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Assume we have perfect hindsight and we know that over the next 20-30-50-100 years BRK BV growth exactly matches S&P 500 total return performance. What is the fair book value multiple for BRK in this case?

Assume that both BRK and S&P 500 have similar risk profiles.

I would think it should be 1.0x BV in that case. In this line of thinking, any higher multiple of BV for BRK should be because of expectation that it would perform better than S&P 500.

Am I thinking about this correctly or do you see any issues?

It depends on *how* you think Berkshire will increase book value.

By purchasing investments, or by running wholly owned operating companies, or a mix?

If it's the former, then yes, fair P/B would approach 1. It would asymptotically approach being a closed end investment fund.

If it's the latter, then fair P/B should approach the typical large firm's P/B.
If a dollar of retained and deployed capex at XYZ company is valued at (say) twice book because of its expected future earnings, why not the same at Marmon?

If it's a mix, as it is now, then it's in between the two. As it is now.

Jim

Thanks Jim.

In the case of increase by purchasing investments, I think it is quite clear that IV should be 1x BV.

But, even in the case of retaining 100% earnings and growing just at the same rate as S&P 500, why would its IV be more than 1x BV?

Start of year 1, with $100 BV. Let's say earnings are $7 by end of year 1 and BV now is $107. Why should it be worth more than 1x BV in this case?

In the absence of buybacks/dividends, BV growth should be same as ROE. If we assume BV growth as equal to S&P 500 total return and our discount rate also equals S&P 500 return, does it not make the case that it would be worth only 1x BV?

Start of year 1, with $100 BV. Let's say earnings are $7 by end of year 1 and BV now is $107. Why should it be worth more than 1x BV in this case?

In the absence of buybacks/dividends, BV growth should be same as ROE. If we assume BV growth as equal to S&P 500 total return and our discount rate also equals S&P 500 return, does it not make the case that it would be worth only 1x BV?



For investments that are internal i.e not publicly traded, the book value is the accounting entry made when the asset was acquired originally and never adjusted upwards as the years go by. So the collection of businesses Berkshire owns that keep improving their intrinsic value over time, yet their increase in Book value does not reflect this increase at all. The incremental earnings do show up - let's say as cash - but that does not reflect the improvement in the intrinsic value which is a projection of the future cash producing characteristics of the business, This would explain why for the wholly owned businesses, you would expect the book and intrinsic value to start diverging. A business on the books at $100 that produces $7 in cash but which created a way of producing a higher rate of earnings growth in 5 years by reinvesting this amount back in the business has increased its IV but but not its BV. For Berkshire's collection of businesses the assumption is that on average the reinvestment characteristics compare favourably to those available to the S&P as a group.

Market values for the equity portfolio are constantly adjusted to produce this estimate of future value. As the proportion of the Berkshire asset base has shifted more towards wholly owned businesses vs public equities, this divergence would expect to increase over time.

I'm not sure that addressed the question you were raising though !

The other thing I've wondered and noticed over time... as WEB refers to the "anchor" of size... The bigger Berkshire becomes and average returns drift lower will it become a self fulfilling prophecy that the slower trajectory of growth will cause it to trade at lower valuation multiples of for example PBV over the next 10 / 20 years.

Eg a 20 year period @ 9% run rate of book growth would result in book value of $1160 whereas 7% equates to $801

1160 x 1.5 = $1740 CAGR 8.84%
801 x 1.3 = $1041 6.07%

Thoughts?

Start of year 1, with $100 BV. Let's say earnings are $7 by end of year 1 and BV now is $107. Why should it be worth more than 1x BV in this case?

Because cash doesn't just stack up in operating companies. (outside Japan)
It typically gets used for expansion capex, which earns a decent return on average.
Absent other information about management being dumb, let's assume it earns the same rate of return as the existing assets.

So, in round numbers, if ROE isn't falling and assets are climbing, the firm is worth more.
Let's assume it's a big company with a serious going concern of a business.
If you value it on earnings power value (as one should for earnings assets) rather than asset value, each dollar retained is worth more than a dollar.
A typical solid firm gets a pretty good return on its assets. Median among S&P 500 firms lately is 16.7%.

