Berkshire Hathaway is priced by the market at $356 b; and it is now the seventh largest company by market-cap in the US. Amazon and Facebook just went ahead of Berkshire recently. It took Facebook about 12 years and for Berkshire more than 50 years to reach where they are today is another matter. Facebook which went public only 4 years ago is priced at high multiples of its earnings. So growth it is that the market is considering when pricing; low growth for Berkshire and high growth for Facebook.
Berkshire is a conglomerate which acts as a holding company of several diversified businesses. Each business is run by an independent CEO without much interference from the head office. It has an extraordinary business model where there aren't much of corporate meetings, forecasts or guidances. There is no smoothing of earnings either. What is earned in a quarter is what is actually reported. It is always a pleasure to read its annual letter to the shareholders. There is no question that Buffett and Munger have turned Berkshire into what it is today with the most contrarian approach possible to business and investing.
Everyone is interested how Berkshire would perform post these two exceptional managers. More precisely, how it would reward its shareholders based on its current pricing? The class A share is trading at $216,000. Its class B shares are worth 1/1500 of class A in terms of cash flows, and are also traded in the market. Berkshire had 1.643 m shares of class A equivalent as of December 2015.
Valuing Berkshire is not easy. One has to value each business separately and add up to arrive at the value of the total business. Analysts do not want to get into that hassle. The easy way for them is to price the stock and call it value.
As much as Buffett likes to see Berkshire's stock price trade close to its book value, it is not the right value for the business. This is because Berkshire's operating businesses cannot be marked to market. It now has many capital-intensive businesses which probably should be valued much higher than book value. Therefore, book value of $155,501 per share for the company is actually not meaningful.
At the very top level, Berkshire is an insurance company; and one of the best runs at that. Premiums received by insurance business are invested in its operating business for acquisitions. The operating business comprises several independent businesses. Premiums and excess cash from operating businesses are also invested in stock markets. Berkshire had an investment portfolio of $159,794 per share as of December 2015. Berkshire also makes underwriting profits consistently.
Analysts price its stock by applying a multiple to its earnings. As per its 2015 annual report, pretax earnings per share from its operations was $12,304. If we apply a PE of 10, the price of operating business will be $123,040. Including investments, which are market to market, the price of the whole company comes to $282,834 per share (class A equivalent). It seems like there is an upside to its market price.
Since earnings accrue to the shareholders after tax, why should we use pretax earnings? Applying a tax rate of 35%, the after-tax operating earnings will be $7,998 per share. With the PE of 10, the operating business will be worth $79,980, and Berkshire will be priced at $239,774 per share. Still higher than its market price.
In 2015, Berkshire class A shares traded at a high price of $227,500 and a low price of $190,007. Let's consider only the high price and remove investments of $159,794 to arrive at the market price of its operating business of $67,706. This price has an implied PE of 8.47. I have not considered the low price because often the market has failed to recognize the value of its operating business altogether, which is illogical. This implied PE has been falling consistently over the last 10 years; it was 37.47 in 2000 and 4.29 in 2012. If we use the 5-year average implied PE of 8.22, the price of operating business will be $65,709 per share and including investments, Berkshire will be priced at $225,503. Again higher than its current market price, but not much.
How about its cash flows? Going forward if Berkshire is not going to be in acquisition spree, we can assume that its reinvestment requirements will be met by depreciation and other non-cash charges. If this assumption holds good, Berkshire's free cash flows will be equal to its earnings. If so, its free cash flows are going to be $7,998 per share in perpetuity without any growth and more if we assume some growth.
At an expected return of 8% and zero growth, the value of operating business will be $99,970 per share and including investments, Berkshire will be valued at $259,764. If we assume a growth rate of 2% in perpetuity, the value of Berkshire will be $295,753.
If we assume that Berkshire's reinvestment requirement will be a function of its return on equity and growth rate, the value of operating business will be $103,969 and Berkshire value will be $263,763 per share. I have assumed that Berkshire will be able to sustain return on equity of 8.50% and growth rate of 2% forever.
So we have a range of prices and values for Berkshire. Interesting part though is that all are above its current market price of $216,000. Both Buffett and Munger are probably right in their opinion about the future of Berkshire.
I would be surprised if Berkshire fails to achieve a moderate growth in the absence of its star managers. If it will not be a market-beating stock, it will also not be a market-beaten stock.
In 2015, Berkshire class A shares traded at a high price of $227,500 and a low price of $190,007. Let's consider only the high price and remove investments of $159,794 to arrive at the market price of its operating business of $67,706. This price has an implied PE of 8.47. I have not considered the low price because often the market has failed to recognize the value of its operating business altogether, which is illogical. This implied PE has been falling consistently over the last 10 years; it was 37.47 in 2000 and 4.29 in 2012. If we use the 5-year average implied PE of 8.22, the price of operating business will be $65,709 per share and including investments, Berkshire will be priced at $225,503. Again higher than its current market price, but not much.
How about its cash flows? Going forward if Berkshire is not going to be in acquisition spree, we can assume that its reinvestment requirements will be met by depreciation and other non-cash charges. If this assumption holds good, Berkshire's free cash flows will be equal to its earnings. If so, its free cash flows are going to be $7,998 per share in perpetuity without any growth and more if we assume some growth.
At an expected return of 8% and zero growth, the value of operating business will be $99,970 per share and including investments, Berkshire will be valued at $259,764. If we assume a growth rate of 2% in perpetuity, the value of Berkshire will be $295,753.
If we assume that Berkshire's reinvestment requirement will be a function of its return on equity and growth rate, the value of operating business will be $103,969 and Berkshire value will be $263,763 per share. I have assumed that Berkshire will be able to sustain return on equity of 8.50% and growth rate of 2% forever.
So we have a range of prices and values for Berkshire. Interesting part though is that all are above its current market price of $216,000. Both Buffett and Munger are probably right in their opinion about the future of Berkshire.
I would be surprised if Berkshire fails to achieve a moderate growth in the absence of its star managers. If it will not be a market-beating stock, it will also not be a market-beaten stock.
No comments:
Post a Comment