Is Berkshire Hathaway Losing Its Book Value Premium?


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To me, there is a glaring omission in the Berkshire Hathaway quarterly report. Nowhere does Warren Buffett talk about his $ 220 billion stock portfolio. The 10-Q is a dense 55-page slog, proliferating in tables and statistics.

More than you can shake a stick, there are detailed breakdowns of all parts of its activity. But, apart from the listing of the securities in the portfolio, no comment on the concentration in banks and the disproportionate position in Apple.

Berkshire Hathaway shareholders pay a 25% premium on the value of its $ 400 billion assets. This is probably the most dangerous metric in my valuation analysis, as it could erode within the next couple of years. I don’t foresee a looming recession so that bank stocks can at least keep the market performing.

Neutral on Apple, but consider Buffett missed the five-year game in Internet and e-commerce properties. Probably, stocks like Amazon, Alphabet and Facebook are outside its valuation zone. In five years, Microsoft has gone from $ 40 to $ 140. Certainly, as scannable as Apple.

Since the 2008-2009 financial crisis, I would say Buffett is a better investment banker than a fund manager. Buying industrial assets years ago, like Burlington Northern Santa Fe and Precision Castparts, has helped to mop up excess cash. They add scope to Berkshire’s portfolio of operating assets, but there is a recurring cyclicality in their numbers. The nine-month profit gain comes from the appreciation of the paper stock portfolio, not the realized gains.

In fact, I was surprised at the flat tone of earnings in all of Berkshire’s operations, including insurance underwriting, industry, energy and utilities. I expected more from Geico, but his combined loss ratio has increased 9.7% since the start of the year.

Burlington Northern’s coal revenues were down 6%. One of the compelling reasons for its purchase years ago was that coal exports could be a growth area, but it isn’t. Who Said Acquiring Businesses Was Easy? There is always a buyer’s premium to pay. Goodwill on Berkshire’s balance sheet is a large number, $ 81 billion on a $ 135 billion fixed asset basis.

But, I would take all that goodwill off the balance sheet as a future liability. Healthy businesses can sell for a price high enough to wipe out the goodwill they have gained. I see these properties as monuments to Buffett’s legacy as a buyer of GDP mining properties that can last forever, like “Ol ‘Man River”.

Net cash flow from operating activities has been stable since the start of the year. There is more cyclicality than pure growth here.

The balance sheet metrics need to be sorted. There is an unrealized gain of $ 107 billion on a portfolio of $ 220 billion. I’m sure Warren is married for life to American Express, Coca-Cola et al. Ditto for bank stocks. I will never understand how he dares to add to that commitment about $ 100 billion from the $ 220 billion portfolio.

Short-term cash equivalents and treasury bills rose $ 14 billion year-on-year to $ 124 billion at the end of September. Some of this has to be in the float generated by Geico and General Re, which is widely available to the parent. Deals, high yield bonds, corporate loans with stocks, warrants, whatever. Unrealized gains paid in cash have a present value, but are substantial over $ 400 billion of present value of assets. The downside is that there are a lot of treasury bills with minimal returns.

What about financial sector bank stocks and the S&P 500 Index? Not so long ago, financials represented 10% of the index, today 13%. I have 20% of my assets in Bank of America, Citigroup and Charles Schwab. Berkshire owns 40% of the portfolio’s assets in financial services, including Wells Fargo and American Express. In the mid-1960s, I was analyzing American Express with Buffett. It held up for over 50 years as I tapped prematurely.

My dream today (and probably Buffett’s) is that the banks’ price / earnings ratio, now close to 10 or 11 times earnings, can be revalued to a ratio of 13 p / e. JPMorgan Chase, at a new high, is already at 13 times its profits. All of this happens over the next two years with aggressive annual share buybacks of at least 5% of market cap. I guess there is no recession and the net interest margin ratio is high, no more than 18 months in advance.

While I give Warren more credit as an investment banker than a portfolio manager, the huge bet on Apple’s nose is a winning ticket worth $ 57 billion, or more than 25% of portfolio assets. Such courage and sense of the street are rarely noticed. Just a handful of big hedge fund bosses are making such a huge percentage of calls with their own money.

What is the fair premium to the book value that investors should pay for Buffett’s wisdom as a stock picker, investment banker, and purchaser of industrial and railroad products? The overall performance of the portfolio is not a barn burner over the past five years. You want Buffett to step in for you and buy when there is panic on the streets like 2008-2009. In a benign bull market, a lot of cream puffs will eclipse it.

Over the past two years, Berkshire as a stock has supported and fulfilled, following a trading range of between $ 190 and $ 220 per share. You could have fallen asleep as a shareholder. I am prepared to overlook substantial goodwill on the asset side of the balance sheet. In retrospect, this year more aggressive investing in stocks was the right concept. The S&P 500 is ahead 24%.

I’m a scared bull, 80% long with 20% high yield bonds. The market price / earnings ratio is expensive at 18. Historically, this is a maximum valuation, even when interest rates are low like today. To turn bullish on Berkshire stock, I would have to model 10% annualized earnings growth for its operating properties, especially insurance and industrials. Add in significant $ 50 billion share buybacks and a buoyant stock market where financials are outstanding performers. Everyone learns to love banks.

And, then, Warren stays healthy and functional in our hectic investment world. His achievement of over 60 years will never be matched again. Investors need to judge whether it’s the bottom of the eighth or the ninth inning here.

Personally, I am not enthusiastic about the industrials held or in the insurance sector where there is a lot of capacity and stable investment income. It won’t reverse so quickly. Holding 40% of the assets in bank stocks is too extreme for me. I prefer Facebook, Alibaba, Alphabet and Microsoft to Apple but it’s weird and questionable.

Time is the ultimate clarity here. Clean, clean, I am neutral. Construction is too hard for me to accept the premium over book value.

Sosnoff and / or its managed accounts own: Alphabet, Facebook, Microsoft, Bank of America, Citigroup, Charles Schwab, Wells Fargo prefers, JPMorgan Chase and Alibaba.

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