The Book Value (BV) of Berkshire Hathaway per
2014
AR (released 2/2015) is $146,186 per BRK.A share or $97.46 per BRK.B
share compared to $134,973 per BRK.A share or $89.98 per BRK.B share as of last
year. The stock currently trades at $147.41 or 151.25% of BV - the premium over
book value has gone up substantially over the last year as that percentage was
at 128.67% ($115.78 share price) this time last year. Buffett’s repurchase criterion
is 120% of BV or $116.95. The premium to book value has widened as the stock returned
27% over the last year compared to book value growth of 8.3%. Net earnings are at
$12,092 per BRK.A share for a ttm-PE of 18.29. This is compared to a ttm-PE of
14.66 last year and 16.93 the year before.
Historical BV Growth: CAGR 1965-2014 at 19.4% vs 9.9% for S&P500.
For 2014, BV-growth was 8.3% for Berkshire Hathaway compared to 13.7% for
S&P 500.
Earnings: $12,092 in 2014 vs $11,850
in 2013 and $8,977 in 2012 per BRK.A share. 2% YOY increased compared to 32%
YOY last year. The increases are attributable to impressive cash generation of
its operating entities. It was also helped by realized investment gains (after
tax) of $3.3B in 2014, $4.3B in 2013, and $2.2B in 2012. PE is 18.29 including
investment gains - at this time last year, PE was at 14.66. Roughly a
third of Berkshire earnings are realized gains historically and so the last few
years have shown a divergence on that count.
Intrinsic Business Value: The two quantitative components of value:
- Per-share investments grew 8.4%
to $140,120 in 2014 - lower compared to 13.6% for 2013. CAGR since 1970 is
at 19% but was only 6.6% in the 2000-2010 time period - long-term growth
is stunning but lumpy over shorter timeframes, and
- Pre-tax earnings from
businesses other than insurance and investments increased 19% to $10,847 -
higher compared to 12.8% for 2013. CAGR since 1970 is at 20.6% and 20.5%
in the 2000-2010 time period.
The third is a measure of the efficacy with which retained
earnings will be deployed in the future - the subjective component.
Growing operating earnings is the main focus. Berkshire did
a few deals whereby ownership stakes in businesses were exchanged for parts of
operating businesses: Phillips 66 and Graham Holdings shares were exchanged in
tax-free transactions. Also, they have a contract with Procter and Gamble to
acquire Duracell the same way.
Plans to continue building Berkshire’s per-share intrinsic
value by:
- Focusing on increasing earning power at subsidiaries
both organically and through bolt-on acquisitions,
- Growth of equity investments,
- Repurchasing when there is meaningful discount to
intrinsic value,
- Making acquisitions while rarely issuing new shares.
Earnings at the non-insurance businesses: Pre-tax earnings at $17.5B in 2014 compared
to $15.5B in 2013. One bad news: $6B capex projected for BNSF in 2015.
“Powerhouse Five” -
Berkshire Hathaway Energy (BHE - formerly MidAmerican Energy), BNSF, IMC (Iscar),
Lubrizol, and Marmon - $12.5B of the earnings is from these five businesses.
This year, they contracted
for 31 bolt-on acquisitions - to cost $7.8B in aggregate - Duracell to close H2
2015 and to be placed under Marmon.
BHE & BNSF are
capital intensive with a huge amount of regulated assets partially funded by
long-term debt. The debt coverage is very good (8:1 for BNSF currently) even
under worst-case assumptions about economic conditions - further, the coverage
ratios are based on pre-tax earnings - EBITDA to interest is the commonly used
measure but that is flawed as it ignores the capital-intensive nature of the
business.
Manufacturing,
service & retail operations: ROC at 18.7% after-tax on $24B of tangible
assets.
Finance Products -
~31K homes sold - $13B mortgage portfolio. Leasing businesses benefit as
manufacturing is in-house in some cases: this reduces the cost-of-inventory
compared to retail pricing which will filter over to the income statement
(smaller annual depreciation charges) in coming years.
Underwriting profit
at the insurance businesses stood at $2.7B for 2014.
Van Tuyl Automotive
dealerships acquisition: ambition is to grow it to multiples the size of $9B of
sales at Van Tuyl currently.
3G Capital Partnerships: Successful Heinz partnership and participation in the Tim Hortons
acquisition by Burger King in a financing role. They are also conducive to more
partnerships with 3G, Mars, Leucadia, and others.
