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First, happy Thanksgiving. Since this is a Berk. Board, I am sure a lot of you are good at valuation. There are three methods I can think of. The first is using multiples. p/s, p/b, p/e, etc. That seems too simple. Another is dcf. That strikes me as not perfect. How do you estimate terminal value, how do you pick the right discount rate, how do you accurately predict cash flow, 10 years into the future? There is 3rd way in between the two, that seems better. There are various variations of it, but it is basically, looking at the past, and listening to earnings calls, to get the future earnings, revenue or cash flow. Predicting a reasonable p/e for the future. Using your logic to figure out if there will be share dilution. Bu doing that, you can predict a future price. From that, it is simple math to pick what price it has to be at to get what return.

I wonder if other people use this method, if there are websites that teach it, or books that teach it. It seems the best method to me.

Thanks in advance.

I think you’ll get as many opinions as there are contributors.

Your approach of trying to learn before jumping in is a good start.

Were it me, at a minimum I would start by:

- filtering Shrewd’m since its inception for everything posted by mungofitch (principally found on the Berkshire & Mechanical Investing boards), and read them carefully. That should take a few days.

- reading The Intelligent Investor by Benjamin Graham - specifically the newly published (October 2024) 75th Anniversary edition with updated commentary by Jason Zweig. (Amazon, $30). That will take another week or so.

That puts you to mid-December for a good basis on how to think about all of this.

- sutton

"I think you’ll get as many opinions as there are contributors."

That's for sure. More opinions actually, since most of us use multiple valuation models.

My preferred model uses book value. Berkshire's stock price tracks sales, operating earnings and net earnings, but it tracks book value the best. In graphs back to 1968, Berkshire's stock price tracks book value with an r^2 of 0.99. Extrapolating BV is no more difficult or imprecise than extrapolating sales or earnings, and choosing a P/BV that corresponds to P/IV is easier than choosing a P/S or P/E that corresponds to P/IV. One good indicator of a fair P/B is the highest P/B at which Buffett has repurchased stock.

Book value is a broad indicator of value. If you want more insight into what determines Berkshire's value, a two-column valuation method (There are variations on two-column methods) will break Berkshire's valuation into two major parts, operating earnings and investments. A sum-of-the-parts valuation method (Again, there are variations on this method) will give more insight into the valuations of Berkshire's parts.

In the end, though, it all adds up to book value. Repurchases distort the relationship between book value and intrinsic value, but so far the effect of repurchases has been small.

Good luck.

Berkshire's value, a two-column valuation method (There are variations on two-column methods) will break Berkshire's valuation into two major parts, operating earnings and investments.

Perhaps a third column should be added for cash (cash equivalent)surplus to what is required for underwriting. If the thesis is correct that WB is holding surplus cash to be deployed during a crisis when asset prices have plummeted below asset values, the cash should have a much greater value than its nominal value. I am wondering if this is causing the stock to trade at a high P/B value compared to previous times.

As an example. Today there may be no company available at a reasonable price. Say, in three years time, BRK may be able to buy value at a 25% discount to the actual value. The time value of holding the cash for 3 years is covered by the short term interest rate, therefore the nominal value of the cash on hand is 1.33 times face value.

Of course, the current high P/B may just be due to investors exuberance.

Aussi

Mark19, BRK is not a typical business which means you need to be a little more careful with applying a single valuation metric. The good news is that the business is VERY predictable and has traded in a valuation band that has been "reverse engineered" by many on this board including Mungo and he has shared a lot of detail behind it (what he calls this 2.5 column method)

Here is a summary of the "Grove Method" (BRK is a collection of different business types and other holdings) - if you really want to understand BRK this is a very good exercise to do at least once.

Grove:1 Non-Insurance Operating Businesses Earnings
Grove:2 Equity Investments less Taxes
Grove:3 Partially Owned Businesses Earnings
Grove:4 Cash & Fixed Income
Grove:5 Insurance Profits

The absolute easiest (and surprisingly accurate) is to use Price to Book. In general 1.4x is expensive 1.3 is cheap.

tecmo
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Okay, thanks. I guess I was wondering about methods that could be applied to general businesses.

