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'I believe Berkshire's intrinsic value can be approximated by summing the value of our four asset-laden groves and then subtracting an appropriate amount for taxes eventually payable on the sale of marketable securities.' Warren Buffett

Most of you will have noticed that Berkshire's market value has dramatically increased in the last 3 years. It has doubled from around this time in 2020. Of course, such short term moves in the market price of Berkshire are of only mild interest to long term investors, who are more interested in the future rate of change in intrinsic value of this unusual company. That being said, we are value investors. We like to know what we own and what it might be 'worth' and we like to compare our situation to all options available and understandable to us. Fairfax Financial was recently discussed on Bill Brewster's podcast which inspired me to compare the two firms, at an albeit very crude high level.

Berkshire and Fairfax are similar in many respects but very different in others. They are both in the float business. Essentially they use float and deferred taxes to juice their returns. In many ways it is a simple business model as Charlie Munger once described it along the following lines ' we collect premiums up front, we earn an investment return on those premiums and we aim to break even or make a profit on underwriting. If done well, it's a hell of a business.

Certainly as 'risk free' interest rates have moved up above 5% combined with a hard insurance market resulting in prospects for underwriting profits, it is a different business to 3 years ago. No doubt these facts and Buffett's investment in Apple have contributed to the doubling of the Berkshire share price. But of course, the catch is that anyone can earn over 5% on the investment side but it takes an unusual set of skills and culture to report underwriting profits for 20 years (bar 2017) as Berkshire has done. And as Buffett points out, in his 2018 letter, future underwriting profit is far from certain. Berkshire's focus on long term results rather than arbitrary reporting deadlines which is supported by shareholders and understood by underwriters arguably suggests it has a better chance than most. There is evidence to suggest that Fairfax, like Berkshire takes long term underwriting profitability seriously. From the 2022 Fairfax annual report

'Our insurance businesses have produced on average a combined ratio below 100% for the last 17 years.'

With the backdrop to what makes a successful float-based business out of the way. How do the valuations of the two firms compare using Buffett's 5 groves. The numbers are by definition arbitrary. What is an appropriate multiple for BNSF based on depressed 2023 Q2 earnings. Or what is an appropriate multiple for Berkshire Hathaway Energy, given its growth potential. Or what multiple should be attributed to Fairfax Financial's operating companies. Despite the obvious fuzziness (to use a previous Buffett phrase) there is enough valuation contrast between the two firms to demonstrate very different market ratings. Spoiler alert. Fairfax is cheaper but Berkshire is a higher quality firm (better underwriting record and better investment track record, although it does have some relative disadvantages: older CEO and harder to move the needle size issue.)

Berkshire Hathaway

Grove 1 ' Non insurance businesses with ownership between 80% and 100%. Intrinsic value (IV) $354.1 Billion.

Main businesses, IV and multiple of profit after tax Q2 2023 run rate.

BNSF $76 Billion (15x)
BHE $53 Billion (17x)
Manufacturing ' Industrial Products $78 Billion (17x)
Manufacturing ' Building Products $63 Billion (17x)
Manufacturing ' Consumer Products $11 Billion (10x)
Services $37 Billion (15x)
Retailing $16 Billion (12x)
McLane $5 Billion (12x)
Pilot $15 Billion (35x?)
Other (Fx gains) zero
(Again, don't worry too much about the multiples. Overall groves 1 and 3 work out at about 15x Q2 2023 run rate PAT. Would Buffett sell the group for this, probably not. There is plenty of quality there compared to alternative uses of capital.)

Grove 2 ' Equity securities - IV $190 Billion.

30 June 2023 market value ($353 Billion) less a huge 50% Apple haircut ($89B) and taking off the $93 Billion of deferred taxes and adding back $19B deferred taxes on Apple haircut. Of course the taxes might not be paid for a very long time and Apple is probably worth more than 15x. We are being conservative and the purpose of this post is to compare the relative valuation of the two firms.

Grove 3 ' Non Controlled Group (Craft Heinz, Occidental, Berkadia Commercial Mortgage.) IV $28 Billion.

I am picking out this valuation from the balance sheet which shows 'Equity method investments' at publicly valued $27,493 Million at Q2 2023. That would equate to 13x.

Grove 4 ' Cash, US Treasuries, Fixed Income. IV $164 Billion.

Excludes cash and debt in rail and energy. Buffett has previously talked about $20 Billion minimum. Not sure if this is higher now. Leaving it in anyway. Berkshire has $166 Billion of insurance float.

Those 4 groves add up to an Intrinsic Value of $736 Billion v current market capitalisation of $776 Billion.

1. $354B (subs)
2. $190B (equities)
3. $28B (20% to 50% interest)
4. $164B (cash and bonds)

Total $736 Billion

Essentially this is Rail, BHE, MSR and the non control group at around 15x after tax. The equity portfolio at 30 June 2023 with Apple haircut of 50%. Deferred taxes taken off. Insurance business valued at cash and bonds only. It is conservative, too conservative on an absolute basis.

