Berkshire Hathaway Inc (BRK.B) Investment Valuation

July 17th, 2013 Posted by No Comment yet

Berkshire Hathaway Inc (BRK.B), incorporated on June 16, 1998, is a holding company owning subsidiaries engaged in a number of diverse business activities.

BRK.B Value Investing Approach

Our basis of valuation is the company’s five years of historical financial records; the balance sheet, income statement, and cash flow statement. Moreover, this is a great measure of the total value of a firm. It is often great starting points for negotiation of a business.

BRK.B Investment in Enterprise Value

Explanation

The market capitalization of Berkshire Hathaway Inc was trending up at a rate averaging 228 percent. In other words, the current price rises 84 percent from 2008 to 2012. In 2009, the price dropped 90 percent from 2008 but managed to rise by 1193 percent the following year.  The total debt was averaging 31 percent and the cash and cash equivalent was averaging 22 percent.  If you are the investor and you are planning to buy the entire business of BRK.B, then you would be paying 90 percent of equity and a 10 percent total debt because cash was less than the debt.

Further, the takeover price of the entire business of BRK.B  to date, July 6, 2013, was \$288 billion at \$112.63 per share. The market price to date was \$114.96 per share.

Net Current Asset Value (NCAV) Method

The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value.

Explanation

The net current asset value approach tells us that the stock price of BRK.B was trading at an overvalued price. For the reason that the market price was greater than the 66 percent ratio.  The 66 percent ratio was only 14 percent of the market price.

As we can see, the results indicate that BRK.B stock did not pass the stock test because it traded above the liquidation value of the company. Therefore, the price is said to be expensive.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.

The MC/NCAV valuation shows that stock price was overvalued from 2008 up to the trailing twelve months. For the reason, its ratio exceeded the 1.2 ratios.  Meaning the price was expensive.

BRK.B margin of Safety (MOS)

The margin of safety requires knowing when the buying price is low in absolute terms, rather than merely relative to the market as a whole. This formula is used to identify the difference between company value and price.

Explanation

The margin of safety was averaging 36 percent,  this means that if you are buying the stocks of BRK.B you have insufficient security. Below is the formula for intrinsic value as this factor the calculations for the margin of safety.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable  Growth Rate)

Explanation

• EPS: the company’s last 12-month earnings per share;
• G: the company’s long-  term (five years) sustainable growth estimate;
• 9: the constant represents the appropriate P-E ratio for a no-growth company, and
• 2: the average yield on high-grade corporate bonds.

Intrinsic value, it factors earning per share and the growth of the company. The result shows that the earnings per share were averaging \$4.85 and the annual growth rate was averaging 23.54 percent, the formula we used is:

Explanation

The sustainable growth rate (SGR) shows how fast a company can grow by using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know how profitable the company is by its return on equity (ROE). Moreover, you also need to know what percentage of a company’s earnings per share is paid out in dividends, which is called the dividend payout ratio. And from there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.

The formula is Sustainable growth rate = ROE x (1 – dividend-payout ratio).

Explanation

The table shows that the return on equity was averaging 7.27 percent, while the payout ratio was zero percent. Return on Equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. It is also known as Return on net worth. Below is the formula for the return on equity.

Return on Equity = Net Income / Shareholders’ Equity

Return on equity shows how many dollars of earnings result from each dollar of equity. The average approach was used in the above calculations for the sustainable growth rate. Moreover, there is another approach in calculating and that is the average ratio approach.

Explanation

To sum up the result of these two approaches, it shows that the margin of safety and the intrinsic value are higher in the relative approach. Walking further, I have prepared a graph for the intrinsic value to illustrate to you how the market and the true value is related to the margin of safety.

Intrinsic Value Graph

Further, as we can see the intrinsic value line was much higher than the enterprise value line, this means there was a margin of safety because the space in between represents the margin of safety.  It is the difference between the true value and the price.

Price to Earnings/Earning Per Share (P/E*EPS)

Facts

The result of the P/E*EPS valuation shows that the stock price of BRK.B was undervalued from the period 2008 up to the trailing twelve months.  The market price was averaging 97 percent of the P/E*EPS ratio, meaning the stock price was cheap. The price to earnings ratio was averaging \$18.15.

Explanation

This valuation shows the relationship between the stock price and the company’s earnings. The price to earnings is the price that the market is willing to pay for the company’s earnings. The price to earnings of the company can change daily as the market price changes. Analysts use the price to earnings ratio more often because it shows if the company is in the growth phase or if the company is mature and how the market is willing to pay. Price to earnings varies as economic changes, different industries and other factors that affect the market price.

The Enterprise Value (EV) /Earning Per Share (EPS) or (EV/EPS)

The result of the EV/EPS valuation tells us that the price (P/E) was averaging 22 percent and the earnings (EPS) was averaging 78 percent. This valuation is either over or undervalued because the result depends upon the analyst’s own discretion.

Enterprise Value (EV) / Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation. EV/EBITDA compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. It is useful for analyzing and comparing profitability between companies and industries. This measure gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

Facts

The EV/EBITDA valuation is one measure of the company’s profitability if you want to see the cash-generating power of the entire firm. And you don’t care whether it’s equity or debt financing this cash-generating operation. The reason why EV/EBITDA is used for pure valuation and it is used to find attractive takeover candidates.  The table above indicates that the EV/EBITDA multiple is averaging 8 times.  It means that in buying the entire business of BRK.B it will take 8 times  the cash earnings of the company to recover the costs of purchasing.  In other words, it will take 8 years to recover the costs of buying the entire firm.

Summary

The market capitalization of Berkshire Hathaway Inc (BRK>B) rises 84 percent from 2008. Also, the total debt was averaging 31 percent and the cash and cash equivalent was averaging 22 percent.  Buying the entire business of BRK.B, an investor would be paying 90 percent of equity and a 10 percent total debt because cash was less than the debt. Further, the takeover price of the entire business of BRK.B to date, July 6, 2013, was \$288 billion at \$112.63 per share. The market price to date was \$114.96 per share.

Net Current Asset Value

The net current asset value approach tells us that the stock price was traded at an overvalued price because the market price was greater than the 66 percent ratio. The 66 percent ratio was only 14 percent of the market price. The MC/NCAV valuation indicates that the stock was overvalued because the ratio exceeded the 1.2 ratios.

Margin of Safety

The margin of safety was averaging 36 percent, thus, it indicates that the margin of safety was insufficient because it did not pass the requirement of at least 40 percent.  In addition, the earnings per share were averaging \$4.85 and the annual growth rate was averaging 23.54 percent. Moreover, the return on equity was averaging 7.27 percent, while the payout ratio was zero percent.

PE/EPS

Moreover, the result of the P/E*EPS valuation shows that the stock price of BRK.B was undervalued. The market price was averaging 97 percent of the P/E*EPS ratio. Meaning the stock price was cheap. The price to earnings ratio was averaging \$18.15.

EV/EPS

The EV/EPS valuation tells us that the price (P/E) was averaging 22 percent. Moreover, the earnings (EPS) was averaging 78 percent.

Further, the EV/EBITDA multiple is averaging 8 times. Meaning, it will take 8 years to recover the costs of buying the entire firm.

Overall

The stock price was undervalued moreover, its margin of safety was not sufficient for a good Buy. Therefore, I recommend a HOLD in the stock of Berkshire Hathaway Inc (BRK.B).

Research and Written by Criselda

Interested in learning more about the company? Here’s company research to know more about its background and history; and value investing guide for the financial status.