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I'm still mulling my valuation models based on the fresh quarterly figures. Normally I do the same thing every quarter, but new things do happen in the businesses, so from time to time I have to decide whether any adjustments or new methods are required.

Normally I use the "peak to date" real operating earnings (steady items only), as I have always to date considered dips in operating earnings to be transient things likely to mislead.

However, as noted in other threads, net real earnings in both the rails and the utilities have been lacklustre lately to say the least, and they have stayed below their prior peaks for quite some time. As a result I have turned off this "max to date" feature in my calculations. This unfortunately makes all my valuations a bit squigglier and worse predictors because of dips in recessions, but it does allow for the possibility that things can get worse for years at a time.

In the case of the railroads, that may be the case. I think it possible that the few really good years we had were not the norm, but a bonus stretch, and perhaps more recent results are a little more realistic as a norm. The earnings are pretty smooth, so for now I'm simply taking trailing four quarters real after tax earnings and applying a multiple. No "peak to date" step any more.

In the case of the utilities, the recent bad results really comes down to the loss accruals for the wildfires, almost all of which fell in Q1 and Q3 last year. (there is a smaller issue of the HomeServices losses, but I'm not treating that as a special case needing attention--it isn't as big, at least not yet). Though the utilities may have a lasting lower profitability because of ongoing losing fights with rate setters, my inclination is to see how that goes in future. Without the "peak to date", generalized weakness will get counted as it crops up. Consequently I am treating those two quarters of *specific* losses as anomalous, and stripping them out in order to estimate the value of the utility business on an ongoing basis. I didn't strip out the entire accrual amounts, which is surprisingly complicated because of odd tax effects and odd "net of insurance proceeds" effects. Instead, I did the following:

* For the poor 2023-Q1, I simply replaced the net earnings figure for that quarter with the average net earnings of 2022-Q1 and 2024-Q1. Seems a reasonable way to estimate the "on trend" number.
* For the poor 2023-Q3, I replaced the net earnings figure with the simple average nominal earnings for BHE in Q3 in the prior 3 years. Since the utility division is growing on trend, and we have seen inflation, that seems to be reasonably conservative.
* Lastly, I confirmed that both of these adjustments are smaller than the idea of simply taking out the wildfire loss accruals, to make sure I'm not being overoptimistic.

I also tried it another way, estimating a "normal" net margin for BHE and setting that a floor on rolling-four-quarter earnings. But that ends up creating adjustments in a large number of different periods for no obvious reason, and introduces the problem of picking the right "floor" net margin. Other than the last few quarters, their margins were very much higher the last few years than in the prior few years. Five years to 2022 averaged 14.2%. Prior six years averaged 11.5%. So what's a conservative normal? So I abandoned this approach and instead decided to go with the two specific adjustments above.

By way of background on my valuation metrics and their intended purpose:
I am not trying to get the "true value" of a share. That's why I never worry about having the "correct" multiple of net earnings. Rather, I am interested in a metric that is numerically stable over time (not too squiggly), and rises at the same rate as true intrinsic value over long periods. My two main uses are tracking the rate of rise to know how the company is doing, and tracking the relationship of market price to the then-current level of my metric to see how current valuation levels compared to historical ones.

I was wondering what some of the more thoughtful posters might comment on these assumptions above as inputs to a company valuation model based on earnings for the rails and utilities. Skipping the "peak to date" idea and therefore considering the recent lower rail earnings as the new sustainable norm, and treating the two (but only the two) specific quarters of bad BHE results as anomalous (implicitly not an ongoing expense in future) because of the specific wildfire losses.

Thoughts?

Jim

"Thoughts?"

I applaud your efforts to come up with a meaningful estimate of earnings. Using an average instead of peak-to-date seems reasonable given BNSF's and BHE's recent history, especially BHE.

I have two comments, or rather one question and one comment.
Question: How comfortable are you with the price multiples you apply? As you know, just a change of P/E from, say, 15 to 16 make a 7% change in the valuation.
Comment: Wildfire losses at PacifiCorp are unlikely to be limited to the 2023 losses. I think we have to come up with some way of factoring in the possibility of a huge loss sometime in the near future.

Thank you for sharing you method and results.

rrr12345

Thanks for the thoughtful reply

Question: How comfortable are you with the price multiples you apply? As you know, just a change of P/E from, say, 15 to 16 make a 7% change in the valuation.

