What is the value of Warren Buffett’s Berkshire Hathaway?
Believing completely in my valuation model and approach, I now rarely read about “the world’s greatest living investor” Warren Buffett and his legendary investment company Berkshire Hathaway.
But perhaps I should pay more attention? Because it seems that each deal or media appearance is worthy of further scrutiny and the well-reported $US26 billion buyout of railway company Burlington Northern Santa Fe is no exception.
This largest-ever Buffett investment, combined with a strong Australian dollar and a controversial 50-for-1 split of the Berkshire B class shares (which lowers their share price from $US3325 per share to about $US67) makes a back-of-the-envelope valuation of Berkshire Hathaway an interesting exercise.
So, with enthusiasm, I offer my value of Berkshire Hathaway.
The average annual compounded rate of growth in Berkshire’s book value – its equity – is equal to its return on equity. We can thus approximate the true rate of return on equity for Berkshire by examining the actual rate of change in book value.
Post acquisition, intrinsic value will not increase by the attractive rate it has in the past, unless returns on equity of the past can be maintained as the book value of the company continues to expand. The law of large numbers applies here. It is relatively easy to achieve 20% on $1 million – I can think of two stocks right now that will do that for you over the next two years (and I’ll be writing about these companies in the coming weeks for Alan Kohler’s Eureka Report), but achieving 20% on the $US118 billion of book value Berkshire has today will be a lot more difficult. That is why Buffett needs elephants, and elephants at the right price.
In the four or five decades since 1964, book value has grown by a compounded rate of 20.1 percent – a startling effort – and because of the high rate of return on equity that it reflects, each dollar retained has created more than a dollar of long-term market value. That is why the share price of Class A shares now stands at over $US100,000 per share.
But Buffett has always warned that, in the future, the massive amounts of capital at his disposal means that while you and I have a universe of thousands of companies that can have a material positive impact on our wealth, his investment universe is a few hundred at best. He needs elephants, and if he doesn’t get them his return on equity must inevitably fall. Recently return on equity has averaged 7.5%.
In valuing the shares, there is the A-class, which trade at over $US100,000 each, and the B-class, to which I referred earlier. The simplest way for me to convey the value is to estimate an A-Class equivalent valuation. And to cut to the chase, the value – based on an assumed 12% return on equity (optimistic perhaps) – is approximately $US108,000.
Given that the B-class shares, as an investment, are 1/30th the value and are about to be split 50-for-1, the value of them based on the optimistic return on equity is $US72. If, however, you assume that Berkshire Hathaway continues to achieve the average 7.5% returns on equity it has recently, the valuation falls dramatically because Buffett is retaining profits and generating a rate of return on them that is less than I can achieve elsewhere.
In such circumstances, the only price to pay is a discount to the forecast $US82,000 per-share book value of the company – about $35 per post-split B-class share.
By Roger Montgomery, 13 November 2009
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.INVEST WITH MONTGOMERY