What is Berkshire Hathaway Truly Worth?

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Investors like to follow every single step of Warren Buffett, the most successful investor of all time. Over the years of managing Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), he has been quite reluctant to repurchase the company’s shares in the stock market. However, in a 2011 annual letter, Buffett wrote that he would buy back stock “aggressively” at the limit price of 110% book value or lower. Recently, Berkshire Hathaway announced that it has bought 9,200 Class A shares for $131,000 per share with the total transaction value of $1.2 billion from the estate of a long-time shareholder, simultaneously raising the cap to repurchase up to 120% of the book value. Should we follow Warren Buffett into Berkshire Hathaway now? Let’s look deeper to roughly determine its intrinsic value.

Warren Buffett and his partner, Charlie Munger often mentioned that they constantly studied segment figures, as the consolidated number would obscure the earning power of each business segment. In order to valuing Berkshire Hathaway, I would divide it into two main segments: The operating business and the value of its investments, both backed by the float generated from the Insurance business. 

The Insurance Business

Berkshire Hathaway is known as an insurance company, as it is the main business operation. The insurance business generates a lot of float, the amount of cash that Berkshire Hathaway gets from writing insurance policies. If the company were breakeven with its underwriting business, the float the Berkshire Hathaway manages would be “free.” In 1970, the float was only $39 million, and in 2011, it has increased significantly up to $70.57 billion, with a compounded annual growth of more than 20%. It is magnificent that the 20% annualized growth is spreading out in more than 40 years. As of September, the float that Berkshire Hathaway reported was $72 billion.

If we conservatively assume that in the future, the Berkshire Hathaway float would grow only a fourth of its historical growth, or 5%, the company would generate only 10% return on its float, or $7.2 billion, and the discount rate was 10%. With Gordon Growth Model, the value of its insurance business would be $151.2 billion.

<table> <tbody> <tr> <td> <p>Annual earnings ($bil)</p> </td> <td> <p>Infinity Growth</p> </td> <td> <p>Discount rate</p> </td> <td> <p>Terminal value ($bil)</p> </td> </tr> <tr> <td> <p>7.2</p> </td> <td> <p>5%</p> </td> <td> <p>10%</p> </td> <td> <p>151.2 </p> </td> </tr> </tbody> </table>

Operating Businesses

The float is one of the main sources to fund Berkshire Hathaway’s investments for acquiring businesses classified into three sub-segments such as: Regulated Capital Intensive Business (Burlington Northern Santa Fe and MidAmerican Energy), Manufacturing, Service and Retail Operation; and Finance and Financial Products. Over the last 3 years (2011, 2010 and 2009), the average pre-tax earnings of the operating business (including insurance underwriting income) were $15.2 billion. Applying a 10% earning yield, the total value of all operating businesses in Berkshire Hathaway would be $152 billion.

The Fair Value of Investments

As of September, the total investments booked in Berkshire Hathaway’s balance sheet was around $133 billion. The majority of its investments were in equity securities, $87 billion, and $31 billion was invested in fixed maturity securities. Warren Buffett is famous for his stock picks, thus the $87 billion in equity securities would comprise its 38 stocks in Berkshire Hathaway’s stock portfolio. Coca-Cola (NYSE: KO) was still the biggest holdings, with 400 million shares, of nearly $15.2 billion in total value, accounting for 20.1%. Wells Fargo (NYSE: WFC), the long-term holding that Buffett first initiated his purchased in 1989, ranked the second. Berkshire Hathaway currently owned more than 422.5 million shares of the bank, with the total value of nearly $14.6 billion, accounting for 19.4% of the total portfolio. International Business Machines (NYSE: IBM), which Buffett just recently purchased last year, stood in the third place. Berkshire Hathaway bought more than 67.5 million shares of IBM, with the total value of $14 billion, accounting for 18.6% of the total portfolio. 

Now the Estimated Intrinsic Value…

Putting it all together, the intrinsic value of Berkshire Hathaway is the sum of two parts: the fair value of its investments (could instead use the value of the insurance business), and the value of its operating businesses. The insurance business was conservatively estimated to be worth $151.2 billion, the fair value of its investments was $133 billion (as of September 2012), and the estimated value of the operating businesses was $152 billion. So the intrinsic value of Berkshire Hathaway would be around $284 - $303 billion. The current enterprise value of the company is $231.41 billion. So Berkshire Hathaway is trading 23% - 31% off its intrinsic value.

Foolish Bottom Line

The move to buy back $1.2 billion from the estate of a long-time shareholder would increase the value of Berkshire Hathaway further. As of September, the book value of the company was $184.6 billion. Warren Buffett has effectively raised the repurchase cap of 120% book value, or $221.52 billion. Clearly, the intrinsic value of Berkshire Hathaway would not stand still but increase over time. As usual, investors might consider aligning with this legendary investor into Berkshire Hathaway for a long time.

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway, International Business Machines, and Wells Fargo & Company. Motley Fool newsletter services recommend Berkshire Hathaway, International Business Machines, The Coca-Cola Company, and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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