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Berkshire Hathaway Inc. Message Board

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  • Novalis_97 Novalis_97 Aug 8, 1998 12:23 AM Flag

    GEICO refuses to give BRK discounts

    Before or after taxes is not relevant. If, for
    that newspaper example, the newspaper's actual P/E
    (after-taxes) was 30 but Buffett's calculated "intrinsic" P/E
    was 25, then Buffett would determine that the
    newspaper was overvalued. If the actual P/E (after taxes)
    was 20, then he'd determine the paper was
    undervalued. Or you could use the pre-tax P/E values instead
    to determine whether the paper was over or
    under-valued. If the paper's actual pre-tax P/E was above 16,
    then Buffett would determine the paper was overvalued;
    if the paper's actual pre-tax P/E was below 16, then
    Buffett would say undervalued. Whether you use the
    after-tax or the pre-tax P/E is not relevant. Whichever you
    use, you want to compare that to a company's actual
    after-tax or before-tax P/E to determine whether the
    company is over- or under-valued. That was the point of
    that example.

    Look at Coke. It's P/E is around
    50. Its pre-tax P/E will, of course, be lower because
    EPS will be higher. But whether you use the after-tax
    P/E or the pre-tax P/E, you want to compare that to
    Coke's "intrinsic" P/E (what the P/E SHOULD be), as
    determined by discounting Coke's cash flow.

    point of the newspaper example was not so much to say
    anything about using after-tax vs. before-tax figures but
    to show what the change in intrinsic value would be
    if you change the assumptions used in the perpetual
    annuity formula. If you say growth is 6% forever, then
    intrinsic value = $1 mil. / (0.10 - 0.06) = $25 million.
    $25 mil. would be the appropriate amount to pay if g
    = 6%. If the company's market capitalization is
    higher than $25 mil., then it's overvalued. On the other
    hand, if there is no growth over time but earnings "bob
    around" around an unchanging value, g = 0% and intrinsic
    value = $1 mil. / (0.10 - 0.00) = $10 mil. In this
    case, if the company's market cap. is $15 mil., the
    company is overvalued.

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