“If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.” —Charlie Munger
Shareholder Letter and Annual Report 2015
Today Warren Buffett’s yearly letter to shareholders was published (click here to read). At the same time the Berkshire annual report for fiscal year 2015 was released (click here for the annual report.
For anyone interested in business analysis and investing this letter should not be left unread. I will not dwell on the content in the letter, except for updating my current estimate of per-share intrinsic business value.
Below, some financial key metrics for the past five years that you will find on page 34 in the annual report.
Per-share book value (for both Class A and Class B stock) increased with 6.4 % during 2015 to $155,501 (Class A) and $103.67 (Class B).
In the section “Intrinsic Business Value,” Warren discusses the qualitative factors used in valuing Berkshire. As always he emphasizes the inherent uncertainty that applies to all kinds of valuations.
As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). It is possible, however, to make a sensible estimate. In our 2010 annual report we laid out the three elements – one of them qualitative – that we believe are the keys to an estimation of Berkshire’s intrinsic value.
In the next paragraph Warren provides two critical inputs to a per share intrinsic business value per share: 1) per-share cash and investments of $159,794, and 2) pre-tax earnings from our many businesses (including insurance underwriting income) of $12,304 per share. This is the first year that insurance underwriting income has been included in the earnings figure.
I used the italics in the paragraph above because we are for the first time including insurance underwriting income in business earnings. We did not do that when we initially introduced Berkshire’s two quantitative pillars of valuation because our insurance results were then heavily influenced by catastrophe coverages. If the wind didn’t blow and the earth didn’t shake, we made large profits. But a mega-catastrophe would produce red ink. In order to be conservative then in stating our business earnings, we consistently assumed that underwriting would break even over time and ignored any of its gains or losses in our annual calculation of the second factor of value.
Today, our insurance results are likely to be more stable than was the case a decade or two ago because we have deemphasized catastrophe coverages and greatly expanded our bread-and-butter lines of business. Last year, our underwriting income contributed $1,118 per share to the $12,304 per share of earnings referenced in the second paragraph of this section. Over the past decade, annual underwriting income has averaged $1,434 per share, and we anticipate being profitable in most years. You should recognize, however, that underwriting in any given year could well be unprofitable, perhaps substantially so.
In the table below I have updated my rough valuation using the data as reported by Berkshire as of today (see links above).
Before this update my rough estimate of per-share intrinsic business value (IBV) per share was $168 per B-share, equal to $252,000 per A-share. The updated IBV per share below was calculated using the so-called two bucket approach, that is per-share cash and investments plus pre-tax earnings times chosen earnings multiple.
A 10x earnings multiple is equal to approximately a 15x after-tax earnings multiplier.
Using a 10x pre-tax multiple without including any insurance underwriting income results in a per-share IBV of $181 per B-share, equal to $271,654 per A-share. If one were to include insurance underwriting income the per-share IBV would increase to 189 per $B-share, equal to $282,834 per A-share.
As for now I will update my watch list with the IBV per B-share excluding insurance underwriting income, that is $181, let’s round it down to $180.
Earlier I have used a price-to-book multiple of 1.65 times. At 1.65 times book the current value per share is $171. A price to book multiple of 1.65 looks like a reasonable multiple compared to the past, and it might even be a bit conservative compared to the values in the table below. So for now I will keep the 1.65 times multiple as rough proxy.
Buffett himself is willing to repurchase stock at a price to book of 1.2 or lower. Assuming Buffett is willing to repurchase Berkshire stock at 2/3 of intrinsic value, this would imply a price to book multiple of 1.8 times, pretty much in line with the per share IBV when using a 10x pre-tax earnings multiplier (including insurance underwriting income) and adding per-share cash and investments.
A reasonable range for the IBV per B-share looks to be about $104 to $189 ($155,501 to $282,834 per A-share).
For your attention I made my first purchase of B-shares back on September 8, 2015, when the market price was $132.21 per share, slightly above the closing market price of yesterday.
Disclosure: I have a position in the BRK.B stock mentioned. I am not receiving compensation for it. I have no business relationship with the company. 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.