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Berkshire Hathaway Inc. Message Board

  • ignoramus_ ignoramus_ Aug 12, 1998 3:30 PM Flag

    Better measure of earnings for BRK

    Been thinking about the "comprehensive income"
    standard.

    I suggest a different definition of "true" earnings
    that I think reflects the Berkshire reality a lot
    better:

    1) Take regular earnings of operating
    companies
    2) Add underwriting gain
    3) Add income on fixed
    income investments
    4) Add realized and unrealized
    appreciation of non-fixed-income securities IN EXCESS of S&P
    500.

    I think that this measure would more or less
    properly reflect the value that Berkshire
    creates.

    What do you think?

    SortNewest  |  Oldest  |  Most Replied Expand all replies
    • I agree with everything said in this
      message.

      But, one caveat which I believe a lot of people
      overlook, is that BRK is an insurance company, unique in
      its supercat exposure, and WILL eventually have to
      pay up. Put that in your Intrinsic Value
      calculations! THEN tell me how over/undervalued BRK is, because
      I must admit I have no clue how to figure that one
      out.

      Anyway, how would you like to be that Ajit (sp?) dude??
      Trying to figure out the actuarials involved with
      insuring multi-billion dollar catastrophes would give me a
      headache.

      Good Luck to all
      DT123

    • You believe that BRK's underlying businesses,
      like See's or 8% of Coke, would be cheaper if you
      bought those companies directly than if you bought BRK
      stock. However, that assumption is generally not true.
      By buying BRK (when it itself is undervalued), you
      are able to buy KO, G, etc. for below their
      individual market prices. It's also an ongoing mystery in
      finance circles why mutual funds often sell below the
      collective value of their stock holdings, but it happens. As
      recently as 12/31/97, BRK stock was undervalued. It's
      "investments per share" was $38,000 and the intrinsic value of
      its wholly-owned subsidiaries was about $20,000, but
      BRK's market price at the time was only $46,000. You
      could have bought it then and gotten all the stocks in
      Buffett's portfolio on the cheap.

      In addition, if
      you buy BRK stock, you benefit from Buffett's ability
      to obtain businesses (whether in whole or in part)
      AT A DISCOUNT. Maybe you have the same ability as
      Buffett to know when a business is selling at a discount
      or not, but most people do not. For example, Buffett
      is buying GRN now because he believes he can
      purchase it at a discount to underlying value (he's paying
      only $20 bil. for $24 bil. in floate). However, the
      average investor does not have the ability to determine
      whether a potential acquisition is selling at a discount
      or not. Buffett has the patience to wait until a
      stock he likes get extremely undervalued.

      It's
      true Buffett's reputation adds something to BRK's
      stock price. But, as Buffett and Graham have said,
      markets are efficient in the long run (but not
      necessarily in the short run), so even BRK stock will be
      correctly valued by the market over time.

      I disagree
      with your assertion that buying BRK reduces
      diversification. Quite to the contrary, I don't think you could
      get more diversified than owning World Book, Dexter
      Shoes, Dairy Queen, etc. (all different types of
      businesses) at the same time, which owning BRK stock amounts
      to.

    • BRK seems as I am now view it is a mixed mutual
      fund. I think I would rather own the underlying
      companies that are not wholly owned by BRK investing the
      difference in those stocks directly. The consequences of
      investing in BRK is that it reduces diversification and I
      am paying a fee for WEB's stock picking. I am also
      stuck with dogs among the gems. What I am interested in
      doing now is determining what premium I am paying to
      WEB for partial holdings as a percentage of BRK's
      pricing versus investing directly in the underlying
      securities while adding a few of my own. Has anyone here
      done that calculation?

      This is not to say that
      BRK has not been good. It has been great.

    • I think Buffett calculates BRK's intrinsic value
      in two ways, one a short-cut way and the other the
      more comprehensive way.

