Trying to Place a Value on Berkshire Hathaway
- By Rupert Hargreaves
Placing a value on a business is always going to be a highly subjective process. The value of a company will depend on a valuers' experience in an individual industry and the quality of the management team running the business in question.
These are the reasons why Benjamin Graham always advocated having a range of values when analyzing the worth of a stock.
By using a range of values, he believed investors could increase their chances of buying and selling the stock near to the right value. Graham thought there was no point in pinpointing the value of a business down to the last dollar and cent because one would never have all of the information required to come up with such an accurate value.
This is the challenge investors will face when trying to value Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). We only know so much about the company. Warren Buffett (Trades, Portfolio) has said he tries to publish as much information as investors need to calculate their own estimate of intrinsic value for the business. However, he's never published a formula he thinks investors should use to arrive at this figure.
The method Buffett seems to use most often to value businesses is a discount cash flow analysis. This may not be the best process to use to value Berkshire, however, due to the nature of the business. The cash flows of financial and insurance businesses can be incredibly volatile and lumpy. As one of the group's three primary business divisions is insurance, this could present a challenge.
Nevertheless, we can use the method to arrive at a rough value.
A Berkshire DCF
In 2020, Berkshire generated $39.8 billion of cash from operations. The group's capital spending totaled $13 billion, which gives an estimated free cash flow for the year of $26.8 billion.
Based on these numbers, and using a 6% discount rate, a discount cash flow analysis with forecast cash flow growth of 2% per annum in perpetuity gives a value for the group's B shares of $298.51.
So that's one way of valuing the business. Another strategy would be to use the group's book value. As is the case with the discount cash flow analysis, this method has its benefits and drawbacks.
Based on its latest accounts, Berkshire's overall book value at the holding company level sits around $192. Buffett's previous share repurchase boundary was 1.2 times book ($230). On that basis, one could argue that the stock looks cheap at $230 per share.
But this is a very blunt way of trying to value a complex business.
Alongside its mammoth insurance business, Berkshire also owns BNSF and Berkshire Hathaway Energy. Comparable public companies are trading at a price-book ratio of 2 to 8 times. Berkshire lists its railroad, utilities and energy businesses as having a book value of $111 billion.
Comparable public company ratios suggest this business could be worth between $222 billion and $888 billion using book value alone.
The insurance business is another problem. Many insurance businesses are not worth more than book value. However, those with a strong franchise can command values of 2 or 3 times book value.
These figures do provide some guidance. There's a good argument to be made that Berkshire is worth 2 times book value based on comparable valuations for underlying businesses. This gives it a value of $384 per B share.
The bottom line
These numbers illustrate how difficult it is to arrive at an accurate evaluation for any business, let alone a company that's as complex as Berkshire. Still, the figures imply the company to be worth anywhere between $230 and $384 per share.
With the stock sitting toward the lower end of this range, there's a good argument to be made that Berkshire is cheap.
Disclosure: The author owns no stocks mentioned.
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This article first appeared on GuruFocus.
