Monday, January 29, 2007

So, What's Berkshire Worth Anyway?

It seems to be pretty clear to most value investors that Berkshire Hathaway is a bargain. But, how big of a bargain is it and how much can we expect to make over the next few years by purchasing a stake in Warren Buffett's masterpiece today?

I view the value of Berkshire as consisting of 2 parts: (1) the investments per share (which includes a massive amount of cash on hand and also includes part ownership of some of the best businesses in the world -- Coca-Cola, American Express, Washington Post, etc.), and (2) the value of the operating businesses.

So what are the 2 parts worth? Total cash and investments per share should be a little over $80,000 per share at the end of 2006, so we'll value these at the market value of $80,000. Now, pre-tax income is going to be very good in 2006 because there was very little hurricane activity. Since we are going to be putting a multiple on these earnings, it is necessary that we normalize them. If we assume that 2004 was a normal year, which I feel is conservative because this was the second worst year ever (after 2005) for hurricane losses, then normalized earnings this year should still be about $5,000 per share. So what is a conservative multiple for these earnings? I think considering the quality of the businesses producing these earnings and the current interest rate environment, a 12 multiple on the pre-tax earnings is a safe number, especially since Berkshrire is still one of the fastest growing large caps in the world. So $80,000 in investments per share + ($5,000*12) = $140,000 value per A share ($4,667 per B share).

So, if we assume investments per share grow at an average rate of 8% over the next 3 years and operating earnings grow at an average rate of 10% over the next 3-5 years (both of which I feel are very conservative -- but remember, Berkshire's growth can be a little lumpy), then we get a value 3 years out of about $180,000 per share and 5 years out of about $215,000 per share. This would yield an annual rate of return of about 15-20% per year over the next 3-5 years by purchasing shares around today's price of $108,000 per A share ($3,600 per B share).

What's the best part about this investment? No, it's not that you are getting a very attractive return and the chance to buy into a business with huge competitive advantages and a rock-solid balance sheet at a 20-30% discount to intrinsic value (although that is very nice). The best part about this investment is that you are getting that 20-30% discount without having to pay a penny in premium for the capital allocating ability of Warren Buffett. You're getting a great business, at a very good price, and you're getting "The Great One" for free.

*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.