🔑 Key Takeaways
- Chris Bloomstran of Semper Augustus has outperformed the S&P 500 with a focus on valuing Berkshire Hathaway, despite the company falling out of fashion in the tech era. The company has a cult-like following, even among investors.
- Berkshire Hathaway's success is built on conservative management, a trustworthy history, and a focus on long-term growth, rather than short-term gains.
- When investing in Berkshire Hathaway, it's important to consider succession planning and the potential culture shift towards shorter-term goals. Price-to-book valuation is limited and investors only capture a portion of the portfolio's gains. Trust in the legacy of Warren and Charlie may not continue with new leadership.
- To determine the investment value of a company that owns a stock portfolio, look beyond book value and focus on the median mid-cycle earning potential. Consider the relationship between maintenance CapEx and depreciation expenses to make a wise investment decision.
- Accurately assessing depreciation and maintenance CapEx is essential in determining the true economic decay and growth potential of assets. Berkshire Hathaway's diversification strategy demonstrates an understanding of changing industry economics.
- Berkshire Hathaway Energy reinvests all profits into building capacity and improving infrastructure, resulting in a high single to low double-digit return. The regulated returns incentivize companies to build power to sell at a price cap basis.
- Maintaining good relationships with regulators is crucial in ensuring a regulated basis of return and balancing maintenance CapEx spending leads to a profitable energy business.
- Berkshire Hathaway faces regulatory hurdles to invest in energy projects, but may make more acquisitions in renewables. Their equity portfolio is heavily concentrated but has the potential for high returns through earnings power and growth.
- While Apple may need to reinvent its product line, its value as a company remains strong and its stock portfolio continues to drive significant growth for investors like Berkshire Hathaway.
- Investors should be cautious when investing in banking stocks due to potential credit problems during a deep recession. Berkshire Hathaway has trimmed its bank portfolio and financial companies may face ongoing troubles. Monitor carefully and consider the uncertain long-term valuation of stocks.
- Despite media attention on losses, Berkshire Hathaway experienced significant growth in economic earnings power and capital deployment, thanks in part to Chairman Warren Buffett's oversight and intelligent investment strategies.
- Berkshire Hathaway is committed to earning high returns on investment and has reduced their cash pile by $50 billion through stock purchases. They may hold up to 90 billion in cash reserves, pushing their assets towards a trillion.
- Berkshire Hathaway's acquisition strategy has improved profitability and the company's use of different valuation techniques has shown a growth in intrinsic value per share. Higher interest rates provide no opportunity cost for uninvested cash.
- To determine the earning power of a business, investment firms use a two-prong approach based on operating earnings and marketable securities. Normalization techniques can be used to accurately value buyback-affected book values, while portfolio changes must also be considered.
- Retained earnings may not be immediately visible, but they play a crucial role in a company's overall profitability. Valuing businesses requires granular data available in financial statements and footnotes.
- Accounting adjustments and understanding economic nuances are essential in calculating economic earnings and fair value for Berkshire. Using conservative tools like gap adjusted financials and sum of the parts approach can help arrive at an understated fair value. Despite the persistence of a conglomerate discount, investing in Berkshire's cheaper stock is ultimately a smart move due to its less volatile stocks and better-valuing shares compared to other investors.
- Berkshire Hathaway stock is not a cash reserve and should be viewed as a long-term investment option. Investors need to have cash on hand for unexpected expenses and distributions, instead of relying on the stock as a source of immediate funds.
- Greg Abel's significant investment in Berkshire Hathaway shares shows his confidence in the company and his potential as the next CEO of insurance operations. His previous successful ventures and positive endorsement from investors make him a promising future leader.
- The unique governance system at Berkshire aligns the interests of directors and management with shareholders for long term success. However, future changes such as ESG checkboxes and CEO role separation may lead to dilution and shareholder uproar.
- Berkshire Hathaway's governance is effective, with Warren Buffet returning half his compensation. Semper Augustus provides valuable insights, with their client letters and podcasts being great resources. Social media trends may not always remain relevant in the future.
📝 Podcast Summary
Chris Bloomstran's Wisdom on Valuing Berkshire Hathaway
Chris Bloomstran, a legendary investor with a company named Semper Augustus, has a track record of annual compound interest of 11.5% since his fund's inception in 1999 as compared to only 6.9% for the S&P 500. Bloomstran understands Berkshire Hathaway better than most except for Buffett and Munger. Berkshire Hathaway has the largest equity position for both Bloomstran and Stig Brodersen. The podcast episode delved deep into valuing Berkshire Hathaway along with stories from the earliest annual meetings, revealing how Berkshire Hathaway started being out of fashion when internet and tech were the buzzwords. They also reminisced about the cult following of the company when at an annual meeting attendees rushed past Warren Buffett to grab choice real estate, making people realize what a cult-like following it garnered.
Berkshire Hathaway's Conservative Management and Trustworthy History
Berkshire Hathaway is a company where trust is verified and it's safe to drink the Kool-Aid, thanks to its 58 years of history with Mr. Buffett running the company. The management team operates the business conservatively as they don't massage Wall Street to ensure they make quarterly numbers. They walk away from business when it's mispriced and write-off or write-down are something the company never did. Berkshire's collection of insurance companies on the planet is the finest, and they don't run an operation in the insurance world to make the quarter, because you don't see the big one-off losses. The surplus capital has grown over time, adding an attribute to the company's success.