The fact is, I don't worry about it at all. As I mentioned, I have two very specific uses for my estimates, and the multiple I use really doesn't matter much for those specific uses. A higher or lower multiple still gives about the same trend rate of increase, and still gives the same utility for comparing the current ratio of price to estimated value versus the historical ratio of price to estimated value. The only difference a multiple of 15 or 16 (or 17 or 18) makes for my purposes is a very very slight shift in the valuation towards the operating companies and away from the investments per share. But the difference is so small that it's not really an issue, unless I decided to use a huge multiple.

In fact earlier today I was thinking that my traditional 15 was so conservative as to be unrealistic, but then I was looking at the fact that net real total income in these divisions has been flat or negative for several years so I thought maybe it's not the time to take out some conservatism. Looking only at very recent results, they are looking more like cash cows perhaps not even deserving a multiple of 15, though I don't really expect that to be true forever.

Comment: Wildfire losses at PacifiCorp are unlikely to be limited to the 2023 losses. I think we have to come up with some way of factoring in the possibility of a huge loss sometime in the near future.

This is true. But the sad act is I have absolutely no way to know how to estimate that, or what the average will be in future. In theory the estimate in current book value is the best guess of the total liability, so for now I'll go with their marks and deal with the revisions as they come in.

A much bigger issue is whether that is the trend, rather than an event. Reading between the lines of Mr Buffett's comments at the annual meeting leads to some depressing thoughts. If utilities are seen as economic punching bags easy to take advantage of, then the whole business model is somewhat broken and ALL recent value estimates are wrong. Again, I have no real way to estimate that penalty, but (other than the two specific adjustments I made) I guess my valuation methodology will follow the earnings as they come in for better or worse, since I'm no longer using the "peak to date" figures. I merely have to be careful not to treat every anomalous loss as anomalous if at some point it appears to be a normal and periodic cost of doing business like big hurricane losses.

Jim

"wondering what some of the more thoughtful posters might comment on these assumptions above as inputs to a company valuation model based on earnings for the rails and utilities. "

Pending the response of a more thoughtful poster, here's what I'm thinking, at least as far as BHE/Pacific Power.

From the 2024Q2 report:

- As of the date of this filing, a significant number of complaints and demands alleging similar claims related to the Wildfires have
been filed in Oregon and California, including a class action complaint in Oregon associated with the 2020 Wildfires for which certain
jury verdicts were issued as described below

and

- Additionally, the U.S. and Oregon Departments of Justice have informed PacifiCorp that they are
contemplating filing actions against PacifiCorp in connection with certain of the Oregon 2020 Wildfires

and

- As of June 30, 2024, amounts sought in outstanding complaints and demands filed in Oregon and in certain demands in California
approximated $3 billion, excluding any doubling or trebling of damages included in the complaints and the mass complaints described
below that seek $43 billion

and

- Generally, the complaints filed in California do not specify damages sought and are excluded from this
amount.

and

- Based on available information to date, we believe it is probable that losses will be incurred associated with the Wildfires. Final
determinations of liability will only be made following the completion of comprehensive investigations, litigation and similar processes

Getting back to the OP: "both of these adjustments are smaller than the idea of simply taking out the wildfire loss accruals, to make sure I'm not being overoptimistic"

My point I'm not sure what wildfire loss accruals to take, and by several multiples. It seems like a gazillion dollars is still on the table, innit?

-------------------

Two things:

1) I'm not sophisticated enough to pull the earnings impairments reserved to date from the Pacific Power P&L, as PP is wholly owned by BHE and thus Berkshire. The judgements thus far are at least $178MM plus $42MM plus $85MM plus $90MM plus ?what did I miss. The Associated Press a few months ago opined "the electric utility [Pacific Power] on the hook for billions of damages". I understand it's a long way from a jury verdict to cutting the check, but I'm not at all sure quantitative 2020 losses are behind us.

2) The one thing we're noticing about climate change is that the changes we've been warned about are happening more quickly than consensus opinion had it even two years ago. So far, this year ha been hotter drier windier than 2020 - when my home was threatened by a wildfire that a jury subsequently decided was caused by Pacific Power - that fire being on Labor Day weekend i.e. a month from now. So far, there have been three fires this season close enough to catch my attention, it's 102 degrees outside, the non-irrigated areas are like tinder and it's six weeks or more to the first significant rain.

