Valuation of Berkshire Hathaway (BRK)

In the 2008 BRK annual report, CEO Buffett writes "BRK has two major areas of value" (pg.5). The first area of value is the investments of stocks, bonds and cash - where my calculations confirm the $122 billion he reports. To arrive at net value, one should subtract any debt which provided the funds.

Here BRK is unusual. The "debt" which provides $58.5 billion or nearly half of these funds is generated as float ("money held, but not owned") by the insurance operations. In computing the debt's cost, the CEO states, "I expect us to average an underwriting profit" (pg. 9), meaning that the cost of debt will average less than zero.

Not only is the "debt" expected to lack long-term cost, there is no date for repayment, as long as the insurance operations of BRK are active, profitable and consistent with today's "float" arrangements. Since this seems likely, there is no reason to subtract the debt from the investment funds.

Although such exclusion of "debt" sounds aggressive, it may be conservative. In this upside down world of no-cost debt, any debt costing less than zero is really an asset. For example, if the $122 billion were growing at an average of 8% and the "float" of $58.5 billion were averaging a combined ratio of 96% (meaning a profit of 4%), then the float would be worth about $29 billion as an "asset."

The second area of value - the "67 non-insurance companies" are measured by their pre-tax earnings. CEO Buffett informs his readers that these earnings were $4,093 per Class A share for 2007 and $3,921 per Class A share for 2008. Deriving these earnings does not come simply from the income statements, but also requires excluding various financial transactions, purchase-accounting adjustments and minority interests. Because I have made many unsuccessful attempts to get this precise number, I continue to use his number.

Because BRK has a "return on average carrying value of 8.1%" (pg.10), it seems as if a valuation of roughly 12.5 times earnings would be appropriate, if not low, providing a valuation of $50 billion on this "private equity" portfolio.

Combining these two "areas of value" provides a general valuation on the closed-end mutual fund method of valuation. As to whether this is a high or low number depends on one's view of the underlying assets. The CEO was careful to declare that the decrease in the first area of value was due to a "decline in market prices, not by net sales of stocks or bonds." The second area of value, of course, has been subject to a dramatic downturn in the economy.