Berkshire's value, a two-column valuation method (There are variations on two-column methods) will break Berkshire's valuation into two major parts, operating earnings and investments.

Perhaps a third column should be added for cash (cash equivalent)surplus to what is required for underwriting. If the thesis is correct that WB is holding surplus cash to be deployed during a crisis when asset prices have plummeted below asset values, the cash should have a much greater value than its nominal value.


Three columns! Good grief, next you'll be wanting to separate out investments into stock holdings, associates (ownership stakes between 20 and 50%) and insurance underwriting, and you'll have 5! What should we call it?

Kidding aside, search the word 'groves' on this board and you'll get some recent thinking about how this might be done.

DTB

You are right. That did it.

Okay, thanks. I guess I was wondering about methods that could be applied to general businesses.
I like "future earnings yield" for identifying GARP stocks. Look at the income statements and the current balance sheet, in your preferred order of importance.

For earnings:
Estimate some earnings CAGR for the next N years (5-7). Calculate the total earnings for that year. (Eg 2030 if N=6).
Discount by M% (20-50) based on your confidence in the earnings predictions. (Obviously for downside only).
Discount I% (15-20 for 5-7 years) for inflation.
Divide by today's market cap.
That's the "future earnings yield". See if you think it's cheap considering the quality of the business (an extremely subjective measure).

Take help from numerical measures, to project earnings and to estimate confidence, but not blindly.

For balance sheet: estimate debt coverage, mix of ST vs LT liabilities, general goodness of assets, especially intangible ones.

With this method, I have had indifferent success compared to indexing so far, but future is always brighter for value investing. Right? Right?

"I think you’ll get as many opinions as there are contributors."

That's for sure. More opinions actually, since most of us use multiple valuation models.

My preferred model uses book value. Berkshire's stock price tracks sales, operating earnings and net earnings, but it tracks book value the best.

Or just ride on the coattails of others. Buy a solid company whose stock has recently hit a high and is still near that high.

Extrapolating BV or P/B or P/S or P/E is just a way of bedazzling yourself with numbers. Just because you can measure something doesn't mean that you can predict with it.


In the end, though, it all adds up to book value.

Not at all. In truth, in the end it adds up to other people buying the stock thereby increasing demand. For us little investors at any rate.

<<Extrapolating BV or P/B or P/S or P/E is just a way of bedazzling yourself with numbers. Just because you can measure something doesn't mean that you can predict with it.>>

Exactly!

There’s this too, BRK shareholders are spoiled the truthful numbers. Elsewhere, I don’t even know what kind of lies are being told to me as I go about elegant numbers, ratios, analyses etc. Why I have triangulated my holdings down to a few, like one!

Extrapolating BV or P/B or P/S or P/E is just a way of bedazzling yourself with numbers. Just because you can measure something doesn't mean that you can predict with it.

I would disagree, if you find the right combination of predictability and forecastability it can be a great combination.

For example: Google has a very predictable business, and as luck would have it has traded in a pretty narrow range making it somewhat easier to forecast future stock prices. I would put BRK in the same category.

tecmo
...

I like "future earnings yield" for identifying GARP stocks. Look at the income statements and the current balance sheet, in your preferred order of importance.

Could you give me an example of that?

I have been studying this, and have come up with about 4 methods that I think are better than the discounted cash flow method.

I will try to share them.

This is one of them.

I think DCF is too vague. Who knows what will happen 10 years in the future, Everyone calculates discount rates differently, and terminal value seems crazy. This is what I came up with through reading the book Wealthy and Wise by David Chenier. Look at past earnings. Listen to earnings calls, and see what they say, and see how accurate they have been in the past. If they have been accurate, then estimate a little less than what they say. Look at historical p/e’s. Use your judgement, and pick a conservative p/e. Market cap = future p/e times future earnings. Look at how many shares they have been issuing per year. Extrapolate that into the future. Say you go out 3 years. Divide Market cap by new share count to get price in 3 years. Say you want a 15% CAGR. The CAGR will be (Ending value/beginning value)^(1/number of shares) – 1. From there you can figure out what price will give you what type of return.

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