What I think I heard at the annual meeting: a) Greg Abel says Pacific Power is working hard to get some sort of blanket indemnity or at least limitations of liability, and b) Warren Buffett says Berkshire "will not knowingly throw good money after bad"

I'm counting on Mr Buffett's reassurance over the years that subsidiaries' liabilities stop at their balance sheet, i.e. the mother ship is not responsible for liabilities - including judgement - incurred by subsidiaries.

Weighing all of this together: I'm not sure that I'd assign any net profit to BHE for the year(s) it takes to be worked out. Heck, bankruptcy seems not unlikely to me. For a conservative forecast for Berkshire, maybe we assign a net of null to BHE for the near future?

-- sutton
who wasn't going to comment on the NYT Gates/Buffett article, but is going ahead to point out that I entirely subscribe to WEB's advice over the years wrt "seamless web of deserved trust", "live your life as not to be afraid to sell the family parrot to the town gossip", not to do anything you wouldn't like to see on the front page of the NYT. It's served me well, but I admit to being surprised now and then at pepole I really thought I knew pretty well showing little moral fiber when some stress came along. I vetoed the hiring of an associate years ago because I thought he was...slippery?...and a junior partner asked me why I'd done it. I briefly explained, and got a cocked head, So it was a character issue? Huh...
Anyhow: character matters. All I mean to say.

"I'm not sure that I'd assign any net profit to BHE for the year(s) it takes to be worked out. Heck, bankruptcy seems not unlikely to me."

And while we're waiting to see the final tally from the 2020 fires, we're likely to see more fires in the future. Electricity transmission and distribution in fire prone areas is too risky a business. Berkshire should try to find a way out of it.

Treating the wildfires as anomalous seems riskier in the face of accelerating climate change (apparently California fires are many times worse this year than last, though I had not noticed it in the SFBA as the winds have not been bringing the smoke down here).

I wonder if Berkshire's reinsurance operations write much coverage for this type of risk? It might be an interesting way to get a read on what one part of the company considers as likely loss to another part.

Hi,

These adjustments all seem perfectly reasonable to me. Hopefully ‘peak to date’ and ‘recent average’ will converge and solve the dilemma, but it seems possible that, as you say, we may not be able to count on those peaks for the utilities.

BTW, I reestablished a small (2%) position before markets opened this morning, primarily because I was very impressed by Buffett’s unBuffetonian slicing of the Apple stake in half, and perhaps even more since June 30, and his ongoing reduction in the BoA stake. Berkshire’s pre-market plunge of 4.5% in the context of the market’s 2.5% plunge (and AAPL’s 6% drop!) seems backwards, and I took advantage by buying some BRK at $409, well below the price I sold at after Q1 results. There may be opportunities to buy more at lower prices, but just in case!

DTB - How do you buy BRK prior to the market opening ?

BTW I used the gambit for currency conversion again and it works a lot faster with the 1 day settlements now in effect. Also, this time I was able to journal shares from U.S. side to CDN side using WebBroker without contacting them for assistance. Thanks again for that very useful information.

I took advantage by buying some BRK at $409, well below the price I sold at after Q1 results. There may be opportunities to buy more at lower prices, but just in case!

My thinking is similar. I'm a big fan of price dips.

I have cash just earning interest, and would love to deploy it back into Berkshire at valuation levels more attractive than those we've seen recently. So I wrote some cash-backed puts this morning.

There are plenty of choices that might make sense depending on your goals, but I wrote Jan $410 for a premium of $18.95. The two outcomes are that I get either
(a) a return of 4.85% on my cash committed for [up to] 165 days, which is an annualized rate of [at least] 10.72%/year. That's in addition to the interest rate that I'm already earning on that cash, currently a little over 5% but falling. Or...
(b) I get some Berkshire stock at a net entry price of $391.05, probably early in the new year. I think a reasonable guess of the stock price early next year might be around $396-411 per B share, so that's a good entry. Maybe 1.33 to 1.36 times year end book as a wild guess?? In any case, a pinch below typical multiples of on-trend value, I think.

