Friday, February 20, 2009

Analysis of Berkshire Hathaway

The paragraphs below are from an article by Whitney Tilson in November of last year when people were worried about Berkshire's index puts. T2's full analysis of Berkshire is available HERE. As Mr. Tilson pointed out, the worries were overblown and Mr. Buffett didn't need to earn a real high return for them to end up profitable, even if the markets didn't recover in any dramatic fashion over the next 13.5 years. Since then, Buffett has been putting money to work, in senior position securities, at rates higher than those Tilson mentioned, in high quality companies such as Harley Davidson and Tiffany (among others). If anything, Berkshire's value has probably increased a bit since Tilson's article, unless, of course, you assume Buffett has lost his touch, which a big portion of sellers seems to think is the case. I tend to disagree and think that Buffett has gotten better. Economic times are tough, markets are volatile and it may be tough to keep a cool head. But what do you want to own coming out of this? Maybe a diversified business that is stacked with competitively advantaged businesses with good balance sheets to take advantage of weaker competitors, where the excess cash and float from all of the businesses are being reinvested by the man who is very likely the greatest investor of all time, at a valuation that may be the cheapest on a price to current value than it has ever been since Mr. Buffett took over in the 1960's? I think so, and I think this is one of those 20 punch card investments that Buffett has talked about. As I type, the Berkshire B shares are at $2,340 per share. There is actually a greater than 6% difference from what the A shares are and should be trading at in relation to the B shares, so there is some added pressure on the B's (divide T2's valuation of the A shares by 30 to get the equivalent value for the B's). I think this is a value that, although we can't predict what will happen over the short run, will prove to be one of the greatest risk vs. reward opportunities I will ever see. The question the investor needs to ask now is: Do I have the fortitude to be greedy when others are fearful?

At $77,500, Berkshire’s stock today is the cheapest, by far, we have ever seen it, going back at least a dozen years.

We estimate Berkshire’s valuation the same way Buffett does: we value the investment per share (cash, bonds and stocks) at market and then place a 12 multiple on the pre-tax operating profits of the company (for more details on this as well as our entire analysis of Berkshire, see our presentation, which is posted here). As of the end of last year, investments per share were $90,343 and our estimate of normalized pretax earnings was $5,500-$5,700/share, which resulted in an estimate of intrinsic value of $156,300-$158,700.

As of the end of the third quarter, investments per share had fallen to $86,000 due to declines in the prices of stocks Berkshire holds as well as Buffett investing tens of billions of cash in a wide range of operating businesses. In light of the severe market decline in October and so far in November plus additional investments Buffett has made, we estimate that investments per share might have fallen to as low as $76,000.

As for Berkshire’s earnings, they are obviously impacted by the weak economy, but this is offset by the many new businesses Buffett has purchased. Over time, the many investments and acquisitions Buffett’s made this year will lead to much higher earnings, but for the next 12 months, to be conservative, let’s assume that pretax earnings are $5,000/share (assuming the severe recession continues and a normal super cat year). This results in an estimate of intrinsic value of $136,000, 76% above today’s level.
Another way to think about Berkshire’s value is to consider that Berkshire’s share price today barely exceeds investments. Thus, today one can own the collection of fabulous businesses that Buffett has acquired over the years for less (pretty much for free).

In this environment, it’s not surprising to us that the stocks of companies with shaky balance sheets, poor business models and/or weak competitive positions are getting clobbered, but Berkshire’s freefall in the past few weeks is certifiably crazy – and a buying opportunity that will long be remembered.