      The short-cut way is to
      define the intrinsic value of BRK's investments in KO,
      G, etc. as merely their market price and to then
      come up with an "investments per share" figure for
      BRK. In the last 3 Letters to Shareholders, Buffett
      has been providing a table showing BRK's "investments
      per share" and Buffett asserts that this figure is
      the first component of BRK's intrinsic value (the
      other component being the intrinsic value of BRK's
      wholly-owned subsidiaries, determined by discounting their
      aggregate earnings and earnings growth rate).

      The
      more comprehensive way that Buffett determines BRK's
      intrinsic value is to look at not only the earnings of
      BRK's wholly-owned subsidiaries (and discounting them)
      but also to discount the "look-through earnings" of
      BRK's holdings in KO, G, etc. Since Berkshire actually
      owns 8% of Coke's outstanding stock, Buffett believes
      Berkshire (and its shareholders) have a claim to 8% of
      Coke's earnings -- just as if BRK owned 100% of Coke,
      BRK (and its shareholders) would have a claim to 100%
      of Coke's earnings. The SEC merely has a rule that
      says if you own less than 20% of a company's stock,
      you can only claim the dividends on that 20% as your
      own income and not 20% of all the earnings outright.
      But in the case of Berkshire, even if it owns less
      than 20% of Coke, 8% of Coke (worth about $16 bil.) is
      still a huge amount of Coke stock, so Buffett has a
      case when he says Berkshire can properly claim 8% of
      Coke's earnings as its own earnings. Just imagine if BRK
      merged with Coke someday (i.e., owned 100% of Coke). BRK
      (and its shareholders) would have a rightful claim to
      100% of Coke's earnings. The same is true if BRK only
      owns 8% of Coke -- BRK's shareholders have a rightful
      claim to (and actually own) 8% of Coke's earnings. It's
      a transitive relationship: if BRK shareholders own
      BRK (true) and BRK owns 8% of Coke (also true), then
      it must be the case that BRK shareholders own 8% of
      Coke.

    • You are exactly correct about averaging the capital expenditures over a few years to determine how capital-intensive the company will probably be in the future. Excellent post.

    • you don't have to discount the Ko, G etc.. all
      you have to do is discount BRk's earnings out 5-10
      years add them up and add the book value or investments
      per share (this will give u a higher value) and that
      is the intrinsic value

    • I agree. My office must have a ventilation problem...damn.

      JimC
      The Toronto Investment Club
      http://torontoinvest.ndsn.com

    • You are correct, in that some advertising costs
      are if fact capitalized and amortized over a deemed
      useful life. However, I'm not sure whether this would
      ever be material enough to factor into the owner's
      earnings computation. It would depend on the company and
      its industry I guess.

      Incidentally, GAAP
      requires a company to disclose its policy with respect to
      advertising costs (ie..expensed as incurred or capitalized
      and amortized). This was promulgated because of the
      disparity of methods used by different companies (even in
      the same industry). This is most often presented in
      the significant accounting policies footnote.

    • Thanks for a very clear explanation.

      To
      add a very minor point, I think that sometimes
      certain advertising expenses may be capitalized, for
      example Account Acquisition Costs and so on. (Is that
      correct?)

      But generally, you are right.

      Yes,
      that's what buffett talked about: if you add back
      depreciation, then you have to subtract cash outlays that you
      capitalize (eg, Capital Expenditures).

    • JimC:

      I think your definition of capital
      expenditures is too comprehensive. Capital expenditures by
      definition are purchases of plant and equipment.
      Advertising, maintenance and R&D are clearly ongoing,
      recurring operating expenses already reflected in net
      income. Your definition and formula would in essence
      deduct these items twice.

      Mr. Buffett's premise
      is that if you are going to add back depreciation (a
      noncash expense) to net income then you must also factor
      in the average annual expeditures for plant and
      equipment to maintain a company's long-term competitive
      position. Many analysts add back depreciation but do not
      allow for the fact that ongoing cash outlays for new
      equipment will also be required.

      The cash flow
      statement reports annual capital expenditures in the
      "investing activities" section. Presumably, an investor
      would be interested in the average of this line item
      over a period of years.

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