My understanding of the really fuzzy bit about valuing the insurance business, is that Berkshire has $166 Billion of float. Which is about equal to the cash and bonds. Groves 1, 2 and 3 are easy to value. We might disagree on the multiples; the growth potential; which trees are dying, but their IV can be reasonably be stated: certainly within a range. Insurance is a whole different matter of uncertainty. In my mind (and this is where I need some help and the reason for this post), by valuing the insurance business at only the cash and bonds we are fully ignoring the 'potential' underwriting future profitability. Is that correct? I can understand the value of the cash and bonds. If I had $164 Billion I can invest that easily and get 5% or $8.2 Billion. It is clearly worth $164 Billion at least. I say at least, as it is in the hands of capital allocators with a history of getting more than 5%. It may not look that way now but even with the huge size of Berkshire there is a good chance it earns even 9% some fine day. But for now its IV is $164 Billion. That is the investment side of the insurance business sorted.

So, what is the value of the underwriting side of the business worth. In the 2018 letter Buffett references the 16 year pre-tax underwriting gains of $27 Billion, with only one loss year. With the scale of insurance operations growing the average over such a long period may be an inadequate starting point for a multiple. Buffett even alludes to that by saying 2018 was a $2 Billion u/w year. But as Buffett and all of us know all too well, insurance underwriting is not so easy as the more recent years have shown (u/w pre tax profits 2019: $400M, 2020: $657M, 2021: $728M and 2022 $90M loss). Although, the first six months of 2023 are currently at an u/w profit of $2,258M going into hurricane season and global warming'). Lots of uncertainty and there is always the big event that wipes out several years. However, it is reasonable to assume that u/w breakeven over a long period is more than possible and touch wood, likely due to the unusual Berkshire characteristics'

'For the entire 16-year span, our pre-tax gain totalled $27 billion, of which $2 billion was recorded in 2018' Warren Buffett

Warren Buffett may value the u/w side of Berkshire conservatively at zero. All things considered maybe he is right. He usually is. Maybe breaking even over the next 20 years would be a good outcome. Ajit Jain is 72. I have no doubt, there are lots of individuals at Berkshire, that together with the culture and shareholder support, can keep the u/w flywheel going for a very long time. I only learned recently, about the Buffett instruction, pre 9/11, about concentration of risk in the twin towers, being ignored by GenRe. That tells me, that individuals with decision making power, can and do, have a material impact on underwriting success, or otherwise. Anyway, I am rambling here.

In summary Berkshire's Intrinsic value on the above basis (importantly with zero value attributed to u/w profit) is $736 Billion compared to $776 Billion market cap, or 5% over valued on a conservative basis. (I much prefer that to the valuation of the S&P 500 which is clearly pricing in a very rosy future for many large firms. Capitalism and competition has a way of humbling financial projections. My preference is for a track record of free cashflow Berkshire style. Call me old fashioned but that's the way I like it).

Let's look at Fairfax.

Fairfax

Berkshire is such a huge organisation and a retail investor, such as me, can only have a veneer knowledge, although many others will know the firm in much more detail. However, the deserved trust in Buffett and Munger makes it possible to be an investor. I can say with a lot of confidence that I know almost nothing about Fairfax Financial. I first looked at the company yesterday after listening to a podcast. So bear that in mind and please do enlighten me where I have made errors in my description.

I have done an intrinsic value of Fairfax using Buffett's groves analogy for comparison. My limited understanding of the company makes that IV calculation suspect. I am probably being overly conservative.

The percentage components of IV for the two firms are described below and demonstrate the Fairfax concentration in cash and bonds:

Groves 1 & 3 (subs and non control group) Berkshire 52% (Fairfax 21%, with 13% being non control group).

Grove 2 (equities with Apple haircut and after D'Tax) Berkshire 26% (Fairfax 12%). Berkshire has way more relative deferred taxes evidencing either Buffett is a better allocator (he is) or Berkshire does less trading and paying taxes.

Grove 4 (Cash, US Treasuries, Fixed Income) Berkshire 22% (Fairfax 67%). My understanding, is that because of Berkshire's long history of success, it is over capitalised, in the eyes of insurance regulators and can allocate to higher return assets, like operating companies and equities. Whereas Fairfax, like most insurers has to tilt more towards 'less risky' bonds. The really important thing Fairfax has done in recent years, compared to other insurers, is that they were in short dated bonds. They did not suffer price declines in bonds when interest rates whet up and are now in the strong position of having a huge 67% bond portfolio earning over 5%. Probably why the shares have done well of late, much like Berkshire but to a bigger extent. Berkshire 'only' has $164 Billion in cash and short dated bonds or 22%, whereas Fairfax has 67%. Higher interest rates are benefiting Fairfax in a major way.

