Wednesday, March 2, 2022

Two estimates of Berkshire Hathaway's intrinsic value; The spike in the VIX bodes well for investors; How to Invest Calmly in a Chaotic World; Inspiring wrestler

By Whitney Tilson

1) In Monday's and yesterday's e-mails, I analyzed Berkshire Hathaway's (BRK-B) fourth-quarter earnings, share repurchases, and CEO Warren Buffett's annual letter.

Today, I'd like to update my estimate of Berkshire's intrinsic value using two methodologies.

The first is the one I've used – and that I think Buffett himself uses – to value Berkshire for more than two decades. Take cash and investments (valued at market) and add the value of the wholly owned operating businesses, calculated by applying a conservative multiple (I use 11 times) to the pretax earnings of those businesses.

This table shows how I calculate Berkshire's investments per share as of the end of 2021:

Adjusting the $351 billion stock portfolio downward by the 9.4% decrease in the S&P 500 Index this year reduces investments per share from $352,000 per share to $330,000 currently.

To value the wholly owned businesses, here are the figures I use to calculate their earnings:

Note that I subtract all of the underwriting and investment profits from Berkshire's massive insurance operations but add back a rough estimate of the average insurance underwriting profits over the past decade ($1.4 billion annually).

This results in $17,877 in adjusted pretax earnings per share in 2021, to which I apply a multiple of 11 times to arrive at a value for the operating businesses of $197,000 per share.

Now add the $330,000 in cash and investments per share to arrive at a total intrinsic value of $527,000 per A-share (or $351 per B-share).

With the A-shares closing yesterday at $476,000, that means the stock is trading 10% below my estimate of its intrinsic value.

My friend and former partner, Glenn Tongue, has come up with a second methodology:

There is another viable way to look at Berkshire's valuation by looking at the economic earnings of the stock portfolio rather than the accounting treatment.

In his annual letter, Buffett notes that while Berkshire owns 5.6% of Apple (AAPL), the only thing that appears in Berkshire's income statement related to this stake is the $786 million in dividends Berkshire received from Apple last year. But in reality, Berkshire owns 5.6% of Apple's total net income, equal to $5.6 billion of what Buffett calls "look-through earnings."

Applying the same calculation to all of Berkshire's stock holdings (including Apple) results in look-through earnings of at least $15 billion.

Adding this to Berkshire's after-tax operating earnings of $27.5 billion yields total economic earnings of $42.5 billion.

If we compare this to Berkshire's current market cap of $702 billion, less roughly $100 billion of excess cash, we can see that Berkshire is currently trading at a price-to-earnings (P/E) ratio of 14.2 times trailing earnings.

Given that the S&P 500 is currently trading at 23.8 times trailing earnings, Berkshire's multiple is downright cheap, especially given that it's a far-above-average collection of businesses.

Thank you, Glenn!

In summary, Berkshire Hathaway is incredibly safe and growing at a healthy rate. And its stock, any way you look at it, is undervalued – enough that the world's greatest investor is buying it back in size. What's not to like?

2) The CBOE Volatility Index, better known as the VIX, is one widely used measure of investor nervousness.

Not surprisingly, it has nearly doubled this year, closing yesterday above 33 – that's a historically high level, as you can see in this five-year chart:

This is good news for investors.

As you can see in this next chart, over the past 31 years, when the VIX has spiked above 33.5, stocks have done exceptionally well over the subsequent year:

3) Here's Jason Zweig with some good advice in the Wall Street Journal: How to Invest Calmly in a Chaotic World. Excerpt:

Now that Russia has attacked Ukraine and emotions are running high, it might be tempting to get out of the market to keep your money safe, if you're feeling afraid – or to bet on what sounds like a sure thing, if you're feeling aggressive. But hasty decisions are often wrong, and big hasty decisions almost always are.

You could try restructuring your portfolio to profit from a scenario that might unfold in the wake of Russia's invasion, like a boom in U.S. exports of natural gas, or rising inflation and higher military spending.

The risk, though, is that scenarios that seem likely often don't materialize—and, even if they do, they can become too popular, eliminating the bargain prices that produce superior returns over time.

A couple of things are pretty close to certain.

One is that it's a bad idea to overhaul your portfolio when you're afraid. The time to become more conservative is when things are going well, not when the world seems to be coming apart.

4) What a great story – this high school senior just won the Virginia 6A state championship in wrestling, despite having no legs!

Here's a short video of the end of the championship match and here's an article about him: 'When you say you can't, he's the reason why you can': Landstown wrestler an inspiration. Excerpt:

Landstown assistant Tracy Branch also remembered that first Lattimore-Velez match.

"I was mesmerized by watching (Lattimore)," he said. "Just seeing him get to the mat by himself, walking on his hands at such a young age, was amazing. Then I saw how tough he was. We had a devil of a time with him."

Lattimore has taught life lessons off the mat, too.

"It's amazing to see how he's adapted to his abilities and that he's been able to use what God gave him and be able to compete at this level," Branch said. "I also know there are days where I don't feel like coming (to practice). Then you walk in here and see Adonis and you go, 'I got to stop complaining.'"

Best regards,

Whitney

P.S. I welcome your feedback at [email protected].

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Empire Financial Research

Whitney Tilson

Empire Financial Research founder and CEO Whitney Tilson is the editor of the Empire Investment Report, a monthly investment advisory that focuses on cheap, high-quality stock ideas.

Whitney graduated with honors from Harvard University and Harvard Business School, where he earned an MBA and was named a Baker Scholar. Whitney spent nearly 20 years on Wall Street, during which time he founded and ran Kase Capital Management, growing assets under management from $1 million at inception to a peak of $200 million.

Once dubbed "The Prophet" by CNBC, Whitney predicted the dot-com crash, the housing bust, the 2009 stock bottom, and more. Now, he's sharing his secrets and strategies with followers of his latest endeavor, Empire Financial Research.

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