Morningstar recently interviewed T2 Partners Founder Whitney Tilson regarding his views on Berkshire Hathaway’s intrinsic value. Mr. Tilson has increased his estimate of Berkshire’s intrinsic value from $110,000 to the mid $130,000 range due to a recovery in the market value of Berkshire’s investment holdings:
Today, Berkshire’s stock portfolio has rallied, the outlook for the economy and so forth, so that’s reflected now in a higher estimate of intrinsic value, in the mid-$130,000 range. The stock’s just above $100,000, so we think you’re buying a $0.75 dollar, 25% discount to intrinsic value [for] the world’s strongest balance sheet run by the world’s greatest capital allocator with decent growth prospects going forward. So it’s just the kind of safe, conservative stock–you sleep well at night–in an environment where we’re nervous.
Mr. Tilson is asked about his valuation methodology for Berkshire Hathaway:
Berkshire is a very large, complex conglomerate, but in valuing it, it’s actually fairly simple. You have cash and investments that you value at market-to-market. Cash is worth cash. The stocks are worth whatever the stock price is.
Then you have 75 operating businesses that are generating substantial earnings. You take the cash and investments, put a multiple on the earnings, and just add the two together.
This is a variation of the two column valuation method that Warren Buffett has implicitly endorsed in his annual letters. The result of using this method is that the intrinsic value estimate is very sensitive to market quotations. This has benefits and limitations. By anchoring the intrinsic value estimate to market prices of Berkshire’s investments, there is an element of conservatism when market prices decline, but also a potential for an overly aggressive estimate if market prices of investments rise rapidly.
I found Mr. Tilson’s comments regarding the valuation of the operating businesses very interesting. It seems that he was using a 12 times multiple on pre-tax earnings in 2007 but is using a 8 times multiple today. Along with the decline in market prices for Berkshire’s investments since 2007, the contraction in the earnings multiple for the operating businesses resulted in lowering his valuation:
The main reason our intrinsic value estimate declined is we stopped putting a 12 multiple, which was a fair multiple back when the market was doing OK. The average company in the S&P 500, we were applying a market multiple.
Well, today the market multiple’s a lot lower, so we’re now applying an eight multiple to pre-tax earnings, not a 12 multiple. That brings the intrinsic value down substantially, but we try and be conservative.
This strikes me as well justified. If the environment in which an investor can purchase private and public companies has changed, this must be reflected in the intrinsic value of a holding company such as Berkshire Hathaway as well. Otherwise, the valuation ignores the principle of opportunity cost. It makes little sense to value Berkshire’s operating companies at an earnings multiple far higher than the valuation these companies would command in the market for a private buyer today.
My view is that multiple models should be used to arrive at intrinsic value estimates whenever possible. In addition to the two column approach, many analysts have used “float based” valuations to come up with intrinsic value estimates. These float based models attempt to arrive at a present value for cash flows that can be expected from earnings on Berkshire’s large insurance float over long periods of time. The valuation of the operating companies is then added to come up with an intrinsic value estimate.
The float based model was discussed here in February in more detail. In general, the float based model comes up with higher intrinsic value estimates than the two column method. I generally consider the two column method as the lower bound for intrinsic value and the float model as the upper bound.
Disclosure: The author owns shares of Berkshire Hathaway.