Fairfax Financial IV

Grove 1 ' Non insurance businesses > 80% ownership IV $5 Billion. Take this with a pinch of salt. I picked up somewhere that these businesses were making $500 Million p.a. and put a 10 multiple on them. I gave Berkshire's subs a 15 multiple on the basis that they are generally higher quality. I have no idea about the quality of the Fairfax subs.

Grove 2- Equities and Preferred Stocks. IV $7 Billion. Market value from the 31 March 2023 accounts less deferred taxes $1 Billion.

Grove 3 ' Non Control Group. IV $8 Billion. 31 March 2023 investments in associates $6 Billion plus Fairfax India $2 Billion. (India is potentially interesting ' around 50% is Bangalore Airport which is planning an IPO. Bullish case is that Bangalore is the Silicon Valley of India + air travel rebounding + general India economic prosperity with a respected business orientated president. Bear case ' illiquid private companies)

Grove 4 ' (Cash & short dated bonds) IV $40 Billion. This is the most important number on the Fairfax balance sheet. Fairfax has insurance float of $31 Billion.

Those 4 groves add up to an Intrinsic Value of $61 Billion v current market capitalisation of $28 Billion.
1. $5B (subs)
2. $7B (equities & preferred)
3. $8B (20% to 50% interest)
4. $40B (cash and bonds)
Total $60 Billion

In summary Fairfax's Intrinsic value on the above basis (with zero value attributed to u/w profit) is $60 Billion compared to $28 Billion market cap. The market cap is 54% of the IV estimate calculated above.

Earnings Power

Another way to look at both firms is earnings power.

I have Berkshire at $57 Billion p.a.

Assumptions:

+ Operating companies and non control group Q2 2023 PAT annualised $25.7B

+Equities owner earnings $23.6B (this needs more work! Based on Q2 2023 market value divided by 15x guess. Although I note Chris Bloomstran referred to $17.7 Billion 'retained profits' from the Berkshire equity portfolio. Grossing that up for a 25% dividend payout ratio is not far off my wild guess of £23.6B.)

+ Interest income from cash, US Treasuries and Fixed Income at 5% $8.2 Billion.

Total owner earnings of Berkshire $57.5 Billion. This equates to a multiple of the current market value ($776B) of 13.5x. (Add in $2 Billion of u/w profit gets you to a multiple of 13.1x. Not much difference.)

I have Fairfax at $3 Billion (before u/w profit).

+ Operating companies and non control group $500 Million

+Equities owner earnings $543 Million (Based on market value divided by 15x guess.

+ Interest income from cash, US Treasuries and Fixed Income at 5% $2 Billion.

Total owner earnings of Fairfax $3,067 Million. This equates to a multiple of the current market value ($28B) of 9.1x.

Add in $1 Billion of u/w profit, gets you to a multiple of 6.9x. Big difference.

Fairfax CEO, Prem Watsa, said this in the Fairfax March 2023 annual report ''this has resulted in our expected future annual operating income of more than $3.0 billion: $1.5 billion from interest and dividend income, more than $1.0 billion in underwriting profit and more than $0.5 billion profit from non-insurance companies.'

Since then, interest rates have increased further adding more interest income on the $40 Billion bond portfolio.

Anyway, there you go. Fairfax looks cheaper than Berkshire on a quantitative basis. It is smaller and will find it easier to grow in future but it does not have an investing track record like Berkshire. Impressive u/w record I have to say, but I don't know much about the quality of the firm compared to Berkshire. An argument could be made that Fairfax is cheaper and will grow faster than Berkshire.

Let me know what you think about the valuations and how you think about valuing the insurance side of the business.

EVBigMacMeal



Below are extracts from Warren Buffett's 2018 annual letter to shareholders of Berkshire Hathaway where he commented on valuing Berkshire.

'Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses -- our economic "trees," so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods.

A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty.
Fortunately, it's not necessary to evaluate each tree individually to make a rough estimate of Berkshire's intrinsic business value. That's because our forest contains five "groves" of major importance, each of which can be appraised, with reasonable accuracy, in its entirety.

Four of those groves are differentiated clusters of businesses and financial assets that are easy to understand. The fifth -- our huge and diverse insurance operation -- delivers great value to Berkshire in a less obvious manner, one I will explain later in this letter.

The interest cost on all of our debt has been deducted as an expense in calculating the earnings at Berkshire's non-insurance businesses. Beyond that, much of our ownership of the first four groves is financed by funds generated from Berkshire's fifth grove -- a collection of exceptional insurance companies.

Our property/casualty ("P/C") insurance business -- our fifth grove -- has been the engine propelling Berkshire's growth since 1967, the year we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Today, National Indemnity is the largest property/casualty company in the world as measured by net worth.

And how it has grown, as the following table shows:

Year / Float (in millions)
1970 / $39
1980 / $237
1990 / $1,632
2000 / $27,871
2010 / $65,832
2018 / $122,732

Q2 2023 $166,000

We may in time experience a decline in float. If so, the decline will be very gradual -- at the outside no more than 3% in any year.

