Wednesday, November 8, 2023

My updated estimate of Berkshire Hathaway's intrinsic value; Why doing extreme sports benefits me as an investor

By Whitney Tilson

1) For many years I've been calling Warren Buffett's Berkshire Hathaway (BRK-B) "America's No. 1 Retirement Stock" because it offers a unique combination of safety, growth, and undervaluation.

While the undervaluation isn't as great as it has been at certain times in the past (see analysis below), I still think the stock should be the bedrock of any conservative portfolio.

I've used a consistent method to estimate Berkshire's intrinsic value for the past two decades, which I believe is similar to the one Buffett uses: take the cash and investments per share and add the value of the operating businesses.

At the end of the third quarter, cash and investments were $363,000 per A-share. Since then, Berkshire's stock portfolio has risen by $18,000 per share, so that's $381,000 today.

Berkshire's pretax operating earnings over the past 12 months were $18.3 billion per share (excluding volatile insurance and investment income but adding back an estimated $1.4 billion of annual normalized insurance earnings).

The chart below shows how the two drivers of Berkshire's value – investments and earnings – have done since 2002. As you can see, there are occasional dips... but overall, these show an extraordinary record of consistent growth:

I was surprised to see that operating earnings have flatlined since 2021... but in reality, they haven't. It's just that the main driver has been Berkshire's enormous insurance operations, which I, very conservatively, exclude (as I believe Buffett does), other than the aforementioned $1.4 billion, because they can be quite volatile.

I apply a conservative below-market multiple of 11 times to Berkshire's pretax operating earnings to arrive at a value of $201,000 per share.

Thus, my estimate of Berkshire's intrinsic value is $381,000 (investments) plus $201,000 (operating businesses), for a total of about $582,000 per A-share or $388 per B-share.

This table shows this calculation for each year-end starting in 2002:

The A-shares closed yesterday at $525,280, meaning that the stock is currently trading at a 10% discount to my estimate of its intrinsic value.

That's close to the smallest discount since the stock hit its prior all-time high in March of last year... but I still like it because it's still somewhat undervalued, incredibly safe, and its intrinsic value is growing nicely.

That said, it's important to have reasonable expectations...

Given its moderate undervaluation today, I think over the next five years, Berkshire's stock is likely to do perhaps two percentage points (compounded annually) better than the S&P 500 Index. In other words, if the S&P 500 compounds at 5%, I would expect Berkshire to do 7%.

2) Following up on my recent e-mails about my seventh 24-hour World's Toughest Mudder I ran last weekend – where I did 65 miles and 200-plus obstacles, finishing third in my age group and raising $22,500 for Ukraine (here's my full race report) – I think pushing myself to my limits like this benefits me as an investor for a number of reasons...

First, do you want to know why Buffett is one of the richest people in the world? In part, of course, it's that he has compounded money at a high rate. But most people don't fully appreciate the equally important second part of the equation: He has done it for a long period of time.

Buffett started investing when he was only a boy – and is still going strong today at 93! He has accumulated the vast majority of his wealth since he turned 70 – an age at which most people have retired (the life expectancy of the average American man is only 77 years).

I want to keep investing and building wealth in my 70s, 80s, 90s, and even 100s. That's not crazy: Based on my diet, fitness, and other aspects of my life, a life expectancy calculator predicts that I'm going to live to 104!

Additionally, being a successful investor requires real mental toughness... There will certainly be periods – which can sometimes last for years – in which many stocks in your portfolio run against you and your overall performance is poor.

When (not if) this happens, will you get emotional and panic, making a bad situation worse? Or will you carefully evaluate the situation and take the right steps to turn things around?

I think the physical and mental resilience I've built up from doing things like the World's Toughest Mudder has helped me successfully navigate a number of difficult periods.

Best regards,