exclude in the second factor the dividends and interest from the investments we hold because including them would produce a double-counting of value. In arriving at our earnings figure, we deduct all corporate overhead, interest, depreciation, amortization and minority interests. Income taxes, though, are not deducted. That is, the earnings are pre-tax."

    Also, I don't understand why you feel comfortable dismissing the maintenance CapEx question.  CapEx is double D&A, and the difference is 40% of pretax earnings. If maintenance CapEx is higher than depreciation, then earnings will overstate the cash-generative power of the business.  If you miss that, how can you value it properly?

    For full disclosure, I am nervous BRK long with a low tax basis.  I am nervous because: (1) I think the depreciation/capex question muddies the earnings power; (2) some of BRK's largest positions seem secularly challenged AND expensive; (3) even though the multple on BRK don't look that high, the "cash & investments" component of BRK is inflated with the market; and (4) Warren has made a number of decisions lately that seem at odds with his lengthy, storied career, including:

    • appointing his underqualified son chair-in-waiting, despite railing against nepotism and dynastic wealth
    • putting out an odd press release two weeks ago, singling out something that has occurred on a daily basis since the internet existed: http://www.berkshirehathaway.com/news/aug1516.pdf
    • partnering with 3G after many years of railing aginst private equity and many of the strategies they embrace (arguably even more aggressively than the average PE firm)
    • buying big into IBM

    For my own valuation, I do the following:

    1. I apply a 25% mark-to-value discount on the "cash & investments" portfolio to reflect my assessment of some of those positions ($160,000 -> $120,000)
    2. I apply a further 10% discount to the "cash & investments" portfolio to reflect the DTLs ($120,000 -> $108,000)
    3. I assume that a bit under half of the excess CapEx over depreciation is maintenance CapEx and deduct that from earnings (excess CapEx is nearly $5,000/sh, so I take pretax earnings from $12,300 to $10,000)
    4. I use an 11x multiple on those pretax earnings. ($110,000)
    5. $108,000 + $110,000 = $218,000/share
    6. I apply no discount nor premium to the SOTP (5 years ago, I would have applied a 10-20% Buffett premium, but I no longer do that because of the qualitative factors bulleted above), though I cannot help but "feel" that BRK will outperform in a big bear market.

    This $220,000/share price target is around where the shares are currently trading.  So my tax basis--which makes my effective market price 10%+ lower--is what keeps me from selling.  Comments/critiques welcome.

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