The nature of our insurance contracts is such that we can never be subject to immediate or near-term demands for sums that are of significance to our cash resources. That structure is by design and is a key component in the unequaled financial strength of our insurance companies.

That strength will never be compromised. If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money -- and, better yet, get paid for holding it.

Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous indeed that it sometimes causes the P/C industry as a whole to operate at a significant underwriting loss. That loss, in effect, is what the industry pays to hold its float. Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses.

Nevertheless, I like our own prospects. Berkshire's unrivalled financial strength allows us far more flexibility in investing our float than that generally available to P/C companies.

The many alternatives available to us are always an advantage and occasionally offer major opportunities. When other insurers are constrained, our choices expand.

Moreover, our P/C companies have an excellent underwriting record. Berkshire has now operated at an underwriting profit for 15 of the past 16 years, the exception being 2017, when our pre-tax loss was $3.2 billion.

For the entire 16-year span, our pre-tax gain totaled $27 billion, of which $2 billion was recorded in 2018. That record is no accident: Disciplined risk evaluation is the daily focus of our insurance managers, who know that the benefits of float can be drowned by poor underwriting results.

All insurers give that message lip service. At Berkshire it is a religion, Old Testament style.

In most cases, the funding of a business comes from two sources -- debt and equity. At Berkshire, we have two additional arrows in the quiver to talk about, but let's first address the conventional components.

Beyond using debt and equity, Berkshire has benefitted in a major way from two less-common sources of corporate funding.

The larger is the float I have described. So far, those funds, though they are recorded as a huge net liability on our balance sheet, have been of more utility to us than an equivalent amount of equity. That's because they have usually been accompanied by underwriting earnings.

In effect, we have been paid in most years for holding and using other people's money. As I have often done before, I will emphasize that this happy outcome is far from a sure thing: Mistakes in assessing insurance risks can be huge and can take many years to surface. (Think asbestos.)

A major catastrophe that will dwarf hurricanes Katrina and Michael will occur -- perhaps tomorrow, perhaps many decades from now. "The Big One" may come from a traditional source, such as a hurricane or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate.

When such a mega-catastrophe strikes, we will get our share of the losses and they will be big -- very big. Unlike many other insurers, however, we will be looking to add business the next day.

The final funding source -- which again, Berkshire possesses to an unusual degree -- is deferred income taxes. These are liabilities that we will eventually pay, but that are meanwhile interest-free.

As I indicated earlier, about $14.7 billion of our $50.5 billion of deferred taxes arises from the unrealized gains in our equity holdings. These liabilities are accrued in our financial statements at the current 21% corporate tax rate, but will be paid at the rates prevailing when our investments are sold.

Between now and then, we in effect have an interest-free "loan" that allows us to have more money working for us in equities than would otherwise be the case. A further $28.3 billion of deferred tax results from our being able to accelerate the depreciation of assets such as plant and equipment in calculating the tax we must currently pay.

The front-ended savings in taxes that we record gradually reverse in future years. We regularly purchase additional assets, however. As long as the present tax law prevails, this source of funding should trend upward.

Over time, Berkshire's funding base -- that's the right-hand side of our balance sheet -- should grow, primarily through the earnings we retain. Our job is to put the money retained to good use on the left-hand side, by adding attractive assets.'

this is an excellent post. Thank you.

You do say how conservative your approach is but it seems extremely conservative.

If Apple gets down to 15X (short of a Taiwan invasion), I think Warren would be buying aggressively.

BNSF @ $76 Billion seems a bit low given UNP has a current market cap of $137B or so - 80% higher - they are not that dissimilar.

Food for thought however.

thanks Longtimebrk. Yes I agree completely with both points on BNSF and Apple.

The current 30x for Apple looks unappealing (Taiwan, sheer size of the business, saturation, tech risk of disruption). I can see why Berkshire would never sell though - it's an incredible business obviously and the taxes would be huge. Sell, then what?

Yes UNP has a big market value. My BNSF earnings number is based on Q2 2023, which could well be depressed in some way. Certainly I am not aware of any reasons why BNSF is not as good a business as UNP in the long term.

Below is just a bit of a unrelated ramble out loud.

Feels good though to be super conservative. It's a brutal world out there and eventually everything goes to zero -:)

The idea of calculating an intrinsic value and then buying with a margin of safety below that, is something that took me a few years to fully appreciate. I remember originally thinking that a MOS was how you made your money as the gap closed, which can have some truth but as Buffett has said, MOS is his due diligence. I like that idea and if it applies to Buffett with all his work and insights, if the less able are to have any edge, an even bigger margin of safety should by definition be demanded.

Mungofitch has mentioned previously that Buffett's fail record is unparalleled. Buffett takes the margin of safety idea very seriously. The future is always uncertain to varying degrees. A conservative IV calculation although different from MOS is in the same arena.

Of course this is all very different to how the big S&P 500 firms are valued today. Will all the excess cash lying around the world, who knows what will happen to stock prices but given the destructive nature of capitalism and competition, conservative intrinsic value calculations and margins of safety when buying make a lot of sense. This is such a different world to what is going on in the markets the last few years...

This is where I get tripped up:

Grove 4 ' Cash, US Treasuries, Fixed Income. IV $164 Billion.

Excludes cash and debt in rail and energy. Buffett has previously talked about $20 Billion minimum. Not sure if this is higher now. Leaving it in anyway. Berkshire has $166 Billion of insurance float.

...

I can understand the value of the cash and bonds. If I had $164 Billion I can invest that easily and get 5% or $8.2 Billion. It is clearly worth $164 Billion at least. I say at least, as it is in the hands of capital allocators with a history of getting more than 5%. It may not look that way now but even with the huge size of Berkshire there is a good chance it earns even 9% some fine day. But for now its IV is $164 Billion. That is the investment side of the insurance business sorted.

If they always hold a large percentage of the float amount in cash, is the cash pile really worth face value? Float is a liability, after all.

IIRC, both Jim and Bloomstran take $50 billion off the cash pile (30% of float value) to account for the amount that will always be held in reserve.

https://berkshirehathaway.com/qtrly/2ndqtr23.pdf
Page 25

Berkshire's common stock repurchase program permits Berkshire to repurchase its shares any time that Warren Buffett,
Berkshire's Chairman of the Board and Chief Executive Officer, and Charlie Munger, Vice Chairman of the Board, believe that the
repurchase price is below Berkshire's intrinsic value, conservatively determined. The program continues to allow share repurchases in
the open market or through privately negotiated transactions and does not specify a maximum number of shares to be repurchased.
However, repurchases will not be made if they would reduce the total value of Berkshire's consolidated cash, cash equivalents and U.S.
Treasury Bill holdings below $30 billion.

I think you have to knock at least $30bn off. It's not a huge difference to IV, though. 5% or so.

AdrianC thanks for that. So the reserve cash is $30 billion...

I wonder if it has value now with risk free returns at c.5%. But was previously worthless when rates were zero. Not as valuable as the remaining $134 billion, which could some day get deployed at e.g. 9%. But unless float shrunk it is equity like. I'm not really sure.

Doing the above 5 groves analysis has helped me understand valuing Berkshire the way Buffett does (well I think it has helped).

My understanding is that the first 4 groves are assets. The 5th grove, insurance float is an accounting liability. However, Buffett does not think that liability should be deducted from the first 4 asset groves. It's more like equity. Gets replaced every year with new float and in normal circumstances does not get paid out. I previously incorrectly though of float as a 5th grove asset but now I see it as a liability that I don't have to deduct i.e. equity like.

Buffett has also talked about how float could only really decline at 3% p.a.

Getting back to the $30 billion ring fenced cash. I suppose if there was a mega insurance event that caused a huge underwriting loss and huge cash pay out. Then the $30 billion has no value. Given that that is always a possibility, then I guess it makes sense to exclude it.

IIRC, both Jim and Bloomstran take $50 billion off the cash pile (30% of float value) to account for the amount that will always be held in reserve.

Just a clarification of my own thinking. A small geeky difference, but important to my way of thinking. The amount I take off the investments per share due to float, 30% as you mention, is not an estimate of the average cash balance as some might suppose.

My thinking is this:
Any good long term portfolio, with a prudently varying and opportune mix of securities and cash at any given time, will be expected to have a certain long term return. Its true intrinsic value is a function of that return. I would generally estimate the value of this portfolio at its market value. (plus or minus a cyclical adjustment at valuation extremes, perhaps, but let's ignore that). Let's say intrinsic value = P1 = market value.

A portfolio of the same size which has to allocate a certain amount of assets to very short term liquidity because it is backing insurance liabilities will suffer by comparison in terms of its long run returns. If the long run returns are lower than the returns in the unconstrained portfolio above, the intrinsic value of the portfolio is lower. So I estimate that it is worth less than its face value. Call it P1 - K.

The 30% of float is just the arithmetic I use to estimate of K, being the amount to reduce the value estimate of the total investments because long run returns will be lower than long run returns from an unconstrained portfolio. K is not the amount of investments per share expected to be held in cash, but the reduction in intrinsic value of the total portfolio because of the liquidity constraints on portfolio allocation.

Obviously different people might estimate K in different ways, but I think it's useful to think in terms of the reduction in the value of the portfolio to Berkshire rather than obsessing about the size of the cash pile. What we call "cash" is just the shortest duration end of the fixed income part of the portfolio, which in turn is just a varying subset of the total portfolio of liquid assets. There is no bright dividing line between cash and non-cash. I think it's best thought of as a single large broad mixed portfolio, with slightly lower returns than would normally be the case because of a liquidity floor, hence a lower intrinsic value.

Jim

For anyone interested here is the original intrinsic value split out, weighted and sorted from largest to smallest.

