Wednesday, November 19, 2008

Thoughts on Berkshire's valuation

This is patterned on the two-column approach to Berkshire's valuation that Buffett encourages in his most recent shareholder letters.

Value of cash + investments at the end of Q3 (under "Insurance and other"): $133.525 billion

Annualized post-tax non-insurance operating earnings for 2009, net of minority interests: $4.24 billion

Market value of Berkshire today: $148.01 billion (B's selling for $3125 a share)

Unrealized investment losses in equities since the start of the year: $7.504 billion (and climbing since Q3)

If you believe the market value of Berkshire's equity holdings represented fair value at the end of Q3 (I dont, and you only need to look at the unrealized investment losses number to believe that this is a reasonable supposition) , then the implied multiple on the post-tax earnings of the non-insurance business is 3.4. 

Since the end of Q3, Berkshire has bought $8 billion worth of preferreds in GE and GS yielding 10%, along with an equity kicker. There's the MidAmerican deal to buy CEG. There is still about 9.8 billion worth of cash that can be deployed (leaving aside the $10 billion that WEB has said he'd set aside for insurance payments). And then, there's the bonds worth about $30 billion, a portion of which is likely to be committed to equities as the market continues to decline. And, last but not the least, the cash thats pouring into Omaha every week (about $8.428 billion for the first 9 months of 2008).

In my opinion, at these prices, Berkshire's current non-insurance businesses are being given away for free, businesses earning about $4.24 billion annually(in a recessionary environment), and Berkshire's current equity holdings are also more than likely undervalued. With Buffett and Munger at the helm, Berkshire is beautifully positioned to take advantage of a situation like today's, both on the investment side and the operational side. 

Berkshire has not been this cheap since Buffett's buyback offer in the middle of 2000. This doesnt mean the price wont get cheaper. It could, but that'd likely only make it an even better bargain than it is already. Berkshire's intrinsic value is growing rapidly at the same time that its price is declining. The spread between price and value will converge ultimately though and that ought to be the only thing that matters to folks buying at today's prices.

Disclosure: Long Berkshire, although I havent added to my position since the middle of 2006.

Often wrong but seldom in doubt,

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