We are adjusting 2008 underwriting earnings downward because we believe that 2006 and 2007 underwriting results are not sustainable given the absence of any large super-cat event during both years.  If this continues to be the case for some years Berkshire’s earnings will be far larger than what we predict but we just can’t count on that happening.

 

Basically, at current prices you get Berkshire’s operating divisions (insurance, utilities, manufacturing, services, retailing), for 4 times after-tax 2008 normalized earnings. Essentially you are paying 4x for a collection of businesses that have been growing pre-tax earnings at a compounded rate of 31.7% for the last 10 years and have great prospects ahead of them.

 What is the normalized earnings power of Berkshire’s op. businesses?

	2006	2005	2004
Insurance – underwriting	$           2,485	$              27	$          1,008
Insurance - investment income	3,120	2,412	2,045
Utilities and energy	885	523	237
Manufacturing, service and retailing	2,131	1,646	1,540
Finance and financial products	732	514	373
Other	-47	-124	-154
Investment and derivative gains/losses	1,709	3,530	2,259
Net earnings	$          11,015	$          8,528	$          7,308

i)                    Insurance – Underwriting

The absence of super-cat’s during 2006 combined with huge premiums after the losses brought by both Rita and Katrina contributed to last year’s extraordinary underwriting results.

 

This year will likely be the second stellar year in a row thanks to a so far very benign hurricane season and the absence of large super-cat’s as well.  It wouldn’t surprise me to see underwriting profits approach $ 3 bn this year.

 

However, as Mr. Buffett has repeatedly said, we just can’t count with such stellar results repeating themselves in the future.

 

As of yearend 2006, Berkshire’s float was $ 50.9 billion and if you add the retroactive reinsurance contract written with Equitas, which adds $ 7 billion, float should be around $ 59 to $60 billion as of today. We assume that float grows modestly to around $62 billion by yearend 2008 and that underwriting profit is a modest 3% or $ 1.86 billion that year. That is a 25% haircut from 2006 underwriting results which we believe is conservative enough.

ii)                   Insurance -  Investment Income

Investment income has grown at an after-tax rate of 23-25% during the last three or four years putting to rest all doubts on Mr. Buffett’s ability to invest Berkshire’s large sums of cash.

 

To be conservative, let’s assume only a 5% increase in investment income year-over-year to reach $ 3.4 billion by 2008. (It is worth noting that for the first six months of the year, investment income has grown by 9.4%).

 

iii)                 Regulated Utility Business

To be conservative, we assume growth in this division’s earnings of just 2% in 2007 and another 2% in 2008 (The big jump in earnings seen from 2005 to 2006 is largely explained by the acquisition of the Western utilities in March of 2006).

 

iv)                 Manufacturing, services and retailing

This group is now firing up on all cylinders… Last year it earned 25% return on tangible net worth!

 

We expect continued growth going forward but again, in sake of being conservative we are projecting 5% growth in after-tax earnings for two years. After-tax earnings should approach $ 2.24 billion in 2007 and $ 2.35 billion by yearend 2008.

 

Again note that so far, for the first six months of 2007, this division’s earnings have increased 17 percent versus the first six months of 2006 (largely because of the inclusion of IMC and Netjets improved results), we believe Netjets will continue to deliver solid growth for the next couple of years because of improving margins in the US network and pent-up demand in Europe.

 

v)                  Finance and Financial Products

Since this division’s results are largely influenced by Mr. Buffet’s opportunistic trading results we simply take on Clayton home’s, CORT and XTRA’s results and grow them at a conservative 2% year-over-year pace.

                So what are Berkshire’s operating units worth?