Cash, US Treasuries, Fixed Income $164,286 22%
Non Apple Equities less tax 120,094 16%
Manufacturing Industrial Products 77,945 11%
BNSF 75,840 10%
Apple (50% haircut) 70,152 10%
Manufacturing Building Products 62,920 9%
BHE 53,380 7%
Services 37,284 5%
Non Controlled businesses 27,820 4%
Retailing 15,855 2%
Pilot Travel Centers (80% interest) 15,504 2%
Manufacturing Consumer Products 10,739 1%
McLane Company 4,669 1%

Total Intrinsic Value $736,488m 100%
Market cap/IV 105%

And below is another version, with adjustments discussed on this thread.

Apple (market value less 21% tax) $140,304 17%
BNSF (Union Pacific valuation) 136,000 17%
Non Apple Equities less tax 120,094 15%
Cash, US Treasuries, Fixed Income (30% haircut) 115,000 14%
Manufacturing Industrial Products 77,945 10%
Manufacturing Building Products 62,920 8%
BHE 53,380 7%
Services 37,284 5%
Non-Controlled businesses 27,820 3%
Retailing 15,855 2%
Manufacturing Consumer Products 10,739 1%
Pilot Travel Centers (50% haircut) 7,752 1%
McLane Company 4,669 1%
Total Intrinsic Value $809,762m 100%
Market cap/IV 95%

Mungofitch said

"Any good long term portfolio, with a prudently varying and opportune mix of securities and cash at any given time, will be expected to have a certain long term return. Its true intrinsic value is a function of that return. I would generally estimate the value of this portfolio at its market value. (plus or minus a cyclical adjustment at valuation extremes, perhaps, but let's ignore that). Let's say intrinsic value = P1 = market value.

A portfolio of the same size which has to allocate a certain amount of assets to very short term liquidity because it is backing insurance liabilities will suffer by comparison in terms of its long run returns. If the long run returns are lower than the returns in the unconstrained portfolio above, the intrinsic value of the portfolio is lower. So I estimate that it is worth less than its face value. Call it P1 - K.

The 30% of float is just the arithmetic I use to estimate of K, being the amount to reduce the value estimate of the total investments because long run returns will be lower than long run returns from an unconstrained portfolio. K is not the amount of investments per share expected to be held in cash, but the reduction in intrinsic value of the total portfolio because of the liquidity constraints on portfolio allocation."

My understanding of valuing Berkshire continues to evolve. I like that Buffett referred to the intrinsic value of the 5th grove (insurance) as fuzzy. The future in insurance is always uncertain even for a diversified insurance book like Berkshire's. Future underwriting and investment returns are clearly not conducive to analytical certainty to any degree.

The 30% of float handicap makes sense. Having liquidity to deal with anything is central to Berkshire's objective of remaining an insurance Rock of Gibraltar. But that comes at a cost on the expected investment returns and should be factored into a conservative intrinsic value calculation.

It is interesting that your K is to handicap future investment returns rather than to provide guaranteed liquidity for claims. Buffett's $30 billion short dated end of the bond portfolio (cash) sounds more like a liquidity guarantee. But maybe they are just the other side of the same coin. 30% of float is a similar number to 30% of cash ($50 billion v $49 billion). Then again both are higher than Buffett's $30 billion number. Although that number has probably increased since last stated.

If K is to handicap the investment return, then valuing all investments at market value (Apple aside) and assuming the investments are trading at intrinsic value, then we have to wonder, does that intrinsic value of investments build in future investment returns or increases in intrinsic value. Probably not. Intrinsic value is a thing that can grow and shrink over time, as new opportunities and threats are digested. I might have wondered into unsound thinking...not sure. But my niggle in understanding is in relation to the $30 billion or $50 billion. I can see how it will not produce investment returns above short dated cash/bonds. But that does not mean it is worth zero. Yes it is worth less than the other non restricted cash which has an optionality value. Then again we are simply talking about being conservative in our estimate of intrinsic value, so it's all good. It then follows that the optionality of Berkshire allocating the excess cash is not included in the intrinsic value estimate. Good to know $115 billion of cash and counting daily could end up going into 9% return investments. That would be upside and a small reason for buying Berkshire today at around most people's conservative intrinsic value.

Do you think Berkshire will move some of the $115 billion excess cash into longer dated treasuries to lock in say 5% for a few years? Or is the optionality factor too attractive.

PS. final post on this tread as I have used up my noise credits for a few months. Having reviewed Berkshire and Fairfax through Buffett's 5 groves approach, I have learned quite a bit but there is still a thick fog, certainly with Fairfax. But with that said, I am of the opinion that Berkshire is quite a different investment than Fairfax. The striking difference is the impact that a major insurance event would likely have on each business. A $15 billion insurance loss would be unfortunate for Berkshire but it would be writing new insurance policies the next day at better prices and would have a prospect of making it back in a hard market. From a short term investment view of Berkshire, the non insurance operating earnings, combined with the quality of the investment portfolio and liquidity to pay claims, without raising capital, would make it a temporary and not huge hit to earning power and intrinsic value. The old story for investing in Berkshire is to protect the down side. You don't need to get rich twice.

A $15 billion insurance loss for Berkshire would be 9% of float. $15 billion is just a random number for illustration purposes. 9% of Fairfax's float would be $2.8 billion which would more than wipe out their earnings power in one year. Fairfax would have plenty of liquidity to pay it and would also earn it back.

It is clear Berkshire has a higher quality of earnings with less relative exposure to insurance which is often lumpy. Berkshire may well be only fairly valued currently, compared to Fairfax, which looks deeply under valued. But Berkshire is significantly less risky as an investment. That does not mean Fairfax can't double in the next two years and outperform Berkshire. It probably will. But I am much more comfortable staying on the Berkshire train in a major way. Who wants to spend their night watching the weather channel.

Not only are Berkshire's earnings higher quality (non insurance) but of course the investment side is also different. Berkshire may find it hard to move the needle due to size and current investment conditions but it has only 22% low risk, low return assets versus 67% for Fairfax. Another important question comparing the two firms is the quality of underwriting. We suspect Berkshire is really good on this front and has a long track record but that can of course change. Fairfax also has a great track record. But I personally am more familiar with Berkshire so it is less risky for me.

I appreciate all of your insights into Berkshire Hathaway. I have learned a lot from your posts, and I am grateful for your willingness to share your knowledge.

EvBigMacMeal

My understanding of valuing Berkshire continues to evolve. I like that Buffett referred to the intrinsic value of the 5th grove (insurance) as fuzzy. The future in insurance is always uncertain even for a diversified insurance book like Berkshire's. Future underwriting and investment returns are clearly not conducive to analytical certainty to any degree.

The 30% of float handicap makes sense. Having liquidity to deal with anything is central to Berkshire's objective of remaining an insurance Rock of Gibraltar. But that comes at a cost on the expected investment returns and should be factored into a conservative intrinsic value calculation.

In his explanation of the 5-groves, Buffett says outright that some of the cash will never be invested:

https://berkshirehathaway.com/2018ar/2018ar.pdf
Page 6:

"In our fourth grove, Berkshire held $112 billion at yearend in U.S. Treasury bills and other cash equivalents,
and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be
untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities.
We have also promised to avoid any activities that could threaten our maintaining that buffer."

It is interesting that your [Jim's] K is to handicap future investment returns rather than to provide guaranteed liquidity for claims. Buffett's $30 billion short dated end of the bond portfolio (cash) sounds more like a liquidity guarantee. But maybe they are just the other side of the same coin. 30% of float is a similar number to 30% of cash ($50 billion v $49 billion). Then again both are higher than Buffett's $30 billion number. Although that number has probably increased since last stated.

It was $30bn in the 2023 second quarter report. Bloomstran says $50bn is about the maximum that Berkshire might have to pay out in a year, or something like that.

Good to know $115 billion of cash and counting daily could end up going into 9% return investments. That would be upside and a small reason for buying Berkshire today at around most people's conservative intrinsic value.

Well, buying at a conservative IV means a good chance of getting a decent result over a long time. The possibility of bagging an elephant could be icing on the cake. Not to be expected. Consider the last 13.5 years:

(Cash & Bonds)/ Float
2010 till now:
105%
92%
100%
94%
101%
99%
102%
109%
105%
111%
113%
109%
92%
99%

They drop the cash & bonds below float value sometimes, but not very far, and not for long.

I had brought up Fairfax simply as an entity to consider for a diversified portfolio, nothing more nothing less. I have owned the stock since the mid 1990's and the returns have been sound. The stock became a cult in the late 1990's and of course it would have made sense to sell but as is the norm I simply held on. Then we had the macro bet years when Prem literally lost his mind.

Things have changed and Fairfax in my view is underwriting and investing soundly. Insurance underwriting will be as it has, surprises will develop. But those with long term experience who have shown both successes/failures and survival at least have some evidence for the outside passive investor to monitor and use for investing or not.

I'll pull back from my further thesis of Fairfax as it is quite opposite of those here and having someone come on board writing in the parent ego state of lecturing whether it is return on equity or insurance underwriting is simply painfully boring and superficial for me to read. Obvious things may need constant re-stating, but they are not what I come to the board to read.

We can, I guess, discuss CarMax and Dollar General. CarMax has been discussed for years here and DG is on the same path. Before that we had a financial marketing firm to discuss but apparently it failed to deliver although appearing cheap and constantly got cheaper.

EvBigMacMeal: The old story for investing in Berkshire is to protect the down side. You don't need to get rich twice...... I am grateful for your willingness to share your knowledge.

And I am grateful for your above sentences which clarify for myself why Berkshire is so important for me (and why I should not give in to "lighten up" temptations when it's a bit richly valued).

