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My take from Monday’s Barrons article “Berkshire Hathaway’s Valuation Hits 6-Year High. Why That’s a Bad Sign” is share price could see limited gains the balance of 2024.

“Berkshire now is trading at an estimated 1.6 times its March 31 book value, against about 1.4 times at the end of 2023 and an average of 1.4 times over the past five years.

As Edward Jones analyst Jim Shanahan wrote in a client note on Monday, Berkshire’s price/book ratio is at a six-year high. That could mean more limited gains for the stock for the rest of 2024, given that investors have long used that number as a valuation yardstick, even though Buffett has de-emphasized it in recent years. Shanahan has a Hold rating on Berkshire.“

Reluctant to sell Calls at today’s price which probably means that’s exactly what action I should take. I’ll probably take the usual course…do nothing. Ha.

Anyone have any thoughts?

Paul (still lookin for The Great OZ n KS)

I found it useful to look at recent history to see how things panned out when the stock has been at similar levels.
I think the last time the stock at these sort of multiples to contemporaneous book value was in January 2018.
For a position established at that point, the 5 year CAGR was 7.5%. Not great but hardly terminal and the first and final years of that holding period co-incided with weak markets.
For holding periods of 6 years and above starting Jan 2018, the returns settled into the 10-12% range that the underlying business generates.

I personally have very little interest in predicting or playing yearly moves in stock price so a 5 year forward expected return is the way I tend to think of prospects.

If the next 5 years are similar and a 7.5%pa return for a 5 year hold is acceptable then there is no real reason to do anything. Obviously the decision is harder today when risk free US treasuries are offerring much higher returns than were in Jan 2018. The other factor is that the next five years will almost certainly see Buffett leaving the helm so there could be some volatility related to that.

Personally I am not doing anything with my Berkshire position. If the market throws up other opportunities, I'd be less hesitant to move some capital from Berkshire but it's a high bar.

The reference to ‘look-through’ earnings is interesting. I had emailed the journalist back in September, about his previous article including valuation comparisons (on a PE basis) with the S&P 500 but not mentioning: all earnings from the portfolio. I had included a link to a post here on Shrewd’m discussing looking through- earnings…seems to have taken it on board, stating that “the look-through PE ratio is appreciably lower than 23”.

Good to see Barron’s getting smarter from reading Manlobbi’s creation.

Email below:

“I enjoyed your article on Berkshire. I particularly liked that you looked at valuation compared to the S&P 500.

I have been a Berkshire shareholder for more than two decades and have followed the company very closely. I am also a chartered accountant and enjoy crunching the numbers on Berkshire. I recently posted on Berkshire’s Q2 results. Extract below and link to full post.

One important fact not included in your analysis is the concept of ‘owner earnings’. Buffett has discussed this many times in the past. Berkshire’s reported earnings, although prepared in accordance with US GAAP, under report earnings from it’s equity portfolio. Berkshire includes dividends from its equity investments but of course these businesses only pay out an element of their earnings in dividends. Since Berkshire’s equity portfolio is so large, the under reporting of earnings is material. When all ‘owner earnings’ are accounted for, Berkshire’s PE ratio is substantially lower than the S&P 500.

One final point. Berkshire’s has returned broadly the same as the S&P 500 in recent years. In a bull market returns have been handicapped be having such a large amount of excess cash, currently defined by Buffett as cash in excess of $30 billion. Cash Buffett can’t find a rational home for. And of course this is due to the shrinking of the investment landscape, against the now huge size of Berkshire.

https://www.shrewdm.com/MB?pid=580754403

When Berkshire reports earnings, most if not all media outlets, reference GAAP earnings, which is understandable. However, Buffett is correct, when he says such numbers are almost meaningless for a conglomerate like Berkshire. He is referring to both investment gains & losses and undistributed earnings from equity investments.

Not that rational Berkshire shareholders are complaining. After all, a little bit of under valuation (not currently the case) would be helpful, given the growing lack of capital allocation opportunities. It would enable Berkshire to buy back it’s own shares below intrinsic value.

Appreciate the article and your interest in Berkshire. It’s an interesting company. If you ever wanted to include a line on owner earnings, hedge fund manager, Chris Bloomstran, is a reliable source. See his annual letters published prior to Berkshire annual report each year.”

...could mean more limited gains for the stock for the rest of 2024...
Reluctant to sell Calls at today’s price which probably means that’s exactly what action I should take. I’ll probably take the usual course…do nothing. Ha.
Anyone have any thoughts?

Their conclusion seems pretty unremarkable. When valuations are a little above average, the short term returns are likely to be a bit below average. And vice versa.

Doing nothing, as you suggest, is always fine.

The biggest utility of the observation might be for people who were already thinking of selling a bit this year for spending money, meaning that it's probably a slightly better than average moment to do so.
Or people who were planning on adding this year, for whom waiting a wee while might not be a terrible idea. You might not get a better entry later on--the future is uncertain--but it's highly probable.

Jim

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