Clay Finck (03:11):

I like how Adam started with the most certain pieces of information first and then worked his way down to the more complex holdings. So obviously the most certain is cash. As of Q1 2022, Berkshire’s cash position was around $102 billion. The market cap today for the company is around 635 billion. This puts our cash position at around 16% of their total market cap. So for every $100 you buy in Berkshire stock today, you’re getting roughly $16 in cash sitting in the business. They also hold fixed income securities as well, but it’s much smaller than a cash position. This total’s 21.7 billion, which is about 3% of the market cap at today’s valuation.

Clay Finck (03:56):

Moving along, next we have the publicly traded companies they own. All of their publicly traded holdings are US listed companies. According to their most recent 13F filing which shows their stock holdings, Berkshire owns roughly $363 billion worth of stocks. Then Adam went ahead and made a couple of adjustments to these stock holdings, the first being, deducting the unrealized capital gains taxes. In theory, if they were to sell all of their stocks today, they would incur a massive tax bill. So this must be taken into account when calculating our intrinsic value. We can find the unrealized capital gains, but we will have to make an assumption of the rate at which those gains will be taxed because many of these holdings might be held for many, many years.

Clay Finck (04:42):

Adam uses a conservative estimate of 21% capital gains tax and Berkshire has about 245 billion in unrealized capital gains as of Q1 2022. So multiplying these two numbers together, we get an amount of 51.5 billion that’s going to be deducted from the stock holdings. Now, this is a really conservative estimate because Berkshires tends to hold many of these companies for a very long time. Coca-Cola for example, he purchased over 30 years ago. And it’s probably not likely he’s going to be selling anytime soon. To assume that he’s going to sell it today and incur that tax hit probably isn’t very likely. He’s probably going to be holding it for many, many years into the future just like many of his other holdings. So it’s pretty conservative to assume that tax hit today.

Clay Finck (05:30):

So we’re going to go ahead and do what Adam did and assume that 21% capital gains tax will be applied to the unrealized capital gains. And then the other adjustment we’re going to make is to mark down the stock holdings by 10% to take into the account that potentially some of these holdings might be overvalued. For example, Apple specifically is 43% of Berkshire’s stock portfolio. If this stock were to decline drastically, then this would really bring down the overall portfolio and be a drag on it. So we want to add some conservatism to account for the fact that the overall market or some particular holdings might be overvalued at this point in time.

Clay Finck (06:10):

After adjusting for the unrealized capital gains tax liability as well as the 10% markdown, this takes the $363 billion stock portfolio to an adjusted amount of 275 billion. This accounts for roughly 43% of Berkshire’s market cap today. Then Adam lists the equity method investments in his analysis, which are companies that are accounted for a bit differently in their filings because they own a substantial portion of these businesses. These only included a few companies. They have an interesting Kraft Heinz, Pilot Flying J, Energy Transmission Texas, and Berkadia. This total came out to 17 billion, which is the equity method investments line in their 10-Q filing, which is filed quarterly by Berkshire. Next up is some of Berkshire’s larger holdings. They own BNSF, which stands for Burlington Northern Santa Fe. BNSF operates one of the largest railroad systems in North America with over 32,500 route miles of track in 28 states as well as some operations in Canada. BNSF’s net operating earnings were 5.5 billion in 2019, 5.1 billion in 2020, and nearly 6 billion in 2021.

Clay Finck (07:28):

Now, to come up with the value for these wholly owned businesses, Adam simply is just applying a 15 times multiple to the normalized earnings of the business. To come up with normalized earnings, you need to look at their current earnings and look back at the past to make sure the current year isn’t an anomaly to the upside or to the downside. Normalized earnings is just what you would expect the company to earn in a normal year. The 15X multiple and the normalized earnings are both subjective estimates to determine the value of any of their businesses. Some investors might consider the 15 times multiple too low, some might consider it too high, but it’s really just what you expect the company to earn in the future. The key in doing this analysis yourself is to be conservative in all of your estimates to be sure you’re not overpaying for the stock.

Clay Finck (08:18):

So the lower multiple you put on the earnings, the more conservative you’re being because a 10 times multiple will give you a lower value of the stock than if 15 times multiple or 20 times multiple. If you’re assuming a 15 times multiple on a company, that means we are accepting a 6.7% return on this particular business, as for every $15 we pay for the company, we are getting $1 in earnings. In other words, you’d invert that and take one divided by 15 is how we land on that 6.7% expected return. If we assume, say a 20X multiple, then we would be accepting a 5% return as we would get $1 of earnings every year for every $20 we put in. The lower multiple you assume, the lower your intrinsic value of the company would be. This is why many value investors are looking for stocks with lower PE ratios.

Clay Finck (09:10):

Say, if you find a value stock with a PE of 10, well, that means you’re getting 10% of earnings each year, because one divided by 10 is 10%. For every $100 you put in, you’re getting $10 worth of earnings. Well, with a company like Amazon, you’re putting in $100 and only getting something like $2 in earnings because their priced earnings ratio is so high today. Adam came up with normalized earnings of 5.5 billion for BNSF. Like I just mentioned, it was 5.5 billion in 2019, 5.1 billion in 2020, and nearly 6 billion in 2021. So normalized earnings of 5.5 billion seems pretty reasonable. Applying the 15X multiple to this, we get a value for BNSF of 82.5 billion, which is about 13% of Berkshire’s market cap today.