Co-Managers: Todd Combs and Ted Weschler invested $7B
each and they outperformed Buffett in 2013. For 2014, their roles were expanded
to also include running businesses - they took over as Chairman of one business
each - combined, those businesses are very small earning around $100M annually
- Buffett’s way of developing a deep-bench!
Long-term economic goal: maximize average rate of
gain in intrinsic business value on a per share basis. Preference is to own a
diversified group of businesses with consistent above-average ROC and second
choice is to own parts of such businesses.
Look-through earnings relevance: “Undistributed earnings of our
investees, in aggregate, have been fully as beneficial to Berkshire as if they
had been distributed to us”. So,
- It is preferable to purchase
$2 of earnings that are not reportable rather than $1 of reportable
earnings for the same acquisition cost, and
- Look-through earnings
realistically portray yearly gain from operations.
“Big-four
investments” (AXP, KO, IBM, WFC) - Berkshire’s share of their earnings was
$4.7B - this is compared to the $1.6B dividends that is reported. But, since
these are excellent businesses, the unreported $3.1B in earnings are as
valuable as the $1.6B reported.
Use of leverage: “We use debt sparingly and, when we
do borrow, we attempt to structure our loans on a long-term fixed-rate basis”
Selling businesses: No interest in selling good businesses Berkshire
owns. Sub-par businesses are also not sold as long as they are able to generate
at-least some cash and managers/labor relations are good. Capex decisions for
the latter are made in a much more cautious fashion compared to the former - it
is unlikely that sub-par businesses will see increased profitability with
increased spending.
BV growth vs S&P 500 Performance Comparison: While this comparison
is shown in the first page of the Annual Letter, it has become less meaningful
over time. The reasoning has to do with how Berkshire’s business structure has
evolved: equity holdings tend to move with S&P 500 and that is now a much
smaller portion of overall value. Also S&P 500 gains are reported at 100%
while Berkshire’s realized gains get reported at 65% because of taxes.
Also, there is another major shortcoming with this comparison: The carrying
value of the businesses that are controlled by Berkshire is much more than
their carrying value and so the BV far understates Berkshire’s Intrinsic Value.
But, IV by definition (discounted value of cash that can be taken out during
the remaining lifetime) is an estimate and so is not quoted in any of the
releases.
Below is a YoY comparison of Berkshire Hathaway's largest equity investments:
Exxon Mobil (XOM) and Tesco plc (TSCDY) are not in the list
as they were both sold-out. Phillips 66 (PSX) is not in the list as the shares
held were exchanged for an operating business acquired from PSX in a
tax-free-transaction. Davita HealthCare Partners (DVA), Deere & Company (DE), and USG Corporation (USG) are new to this list this year as those holdings and their values have grown to be among his top investments - not because they are new positions.
Below is a comparison of Berkshire Hathaway's asset
distribution in the "Insurance & Other" area for the last five
years:
The equity exposure is at just over 53% - it is near the
highs reached last year. So, it is apparent that Buffett is not that concerned
about valuation of his holdings despite the increases in the last few years.
Expects stocks to
outperform with lesser risk over the long-term: Vast out-performance of
stocks versus other securities (treasuries, etc.) historically can be traced back
to the fact that currency-denominated-securities are far less volatile but
higher risk (purchasing power reduction of currencies over time constantly works
against you). This is the opposite of what is taught in business schools -
volatility is synonymous with risk. Vast majority of investors should have a
long-term (lifetime) orientation - the focus should be on increasing purchasing
power over time - for that, partial ownerships in a diversified set of businesses
(stocks) purchased over time is far less risky compared to currency-denominated
options.
Conglomerate
Advantage: Conglomerates receive a bad rap mainly because of CEO dishonesty
and/or incompetence: many CEOs go for easy ways out - buying low-quality
businesses with low-PE and projecting per-share-earnings growth is a classic
but deeply flawed strategy. If done right, conglomerates can develop a deep
competitive advantage over time: the CEO does the role of capital allocator
amongst the various businesses and his focus is on doing it in the most optimal
way - compare that to a declining business where it is much more difficult to redeploy
capital (would involve admitting mistakes made, firing associates and probably
the current CEO as well, etc.) into unrelated businesses (would involve hiring expensive
“money shufflers” - hiring experts in the field, investment bankers, lawyers,
accountants, etc.).
Warren
Buffett's writings (
pdfs) are a
treasure trove of information and are a very good option for anyone starting
out on individual investing. In this year’s letter Warren Buffett recommended
two books:
