Berkshire Hathaway Inc. (NYSE: BRK.A, NYSE:BRK.B) should be especially successful when interest rates are on the high side and markets are turbulent. Well, that’s exactly where we seem to be! So, should you open or increase positions? at the moment?
Berkshire will continue to trade shares and floats
I’ve been advocating this approach for a while (see other Berkshire Hathaway-related posts on my author page) with some arguments as to why it makes sense. Let’s refresh our regular schedule:
The mean P/(BV+F) in the table (yellow column) is 0.99 with a standard deviation of 0.12.
BRK BV+F traded at $273 versus $276 at the end of last quarter. The S&P is down 4.9% since then. We can apply this figure to the value of the stock portfolio at the end of Q2, adjust for the 21% corporate tax, and estimate BV+F right now. The answer is $271, which is colored red in the table. This method allows you to track BV+F more dynamically than just quarter-end data. According to this indicator, BRK currently does not show any special value.
I claim that equity and floating rate represent the intrinsic value of BRC. This is the only way to trade. However, this method assumes some value of the insurance company from “first principles”, i.e. the balance sheet of the company.
When he bought Geico, Buffett paid almost all of his equity and float. So, from Buffett’s point of view, an outstanding insurance company (we know from his writings that Buffett thought the same about Geico) may be worth more than the value of equity and floating rate. Of all the major P&C insurers, only Progressive ( PGR ) trades above BV+F. We shouldn’t be surprised since PGR has consistently beaten Geico over the past few years!
Since BRK’s various assets are more productive than the bonds on PGR’s balance sheet, this means that BRK is probably undervalued. This may be due to the conglomerate’s concessions or the fear of Buffett’s irreplaceability.
Of course, BRK can be valued as a multiple of its book value. From our table, this multiple is 1.37. Although mysterious, it is consistent with Buffett’s old preference for buying stocks at a BV of 1.2. Between the two methods, I prefer to use BV+F because it has some logic behind it and 1.37 has no apparent logic behind it.
It may be objected that BV+F does not reflect BRK’s earning power. Instead, each BRK segment should be analyzed and evaluated individually and the company evaluated as the sum of its parts (SOTP). I can agree with it in principle, but not in practice.
For example, how do you value BRK Railroad (BNSF)? Usually by comparing it to a public railroad, usually Union Pacific (UNP). By following this path, the SOTP analysis eliminates the requirement to calculate the intrinsic value of BRK through its earnings power analysis. The same goes for BRK’s BHE utility. So far, I have not seen any serious attempt to evaluate BRK’s insurance empire. Not sure if it’s really necessary. SOTP adjusts many moving parts to execution and assumes certain arbitrary assumptions about many of BRK’s businesses. It makes the analysis error-prone.
I believe that quantification should be simple even for a large enterprise like BRK. If this is not possible, this is an indication to abandon the assessment altogether. In Buffett’s words, “too hard.”
Because of this, BV+F is about as simple as it gets. For other insurance companies, it is very simple to calculate the fleet from the balance sheet. But even this is not necessary for BRK – the company reports its float every quarter.
Berkshire on Reddit
I didn’t follow the Berkshire section on Reddit until one of my readers tipped me off. It turns out that my articles are being copied there (for example, here). Even if I don’t know, I don’t mind at all.
The same reader sent me a Reddit link to another grading method that is very similar to the one I’m suggesting. The story is much more compelling.
David Sanford (Sandy) Gottesman was an American businessman and investor who died recently (September 28, 2022). He founded First Manhattan Co (FMC) and was close to Warren Buffett. Allegedly, he was also BRK’s second largest individual shareholder behind Charlie Munger!
His company FMC provides investment management services to high net worth individuals and other clients and has many BRKs in his portfolio.
Based on Reddit, FMC (and possibly Mr. Gottesman) bought BRK when it was trading below BV+Float+1/2 of the deferred taxes on the stock. Presumably, this formula was not generally accepted until recently.
Mr. Gottesman met Buffett in 1963 and must have come up with his formula long before I did (I started using it in the late nineties). Buffett himself may be familiar with the formula, as Mr. Gottesman speaks frequently on the phone with Buffett every day and has visited him several times in Omaha.
The moment I saw Mr. Gottesman’s formula a couple of days ago, I immediately understood the difference – I was thinking along the same lines, but decided not to adjust the deferred taxes.
But in the first place, why should we add half of the taxes deferred to stocks? Book value is fully net of deferred taxes on the shares as shown on the balance sheet. However, a long-term investor will pay these deferred taxes in the future. Thus, given the long holding period, the present value of deferred taxes should be lower than the book value. That’s why composition is so important!
While analyzing BRK and Markel Corporation (MKL) (another long-term holder of the stock), I came up with a simple rule of thumb: the present value of deferred taxes is only 45% (or roughly half!) of deferred taxes. balance, if the holding period is 5 years. (The same figures for years 10 and 15 are 36% and 30%.)
However, I decided not to use this to rate Berkshire for several reasons. First, the difference is not that big. At the end of 1Q22, BRK had approximately $37 billion in deferred taxes on shares. Half of that is only ~3% of BRK’s market cap. Second, as you can see, the average market price/(BV+F) is 0.99, and it’s hard to find a better forecast. Third, we don’t know what the holding period of Buffett’s and Munger’s successors will be. Fourth, I want everyone to be conservative in choosing between the two methods. In the end, the simpler the better.
I will continue to use my method, but it was nice to learn about Mr. Gottesman’s perspective.
With BRK trading close to BV+F, there are several catalysts for the stock. Higher interest rates are good for Berkshire because it has $100 billion in cash on its balance sheet. With the stock market down, Berkshire can find good acquisition targets in various segments. Completing the acquisition of Alleghany Corporation ( Y ) expected in Q4 will also be a bit of a hit. I am optimistic about buying Occidental Petroleum (OXY) quickly (in part).
But this is balanced by geopolitical concerns. As Buffett reminds us from time to time, Berkshire is not immune to nuclear weapons. I recently posted “Asset Allocation and the Nuclear Threat” where I tried to summarize my view on buying stocks today. I will stick to BRK without trying to add to my position.