Clay Finck (10:00):

Moving along to Berkshire Energy which operates a global energy business, there are a number of energy related businesses within the segment, and it’s similar to BNSF in that the earnings are stable and predictable and tend to grow over time. The net operating earnings attributable to Berkshire were 2.8 billion in 2019, 3.1 billion in 2020, and 3.5 billion in 2021. Applying a similar methodology as BNSF, the earnings that Adam used was 3.5 billion for Berkshire Energy. So I’m going to go ahead and use that as well and apply a 15 times multiple. That gives us a value of 52.5 billion for Berkshire Energy.

Clay Finck (10:43):

Next is the manufacturing service and retail business. The breakdown of pretax earnings in Berkshire’s annual report shows $9.5 billion worth of pretax earnings in 2019, 8.0 billion in 2020, and 9.8 billion in 2021. Roughly half of this is coming from what they label as their industrial business which includes aerospace, power industrial needs, specialty chemicals, and a number of other products and service businesses. I don’t want to bore you too much with the specifics of the business here, but Adam did a similar breakdown of the valuation in that he assumed a normalized earnings of 9 billion for this segment. With a 15 times multiple, we come up with a valuation of 135 billion.

Clay Finck (11:28):

Getting towards the end here, we have the underwriting business which Adam assumes will earn 1.8 billion assuming a 3% underwriting margin, which seems to be pretty conservative so I’m going to stick with that as the earnings are fairly small relative to some of the other lines. At a 15 times multiple, this gives us a value of 27 billion. The final line in his sum-of-the-parts spreadsheet is the debt held by the parent company. This is 21.3 billion, and this ends up being subtracted from the total. Before we sum-of-the-parts, I wanted to mention that I chose not to increase the estimates that Adam used for his earnings estimates. One could argue that due to inflation and such, that the earnings could be something like 5% or 10% higher, but with the high level of economic uncertainty today, I chose to just keep those earning estimates the same and add a little bit more conservatism to our estimates.

Clay Finck (12:25):

Summing up the parts, this gives us a total value of Berkshire to be 693 billion. Taking that number and dividing it by the shares outstanding, this gets us to an intrinsic value of $314 per B-share for Berkshire. The stock at the time is trading at around $285, indicating that Berkshire today is trading at potentially a 10% discount based on our conservative estimates.

Clay Finck (12:52):

Back when Adam recorded this conversation with Stig, he came up with an intrinsic value of 292 using this method, which is a bit lower than what we have today. And much of that is due to the appreciation of Berkshire’s publicly traded stocks since then. Apple is around flat on the one year chart, but their energy holdings such as Chevron are up nearly 50% in the last year just to give you an example. Now, me saying that it is potentially trading at a 10% discount does not mean that you should go out and buy it at 285 today and then sell it when it hits our calculated intrinsic value of 314. As long term investors, if Berkshire is a business we would be comfortable buying and holding for the next 10 years, then today’s price is probably a fair price to enter a position.

Clay Finck (13:38):

I’ve been to a few Berkshire meetings in person and if I recall correctly, I believe Buffet has stated that he expects Berkshire to compound at roughly 10% per year on average. This is a pretty solid return when considering how low interest rates are, but obviously it’s at the whims of how strong the overall economy is and how the businesses actually end up performing. Especially their Apple position, as that is a large portion of their overall value. To help become more comfortable with determining the intrinsic value, Adam actually did so using a number of different methods, not just the sum-of-the-parts method. This one makes a lot of sense to me and I thought it would be helpful and interesting to walk through it with the listeners.

Clay Finck (14:23):

Another great point that Adam and STIG made in that video was to take a look at the share repurchase activity that Berkshire has been doing. Because if Berkshire is buying back their own shares, that alone tells you that Warren Buffet believes that his stock is undervalued, which can give you a hint that the intrinsic value is well above whatever price he paid because Warren knows Berkshire better than pretty much anyone else out there.

Clay Finck (14:45):

So looking at the most recent 10-Q, I searched for the word repurchase and found the repurchase information for Q1 2022. They bought roughly $3 billion worth of Berkshire’s shares during the quarter. Their average price in January was 299. In February, it was 312. And in March it was 322 per B-share. For reference, Berkshire actually purchased $27 billion worth of shares in 2021. While the stock price during that period really ran up, it was $230 at the beginning of the year and closed the year at around $300. So seeing that repurchase activity from Berkshire can give us a pretty good idea that today’s price for the company is probably a pretty fair price assuming you’re a long-term investor and really have that long term approach.

Clay Finck (15:31):

All right. That’s all I had for you guys for today’s episode. If you guys have any questions related to anything I discussed during this episode, feel free to reach out to me. My email is clay@theinvestorspodcast.com. And be sure to give me a follow on Twitter. My username is @clay_finck. I’m also starting to post some content on Instagram so please give me a follow there as well, @clay.finck. That’s C-L-A-Y.F-I-N-C-K. I tried getting the same username there, but I wasn’t able to do so. So thanks a lot for tuning in. I hope you guys enjoyed it and we’ll see you again next time.

Outro (16:06):

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