When I heard the media reporting that the Barron's cover story this weekend was a piece warning investors that shares of Berkshire Hathaway (BRKA) were overvalued, I was both surprised and in agreement. I think many publications would avoid panning Berkshire's investment merits, even if they believe the stock to be too high, just because we are talking about the greatest investor who has ever lived. On the other hand, the case that BRK is overvalued is pretty strong, so from that standpoint, Barron's might be doing investors a favor by pointing it out.
I didn't read the full article, but the news wires are reporting that Barron's concluded that BRK is about 10% overvalued at current levels. I decided to take a quick look at the stock's valuation to see if I agreed with that. I was already aware that Berkshire's P/E was well above 20, which is why I do not own any shares in the company, but at that same time, one could surely argue that most of Berkshire's value should not be measured using a P/E ratio. As a result, I did some quick number crunching using book value rather than earnings per share.
The reason for using book value is quite simple. A majority of Berkshire's net worth comes from stock holdings in public companies as well as operating businesses (from which most of the net income is derived from the insurance business). Insurance companies are valued using price-to-book ratios (typically they garner a ratio slightly above one) and common stock investments can be valued easily using current market values.
As of September 30th, Berkshire's book value was $120 billion. Of this, more than half ($66 billion) lies in the company's stock holdings. That leaves $54 billion in book value from Berkshire's operating businesses. If they were solely in the insurance business, I might assign a price-to-book value of somewhere around 1.2x to them, but Berkshire is more than just insurance. As a result, you could conclude that Berkshire's operations should be valued at two times book, so let's use that number.
Quick math nets us a value for Berkshire of $174 billion (2 x $54b + $66b). At Berkshire's current quote of $137,000 per share, that would make BRK about 18% overvalued, even more than the Barron's estimate. Buffett clearly is worth a premium for most investors, but at the very least, Berkshire stock hardly looks like a bargain after a huge move upward in recent months.
Full Disclosure: No position in Berkshire Hathaway at the time of writing
Monday, December 17, 2007
Barron's Pans Buffett's Berkshire
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3 comments:
First, BRK's P/E is roughly 15, not 20+.
Second, I would suggest a better quick and dirty valuation would be done in three parts: 1- Insurance, 2- Operating Companies, 3- Stock/Bond Portfolio.
1. Insurance based on revenue (1x) and eps (8x) multiples is worth 40+ billion.
2. Operating companies have ttm earnings of ~$5billion. With a 13x multiple that's worth $65 billion
3. Stock and Bonds worth ~$100 billion.
Total = 40+65+100 = 205 billion which is roughly equal to the market cap at today's prices ($135k per A share).
$47 billion in cash is not counted here and assumed to be needed for insurance operations.
IMO, this is a conservative valuation. 18% overvalued -- not so much, mildly overvalued at $150k per A share -- perhaps.
Consensus estimates for 2007 EPS is $6,297 per share, which gives BRK a P/E of 21+ or so. Yahoo! Finance lists the P/E as 15, but you can't take that number at face value a lot of the time (computers don't take out one-time items when calcuating ratios for web sites). So I think that's how Barron's figured the P/E (using operating earnings). For non-operating income (stocks, etc) you add in the value of public investments.
I think BRK will (and should) carry a premium while he is alive and well, but the real question is, does that premium go down a bit when someone else is running the show...
nevermind the last comment, my bad.
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