I wonder how many Berkshire put contracts Berkshire could write before the market makers noticed and stopped offering decent premiums?

Jim

DTB - How do you buy BRK prior to the market opening ?


Just like any other limit transaction - on Interactive Brokers you just check ‘Allow transaction outside of market hours’, or some such. On TD WebBroker which still feels like 1995, I never do this but apparently it’s possible: https://www.td.com/ca/en/investing/direct-investin...




BTW I used the gambit for currency conversion again and it works a lot faster with the 1 day settlements now in effect. Also, this time I was able to journal shares from U.S. side to CDN side using WebBroker without contacting them for assistance.

Yes, that is a nice recent improvement. It was always a little awkward doing it over the phone, as it must be pretty obvious to them that you are just skipping out on paying them $1000 in slippage from their awful exchange rates. It even surprises me that they allow this at all, but I guess they figure they may as well tolerate us since they can still rip off 95% of their customers who are not even aware that they are getting ripped off.

Weighing all of this together: I'm not sure that I'd assign any net profit to BHE for the year(s) it takes to be worked out. Heck, bankruptcy seems not unlikely to me. For a conservative forecast for Berkshire, maybe we assign a net of null to BHE for the near future?

Thanks for your thoughts, though that last one is not the cheeriest view!

I certainly appreciate that there are more losses to come. But, given that the value of any enterprise with earnings is based primarily on earnings well after the 5-10 year mark, for me the question is not how bad will it be this year and in the next couple/few years, but rather, if we knew what the future would be like on average what would this year look like? What would this year look like if it were (in the context of the substantial future) neither unusually good nor unusually bad? I believe there will be losses and mitigation expenses, more than in the past, but not enough to make every year profitless on average.

In other words, I think that BHE (which is of course more than just PG&E) will be earning money over the decades to come. And, by extension, using a really unusually bad year as the estimate doesn't seem right. The question is, how much is a reasonably prudent assumption?

These are the net after tax earnings and net profit margins at BHE in the last few years,

13.11%
14.12%
14.70%
14.23%
14.79%
 8.96% (oops)

Maybe it would be sufficient to pencil in an expectation that the firm can probably still make a certain percentage in future? Maybe 12% doesn't seem too crazy as an answer to that question: "neither unusually good nor unusually bad relative to all future years"? The average for the last 3 years (average of 12 rolling-four-quarters figures) is 12.34%, which is basically made up of two normal years and one recent bad one.

Or, another way to look at it: until the recent issues, 2021 and 2022 represented the modern normal. The three US energy operations (after their proportional share of interest expense) accounted for almost exactly half of the net operating profit of BHE. Let's say the other units stay profitable at the old normal levels, and a very conservative view of the US energy operations is that they will be only half as profitable as they were before at the prior "normal". So, we'd see the new normalized net margin at 3/4 of the rate of those two years, which would put it at 10.9%. Somehow my gut feels that it's too conservative to assume that US utilities will forever have only half the profitability of the past. On the other hand:
* Net margins have been very good in the last five years before the fires at 14.2%, partly because of a changing mix of businesses. Average 2012-2015 was only 11.5%, so maybe 10.9% doesn't seem crazily low by comparison?
* A lot of the net profit at BHE comes from a negative tax rate from green tax credits that might not last forever.

For a sense of scale:
The 2023 full year net profit at BHE as reported came in at $2331 after accruals and so forth. That's the worst rolling-four-quarter period from the wildfires.
At the "old normal" average margin of the prior 5 years the profit would have been $3691, 58% higher.
The 10.9% net margin assumption above, based on "half the earning power value of the US energy utilities is permanently gone", would put the cyclically adjusted earnings at $2835, somewhat below the midpoint between the two.

Jim

I wonder how many Berkshire put contracts Berkshire could write before the market makers noticed and stopped offering decent premiums?

I only started writing puts regularly after reading that Apple accomplished a chunk of their buyback by contracting with a large bank to write puts. Now I do it all the time, it's a reasonable way to goose returns and/or acquire stocks that I like at prices I am amenable to.

I looked at BRKB puts this morning, September and October ones, and none of them looked particularly attractive to me. Even with the huge VIX spike, it didn't appear to me that Berkshire options jumped enough. Other options went crazy (NVDA for example) and premiums were sky high. In the end, I did nothing of consequence this morning.

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