Thanks for sharing, EV. Just one comment: You are correct to value the cash, T-Bills and fixed maturity assets at face value, including the $30B in cash held in reserve. These assets are worth the interest stream to be received, plus terminal value, discounted at a discount rate equal to the total annualized return. That comes out to today's ptice. For example, a $100, two-year note currently priced at $100 and paying 4.9% interest will pay an interest stream of 4.9% per year, with a terminal value of $100. When discounted at the total annualized return of 4.9%, the present value will come out to $100.

Same thing for equity securities. These assets are worth the dividend stream to be received, plus terminal value, discounted at a discount rate equal to the total annualized return, say 7%. If the market has valued the equities correctly, then the discounted present value comes out to market value. If the market has overvalued one of the equity securities, then a case can be made for applying a haircut to that security, but bearing in mind that these securities are available for sale at today's price. I am hopeful that Berkshire's equity portfolio will return more than 7%, but whatever the future return turns out to be, applying a discount rate equal to the annualized total return to the dividends and terminal value will bring the present value back to today's price.

Thanks for sharing, EV. Just one comment: You are correct to value the cash, T-Bills and fixed maturity assets at face value, including the $30B in cash held in reserve. These assets are worth the interest stream to be received, plus terminal value, discounted at a discount rate equal to the total annualized return.

Don't forget that float is a liability.
We are generously assuming that the investment assets are worth something because we get to keep the returns on them more or less forever.
If the loan is perpetual and bears no interest rate, we make the very aggressive approximation that we don't really even owe that money.

But never forget that we don't own the investment assets.

If you have $1bn in float liability and $1bn in investment assets, the net asset value is zero. Zero.
We say that the assets are actually worth something to us though, because we get the investment profits on them for an indefinitely long time.
If it's a perpetual interest free loan, we make the first approximation (a quite aggressive one) that it's as if we don't owe anything at all. Whee!

But let's break it down a bit:
That $1bn in investment assets is broken down into (say) on average $750m in "normal" investments and $250m in cash or very short term liquid assets that will forever have an after tax real return of zero. And, don't forget, a true $1bn liability.
You can make a reasonable case that the $750m is worth something despite having an offsetting liability, maybe even as much as face value, because you get to keep the profits and never have to repay the "loan" of float. OK.
But the other $250m? There is an offsetting liability, AND it will forever earn nothing, so I can't see any case for assuming it's worth anything at all to the shareholder.
That part is like a perpetual interest free loan that you can't ever earn anything on. It's useless. The assets and liabilities simply cancel out.

Perpetual cash is worth face value, sure. (using "cash" as shorthand for "some liquid assets forever with no real investment return")
But perpetual cash with an offsetting liability isn't worth squat.

The case that we can ignore the float liability rests on the notion that we get to keep the earnings on the investments.
But there are no earnings on some of those investments, and never will be, so they're not worth anything to us.

Jim

The case that we can ignore the float liability rests on the notion that we get to keep the earnings on the investments.
But there are no earnings on some of those investments, and never will be, so they're not worth anything to us.

Over the last decade Berkshire has kept an average of 82% of float in cash (average of year-end numbers).
At last report it was 86%.

But given Berkshire's huge size, is it material enough to worry about?

Deducting 0%, 50% and 100% of float from cash makes a +/-10% difference to my 5-groves IV estimate.

Not big at all.

I've spent far too much time on it!

' I've spent far too much time on it!'

This is wise introspection

We probably all are guilty of this.

As to both Berkshire and Fairfax...

I'm not going to speak from the parent ego state lecturing or insulting anyone here with a description and analysis of float. We are not naive child mindset investors obviously. 50 years of investing, 48 with Berkshire and almost 30 owning Fairfax send me to a simple model as to these businesses.

Basically my rule of thumb is again of very elementary thinking: Either you trust management as to their levels of reserves/underwriting and investing or you don't. In my view both Fairfax and Berkshire are extremely trustworthy as to insurance underwriting over time. Fairfax once made some awful macro bets but those ended long ago. Fairfax invests successfully today.

If you choose to pit one vs the other that's fine but both are well run insurance underwriters.

I'm not going to speak from the parent ego state lecturing or insulting anyone here with a description and analysis of float.

Well, you can count me as a glutton for those types of insults. Keep 'em coming, please, and much obliged.

'Basically my rule of thumb is again of very elementary thinking: Either you trust management as to their levels of reserves/underwriting and investing or you don't.'

The discussion that I participated in was about how to value the float. I think we all here take it for granted that Berkshire reserves prudently.

I for one would be interested in your opinion on how to include float in a valuation of Berkshire.

If you look at Travelers today you'll see some convoluted "Core Earnings" discussions. It is the NEW NEW THING for the insurers who are locked in to some very low yielding long term bonds. These of course have huge losses, thus investors are steered to "core" or whatnot.

You'll not find that with Berk or Fairfax. Fairfax's investment portfolio today is excellent.

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