This is the second post of a multi-part series covering the Berkshire Hathaway 2008 Annual Report and Warren Buffett’s letter to shareholders. The first post in the series covered some highlights from Warren Buffett’s annual letter. The remaining posts will cover my approach to evaluating the intrinsic value of Berkshire Hathaway based on the data provided in the report. This post outlines the valuation methodology that will be used and will be followed by a closer look at each of Berkshire’s sources of intrinsic value. Finally, I will provide a summary of my intrinsic value estimate.
Warren Buffett always notes that merely reviewing Berkshire Hathaway’s consolidated financial statements will not result in an accurate estimate of Berkshire’s value. This is because there are a number of distinct sources of intrinsic value within Berkshire that must be evaluated separately. This “sum of the parts” approach is necessary in a situation where you have a diverse collection of operating companies that do not share the same underlying business economics.
Insurance Subsidiaries
In the case of Berkshire Hathaway, the main source of value resides within the Insurance subsidiaries. The insurance companies within Berkshire provide most of the capital used to fund purchases of marketable securities as well as wholly owned subsidiaries. Therefore, coming up with an accurate estimate of intrinsic value for the Insurance subsidiaries will be the first order of business.
Regulated Utility Business
Berkshire has a significant regulated utility business through its ownership of 87.4% of Mid American Energy Holdings. Mid American owns regulated utility businesses in the United States and the United Kingdom along with natural gas pipelines accounting for 9% of the natural gas consumed in the United States. In addition, Mid American controls U.S. Home Services of America which is the second largest real estate brokerage firm in the country. MidAmerican will be evaluated as a stand alone entity as the second major source of intrinsic value.
Operating Companies
In recent years, Berkshire has added many more operating companies and there are now 67 non-insurance companies falling under the Berkshire Hathaway corporate umbrella. These companies operate in a wide variety of industries and often have dramatically different underlying economics. Is is necessary to come to a conclusion regarding the overall valuation of the operating companies which represent the third major source of intrinsic value for Berkshire.
Finance and Financial Products
Revenues from manufactured homes and financing activities is provided by the Clayton Homes subsidiary and Berkshire also controls interests in furniture and transportation equipment leasing. This represents the fourth source of intrinsic value.
Through this “sum of the parts” evaluation, it should be possible to arrive at a valuation for Berkshire Hathaway as a whole. I will be posting an evaluation for each area noted above over the course of the weekend.