Tuesday, September 27, 2011

Berkshire Hathaway Price-to-Book

There has been a lot of talk after Berkshire's announcement of share repurchases.  People love to second-guess Buffett and read all sorts of things into his actions and statements.   These things tend to be like the Rorschach blot; people read into things what they want to see.

In this case, the story is that there are no more interesting investment opportunities in the market anywhere in the world and that's why Buffett is going to buy back Berkshire stock; there is nothing else out there.   (Others said that this a a bullish bet on the U.S. economy by Buffett as BRK has exposure to housing and other economically sensitive areas.)

I tend to disagree with that comment.  As I said in a post not too long ago, I think Berkshire Hathaway is an incredible bargain and opportunity at book value or slightly more.  

The other thing is that I noticed people using different price-to-book value ratios, so I calculated the numbers myself (I might have said that BRK traded at a P/B ratio of 1.7x in the last ten years, but that was wrong.)

Here are the correct figures using book value per share figures published in BRK's own 10-Ks. 

Price-to-Book Value Ratio of BRK

             BPS        BRK price at year-end         P/B ratio
1994     9,893      20,400                                  2.06
1995    14,025     32,100                                  2.29
1996    19,011     34,100                                  1.79
1997    25,488     46,000                                  1.80
1998    37,801     70,000                                  1.85
1999    37,987     56,100                                  1.48
2000    40,422     71,000                                  1.76
2001    37,920     75,600                                  1.99
2002    41,727     72,750                                  1.74
2003    50,498     84,250                                  1.67
2004    55,824     87,900                                  1.57
2005    59,377     88,620                                  1.49
2006    70,281   109,990                                  1.57
2007    78,008   141,600                                  1.82
2008    70,530     96,600                                  1.37
2009    84,487     99,200                                  1.17
2010    95,453   120,450                                  1.26

                                      Five year average:     1.44x
                                      Ten year average:      1.57x
                                      Average since 1994:  1.69x

So you can see that the p/b ratio of BRK has been around 1.4x, even in the recent past during hard times for the economy.  A P/B ratio of 1.5x for BRK would not at all be a stretch.

There are, of course, arguments for a trend towards a lower p/b ratio over time.  One is that Buffett is now 81 years old and is not getting any younger.  To the extent that it was Buffett's brilliance that made BRK such a success, a post-Buffett BRK would not be treated so kindly.  The other is that as BRK gets bigger, it gets harder to find deals to 'move the needle' on intrinsic value.

These are issues to be sure.

But Buffett strongly believes that BRK is worth far more than stated book value per share.  Why is that?

The 2010 BRK annual report has a great analysis/explanation of BRK's intrinsic value.  This is highly recommended reading even for non-BRK-investors.

I will sum up one quick point here.  A long time ago, much of BRK's assets were invested in listed companies so they did sort of look like an equity fund (actually, that's not the best analogy as BRK was an insurance company that invests it's float.  There's a big difference, but that's another long post for another day).  However, over the past few years BRK has invested in operating businesses and that part of the business has grown rapidly.   The annual report shows the percentage gains in each category and it is very interesting.  Total investments per share has not grown that fast over the past 10 years while pretax earnings from their non-investment, operating businesses has grown by more than +20%/year.

Anyway, you can argue that the intrinsic value of BRK will exceed the growth in book value in that case.  Also, the more closely BRK looks like an equity mutual fund, the closer to book value it should trade at (since BRK's investment holdings are marked-to-market, net of tax liabilities on unrecognized gains).

However, the more the operating businesses grow, the higher the P/B ratio should tend to trend.  Why?  Because earnings growth of operating businesses will not be reflected on the GAAP balance sheet at all (profits earned will be booked as gains, but the value of the business will not).

So I just grabbed a couple of numbers from the 2010 annual report to illustrate this point.

                 Per share                    per share                        Price of
                 investments  (A)        pretax income  (B)        BRK  (C)         A/C      (Bx10)/C
1990           $7,798                         $102.58                          $6,675         117%      15%
2000         $50,229                         $918.66                        $71,000           71%      13%
2010         $94,730                      $5,926.04                      $120,450           79%      49%

I just pulled per share investments and per share pretax income from the annual report and I just made up the other ratios, A/C and (Bx10)/C.

A/C just represents how much of the investments per share accounts for the share price of BRK.  (Bx10)/C represents how much the operating businesses are worth as a percentage of share price.  I just used a multiple of 10x pretax earnings to value the non-listed, operating business of BRK.

So you see that back in 1990, investments per share represented an amount exceeding the value of BRK stock, and the value of the operating businesses represented only 15% of the share price.

This continued into 2000 where the value of the operating business was still only 13% of the share price; you can see how the investments per share was really the driver of the value of BRK.

However, if you look at the figures for 2010, investments per share still represented 79%, or a large portion of the share price of BRK, but the operating business pretax income has grown substantially to account for 49% of the share price.

One can argue that the market has failed, over the years since 2000, to take into account the tremendous growth in BRK's operating businesses.

Now that the stock is trading at close to book value per share, you can see why it is such an incredible value, and Buffett thinks so too.

This is the reason why BRK has announced a share repurchase; the value is just too compelling.

1 comment:

  1. Hi kk,

    been going through your posts recently. great blog, keep up the good work =)

    anw just want to get your opinion on BRK's current price to book. It's about 1.25 times now after last friday's correction.