Berkshire Hathaway: Intrinsic Value (Part 2)

Adjusted book value per share

In this post I will take a look at two balance sheet items on the liabilities side, and adjust the reported book value figure for float (a liability or “Money we hold but don’t own” as Warren explained in the shareholder letter in 1997) and the deferred tax liability. This will result in an adjusted book value per share, that can be compared to book value per share as reported in Berkshire’s financial reports, and also to the market price per share.

Before getting into the adjustments I have inserted a few quotes below from Warren to give some context, and also to provide some reasoning for the adjustments that will be done to book value.

Book value far understated intrinsic value

“Book value far understates Berkshire’s intrinsic value, a point true because many of the businesses we control are worth much more than their carrying value. Inadequate though they are in telling the story, we give you Berkshire’s book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire’s intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value.” ― Warren Buffett, Owner’s Manual

Deferred tax assets and float: The benefit of debt

“Of course, we ourselves will periodically have a terrible year in insurance. But, overall, I expect us to average an underwriting profit. If so, we will be using free funds of large size for the indefinite future.” ― Warren Buffett, Letter to Shareholders 2008 

“Besides, Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets than our equity capital alone would permit: deferred taxes and “float,” the funds of others that our insurance business holds because it receives premiums before needing to pay out losses. Both of these funding sources have grown rapidly and now total about $135 billion. Better yet, this funding to date has often been cost-free. Deferred tax liabilities bear no interest. And as long as we can break even in our insurance underwriting the cost of the float developed from that operation is zero. Neither item, of course, is equity; these are real liabilities. But they are liabilities without covenants or due dates attached to them. In effect, they give us the benefit of debt – an ability to have more assets working for us – but saddle us with none of its drawbacks.” ― Warren Buffett, Owner’s Manual

Adjustments made and some explanations behind them

• Reported book value per A-share has been taken from the annual reports of Berkshire, except for the quarter ending in March 2014 that has been taken from the first quarterly report of 2014.
• Assuming that the insurance business as a whole runs an underwriting profit on average means that the cost of funding the float is zero or negative. If this is the case the economic value of float is zero, i.e., no liability. From this, a conservative estimate that looks reasonable would be to add back 80% of this float liability. Adding back 100% at the end of Q1 2014, would increase the adjusted book value per A-share by approximately $9,500.
• Deferred tax liabilities, most of them related to unrealized profits on investments that won’t be paid until realized. Depending on how long, also an interest-free loan that is dependent on when it will be repaid. Assuming that Berkshire will hold on to its investments for the long run, with some divestments expected to take place during the coming years, adding back 80% of the deferred tax liabilities looks like a reasonable assumption. Adding back 100% at the end of Q1 2014, would increase the adjusted book value per A-share value by approximately $7,300.

See graph below for an comparison of this adjusted book value, as described above, to the market price for the last ten years. Historical prices for Berkshire’s A-share (NYSE:BRK.A) has been taken from Google Finance.

The table below shows the adjustments made to book value, with all numbers being stated as per share of A-shares. Click on images to view larger versions.

Some concluding thoughts: Book values so far

Adjusted book value per A-share from the above table amounts to $205,604 ($137 for B-shares)at the end of March 2014, compared to $187,350, giving a margin of safety of 9.7%.

Summarizing the different values so far, from this post and the earlier one, we get some interesting amounts.

Abbreviations used in the table are:

• BV, % = Cell X / Book Value
• MP, % = Cell X / Market Price
• MoS = MP,% – 1

In the next post I will look at intrinsic value from the so-called two-bucket approach that derives the value from per-share investments and value of non-insurance businesses.

Looking at the end of the first quarter 2014, there still was some room for the market price to catch up to the estimated adjusted book value. At the same time the margin of safety was 9.7%, the lowest since year-end of 2011.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

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