No. of Recommendations: 15
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
