Keep INVESTING Simple and Safe (KISS)
****Investment Philosophy, Strategy and various Valuation Methods****
The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Berkshire Hathaway: A Safe, High-Quality, Growing Company
Stock price (5/4/17): $249,540
$166.34 for B shares
Shares outstanding: 1.64 million
Market cap: $409 billion
Total assets (Q4 '16): $621 billion
Total equity (Q4 '16): $286 billion
Book value per share (Q4 '16): $172,108
Repurchase maximum price (1.2x book): $206,530
Downside to the Buffett repurchase put: 17%
Float (Q4 '16): $92 billion
Revenue: $224 billion
Berkshire Hathaway today is the 11th largest company in the world (and 4th largest in the U.S.) by revenues
Berkshire Hathaway today does not resemble the company that Buffett bought into during the 1960s
It was a leading New England-based textile company, with investment appeal as a classic Ben Graham-style "net-net"
Buffett took control of Berkshire on May 10, 1965
At that time, the company had a market value of about $18 million and shareholder's equity of about $22 million
Buffett is doing a good job investing – the latest examples being Precision Castparts, Kraft and Duracell– but the cash is coming in so fast (a high-class problem)!
Berkshire will generate free cash flow equal to the $32.7 billion paid for PCP in ~2 years
Markets have a way of presenting big opportunities on short notice
Junk bonds in 2002, chaos in 2008
Buffett has reduced the average maturity of Berkshire’s bond portfolio so he can act quickly
"Over the years we've…attempt[ed] to increase our marketable investments in wonderful businesses, while simultaneously trying to buy similar businesses in their entirety." – 1995 Annual Letter
"In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshire's intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per-share ownership of investments (including cash and equivalents) and the second column shows our per-share earnings from Berkshire's operating businesses before taxes and purchase-accounting adjustments, but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column." – 1997 Annual Letter
"In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs." – 1997 Annual Letter
Buffett's Comments on Berkshire's Valuation Lead to an Implied Historical Multiplier of ~12x
1996 Annual Letter: "Today's price/value relationship is both much different from what it was a year ago and, as Charlie and I see it, more appropriate."
1997 Annual Letter: "Berkshire's intrinsic value grew at nearly the same pace as book value" (book +34.1%)
1998 Annual Letter: "Though Berkshire's intrinsic value grew very substantially in 1998, the gain fell well short of the 48.3% recorded for book value." (Assume a 15-20% increase in intrinsic value.)
1999 Annual Letter: "A repurchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value...We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated...Recently, when the A shares fell below $45,000, we considered making repurchases."
Unlike Buffett, we included a conservative estimate of normalized earnings from Berkshire's insurance businesses: half of the $2 billion of average annual profit over the 12 years prior to 2014, equal to $600/share prior. Starting in the 2015 AR, Buffett began to include all insurance earnings, so this is reflected in 2014 and 2015 earnings. Both we and Buffett exclude investment income.
Historically we believe Buffett used a 12 multiple, but given compressed multiples during the downturn, we used an 8 in 2008-2010 and 10 since then.
Berkshire Is Trading 16% Below Its Intrinsic Value
* Investments per share plus 12x pre-tax earnings per share through 2007, then an 8x multiple from 2008-2010, and a 10x multiple thereafter. 12-Month Investment Return • Current intrinsic value: $296,000/share • Plus 6% annual growth of intrinsic value of the business • Plus ~$10,000/share cash build over next 12 months • Equals intrinsic value in one year of $324,000 • 30% above today's price Catalysts • Continued earnings growth of operating businesses • Likelihood of meaningful acquisitions • New stock investments • Additional cash build • Share repurchases (if the stock drops to 1.2x book or below; it’s
currently at 1.45x) Conclusion: Berkshire Has Everything I Look for in a
Stock: It's Safe, Cheap and Growing at a Healthy Rate • Extremely safe: Berkshire's huge hoard of liquid assets, the
quality and diversity of its businesses, the fact that much of its
earnings (primarily insurance and utilities) aren't tied to the
economic cycle, and the conservative way in which it's managed
all protect Berkshire's intrinsic value, while the share repurchase
program provides downside protection to the stock • Upside: trading 16% below intrinsic value (without giving any
credit to immense optionality), with 30% upside over the next
year • Downside: Only 17% downside to 1.2x book value, which is
where Buffett it will to buy the stock, thereby putting a floor on it. • Growing: Intrinsic value is growing at roughly 6-8% annually