No. of Recommendations: 5
We more or less all agree that with a price of around 1.6x BookValue (BV) Berkshire is richly valued right now, at the upper end of it's typical valuation range of 1.2-1.6x BV. We also agree that for the next 1-2 years we therefore can't expect higher prices and have to rather expect the price to be flat.
At first glance selling now therefore makes sense. But is that so? How big a difference in $ would it really make over the long term? I just created a little Excel sheet to answer that question for myself, with 2 scenarios over 20 years:
A) Inaction vs. Selling:Selling BRK-B now for $400 and investing the proceeds in company X which - as I assume for Berkshire - is a constant grower and grows (in value and price) 8%/year.
Result: At a typical valuation (Price = 1.4x BV) 20 years from now he BRK-B portfolio would have a value of
$1631. Replacing it now with company X would result in
$1864 instead.
B) Inaction vs. clever Trading:Selling and investing for 2 years in that constantly 8%/year in price growing company X, while Berkshire's price remains flat over those 2 years. Then, after 2 years, selling X and buying back Berkshire for the same $400 where it's now, resulting in then with the proceeds from the sale of X buying 1.17x shares of BRK-B for each share sold now.
Assuming 10 years later Berkshire's price again gets "over the top", again is richly valued and that trade will be repeated: Swapping a richly valued Berkshire share whose price remains flat for 2 years for shares of a company X whose price constantly rises 8% during those 2 years, and selling X and buying back Berkshire after that.
Result: While the inaction Berkshire portfolio after 20 years still would habe a value of
$1631 (see above) the trader's portfolio would have a value of
$2219.
Link to the spreadsheet "Berkshire - Trading when overvalued.xls":
https://docs.google.com/spreadsheets/d/15c0dr0mbfg...Explanation:- I assume for both, Berkshire and company X, 8% growth in value and - apart from the two times in those 20 years unusually high valuation of Berkshire - in price (cell E1)
- Column B is the resulting development of Berkshire's BookValue, starting with it's current BV of around $250
- Col C is the price at a typical valuation of 1.4x BV
- With Col. E it gets interesting: I assume that the current price of a BRK-B of around $400 stays flat for the next 2 years (in other words: As earnings increase it gets cheaper again). After that it's valuation again is in the middle of it's normal range, at 1.4x BV, resulting in a price of $441. In year 11 it again is very richly valued at 1.6x BV and again the price stays flat for the next 2 years.
- Col. G: In Year 1 (now) BRK-B is sold for the current $400 and replaced by a share of company X for the same $400. X grows in price 8%/year, resulting in Year 21 in $1864 instead of $1631 without that swap of companies.
Is that really worth it? $230 more = 15% more after 20 years compare with inaction? Worth saying goodbye to the most bulletproof company I know of? For me clearly not.
- Col I is the really interesting one: After the 2 price wise flat Berkshire years one sells company X which during that time did grow in price 8%/year and with the proceeds buys back into Berkshire which still is at $400, resulting in now owning 1.17 BRK-B shares versus the 1 BRK-B share without any action. Well done!
In Year 11 one does the same trade again: "Knowing" that BRK-B's price of then $864 will remain flat for the next 2 years one sells and buys with the proceeds shares of company X, "knowing" that contrary to Berkshire's price X's price will constantly rise 8% during the next 2 years. And after them one sells those shares of X and with the proceeds buys BRK-B shares again, for still unchanged $864.
Result: For each BRK-B sold 2 years ago one again gets 1.17 shares now. So thanks to those absolutely perfect(!) trades every 10 years when Berkshire was very high valued instead of 1 share BRK-B one now has 1,36 shares, resulting after 20 years in them being worth $2219 instead of $1631 in the inaction scenario, 30% more.
Please note my apostrophs around the word "knowing". To make those additional 30% more profit after 20 years you have to have perfect timing, have to "know" that Berkshire's price remains flat for 2 years and to "know" that company X's price will constantly rise during that time. Good luck!
If you are convinced that Berkshire's price will remain flat for 1-2 years but not which company's shares will constantly rise duringm that time you may prefer to stay in cash during those "lean Berkshire years" --- but then you can't calculate with an increase of that cash of 8%/year and the difference to inaction will be even smaller after 20 years.
Two more comments:- I had to find my once great Excel skills because of "inaction" in this area are rusty. My apologies in advance for all eventual mistakes that little sheet might contain.
- A while ago I posted another link to my Google drive, to a photo of "Berkshire Rd." close to Perth, Australia. That link did not work at least for our member Aussie, so I try again:
Berkshire Road.jpg:
https://drive.google.com/file/d/1sCn6Et2kFxk8W-mnu....