In your example, they had $100 of book in year one. If they are like a current median big firm, they are earning 16.7%, so $16.70 net profit.
In year two they had $107 of assets in year two. Since typical ROE is high, that was a bad year, but let's go with it.
But year two is typical for returns and they earn the currently typical l6.7% on assets, or $17.87 on $107 in assets.
The difference is $1.17/year. Would you pay more than $7 for earnings of $1.17? I would.
If so, then the $7 in retained book is a worth a multiple considerably greater than 1.

Operating companies typically trade at P/B ratios well above 1.
In short, the reason is that their situation lets them allocate that capital at higher returns than you're likely to get.
So an incremental $1 held and managed by them is on average worth more than $1 to you.

Jim

The bigger Berkshire becomes and average returns drift lower will it become a self fulfilling prophecy that the slower trajectory of growth will cause it to trade at lower valuation multiples of for example PBV over the next 10 / 20 years.


Sure.

But remember: their capital allocation skills will presumably fade gradually from excellent towards typical, not from excellent to useless.

The average US stock in the average year has historically returned around inflation + 6.5% on purchase price.
i.e., that's what a monkey with a dartboard might expect in a year that the stock market is not overvalued.

So, I see Berkshire's future rate of growth in value per share converging slowly down towards that number--let's be conservative and round down to 6%.
When they reach that number they will be no better than an average pick.
But inflation + 6% is not so bad.

At that point, the only reason Berkshire would be a good pick is that it's frequently cheaper than the broad market.
And it doesn't contain as many odious business units, depending on your tastes.

None of this suggests that the fair P/B for Berkshire will drop.
That will be determined primarily by how they allocate their incremental capital.
Their stocks and bonds will deserve a multiple of 1.
Wholly owned businesses units doing capex will deserve a higher multiple.
(median P/B among S&P 500 firms is 3.5 these days. Maybe a bit rich, but they generally deserve much more than 1)
Whatever mix Berkshire ends up with will give fair value somewhere in the middle.
These days, somewhere in the 1.5 range seems to work.

The simple way to know what the "fair" P/B should be? Watch the trajectory of ROE.
If ROE is sliding on trend over time, the fair P/B should be lower. And vice versa.

Jim

In your example, they had $100 of book in year one. If they are like a current median big firm, they are earning 16.7%, so $16.70 net profit.
In year two they had $107 of assets in year two. Since typical ROE is high, that was a bad year, but let's go with it.
But year two is typical for returns and they earn the currently typical l6.7% on assets, or $17.87 on $107 in assets.
The difference is $1.17/year. Would you pay more than $7 for earnings of $1.17? I would.
If so, then the $7 in retained book is a worth a multiple considerably greater than 1.

If the company earns more than 7% on its reinvested earnings, it would grow its BV more than 7%. So in your example, BV would grow by $8.17 to $115.17 in year 2, which is 7.6% growth in BV. That would be in our example outperforming the market.

I guess a simpler way of saying this is BV would grow at the rate of ROE in absence of dividends and buybacks. So if you assume BV would grow at the same rate as the market, it should not be worth more than the book value. Any premium to BV must be due to expectations of outperformance over the market.

So if you expect BV to grow at 8% over long term and expect market to return 8% over long term, does it still make sense to value BRK at a BV multiple higher than 1x?

Thanks for indulging me on this. I valued BRK half a dozen ways and they cluster around 1.5x BV. But when I assume that it would provide returns equal to market, I keep thinking it should not be valued at 1x BV. I cannot quite square these two.

> Thanks for indulging me on this. I valued BRK half a dozen ways and they cluster around 1.5x BV. But when I assume that it would provide returns equal to market, I keep thinking it should not be valued at 1x BV.

- Some parts of BRK should be valued at 1x BV. This is because the BV for the asset accurately reflects the present value of a market-tradeable asset.

- Some parts of BRK should be valued at >1 x BV. This is because the BV does NOT reflect the present value of the asset it would have if it were market-traded.

- Things like CGT, ability to trade large positions or assets near current prices, should also be taken into consideration.

lux

Jim on the MF boards shared a graph showing BRKA vs 2 pillar approach, buyback level and 1.5 bv. Anyone perhaps have the link handy?
thanks

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