The Implications of Berkshire Hathaway's Succession Planning and the Risks of Relying on Price-to-Book Valuation
Investors rely on trust and the legacy of Warren and Charlie, which might change when replacements take over. The insurance operation, railroad and utility operations make up three-quarters of Berkshire's value. The company's portfolio declined by 16%, which highlights the potential risks of using price to book for valuation. As the portfolio grows, investors capture only 79% of the upside in terms of any gains which are accreted to book value. Even though price to book is often used as a valuation shortcut, it doesn't offer a complete picture of a company's intrinsic value. Investors should be vigilant in watching out for any culture shift towards a shorter-term orientation.
Valuing a Stock Portfolio
Valuing a company that owns a portfolio of common stocks is almost like valuing a cyclical business, where you try to figure out what the median kind of mid-cycle earning power is. The cheaper the stock portfolio gets, the more attractive it is for investment which equates to higher perspective returns. You have to look beyond book value to determine the true value of a company's underlying assets. Berkshire's book value declined last year due to the overall decline in the stock market, but its portfolio was worth more. The relationship between maintenance CapEx and depreciation expense is an important concept in valuation and has held over time for Berkshire.
Understanding the Relationship between Depreciation and Maintenance CapEx for Optimal Asset Management.
Depreciation and maintenance CapEx are important factors in understanding the true economic decay of an asset. While depreciation is a non-cash charge, it represents the cost of replacing an asset, and maintenance CapEx is crucial to assess in relation to the depreciation charge. Some companies may have a lower maintenance CapEx than depreciation charge, indicating well-maintained assets with hidden earning power. Growth and maintenance CapEx can be distinguished by looking at capacity improvements that result in economic returns. It is important for analysts to figure out the real economic decay and growth potential of assets. Berkshire Hathaway's depreciation charge is a fair proxy for maintenance CapEx, and their diversification into rail and energy demonstrates an understanding of changing industry economics.
Berkshire Hathaway Energy's Strategic Investments in Capacity and Infrastructure
Berkshire Hathaway's energy operation has reinvested all profits into building capacity and improving infrastructure, resulting in a high single-digit, low double-digit return. They have found places to invest economically and have spent an enormous amount of money building out capacity. The business is valued at 87 billion and is expected to be worth more than the railroad in two to three years because of the home it offers for capital spending on growth CapEx. Regulated returns are granted by state regulatory commissions and ferq, with regulators setting prices based on rate cases and allowing a return based on equity capital, incentivizing companies to build power to sell at a price cap basis.
The Role of Regulators in Utility Company Profitability
Regulators play a crucial role in the profitability of utility companies. Maintaining good relationships with regulators is important to ensure a regulated basis of return. The return on equity has gradually decreased over the past two decades and national averages are around 8-10%. A well-run utility maintains a happy medium between overspending and underspending on maintenance CapEx. A monopoly business can earn an economic return if properly managed. Berkshire's energy business is growing at a rate of 10% per year and is set to become the second-largest piece of Berkshire after the insurance operation. The energy business has an insatiable appetite and will continue to grow as long as they have the capital to build projects.
Berkshire Hathaway's Potential in Energy Investments, Concentration of Equity Portfolio, and Capability for High Returns.
Berkshire Hathaway has the capability to invest in more energy projects if they could bid on them, however, it takes a long to get things done as they have to work with regulators and show their skillset to do what they are doing. The energy assets that Berkshire bought from Dominion are perceived to be dirty; however, Berkshire may make more acquisitions on that front as the political landscape steers towards renewables. The concentration of Berkshire's equity portfolio has always been in a handful of companies, such as Coca-Cola and now Apple, which runs between 40% to 50% of the stock portfolio. Although last year, Apple produced a 26.4% loss, Berkshire has the capability to make high single DTS, low double G returns if they include multiple expansion, ongoing growth, and earnings power.
Berkshire Hathaway's reliance on Apple for growth
Apple is a great consumer company, but it needs to reinvent its product line. Despite being sticky, its growth rate cannot be as fast as it had been historically. While it's perhaps not worth 25 or 30 times earnings, it can be valued at 20 times earnings, dropping it from 25 to 15 is a 40 percent down on multiple offset by the business grow. Apple's stock portfolio is now back to pushing, and is approximately 150 billion with the others being about 25 to 30 billion positions. Coke won't grow as it had, and the other three share the same size as Apple, but Apple is the 800 pound gorilla. Overall, Berkshire had a growth of about 10 percent in the first quarter, majorly due to Apple.
Tread Carefully with Banking Stocks
Investors should tread carefully with banking stocks as there could be potential credit problems due to asset liability mismatches and duration mismatches during a deep recession. Berkshire Hathaway has trimmed down its bank portfolio due to asset liability mismatches. Although it still owns Bank of America and American Express, the stocks might not provide wonderful returns in the future. The portfolio could at best match the S&P 500. Financial companies might face ongoing bank troubles, and some banks could get into trouble if the economy devolves further. Therefore, investors must monitor the stock portfolio carefully. The intrinsic value of the Berkshire Hathaway portfolio is cheap, but the long-term valuation of stocks like Apple is uncertain.
Berkshire Hathaway sees strong growth in economic earnings power and capital deployment in 2022.
Berkshire had a great year in 2022 in terms of increasing its economic earnings power and deploying capital intelligently. Despite media focus on the loss mentioned, they experienced an 18.1% gain in earnings power, durable and profitable growth, and superb capital allocation. Chris Bloomstran explains that economic earning power is normalized by removing the volatility of the stock portfolio and underwriting and factors in tax benefits and normalizing pension maps. Berkshire grew their economic earning power by about 7 billion last year, but the stock was up only 4%, and book value per share was down as they bought back 1.2% of stock. Berkshire's 92-year-old chairman continues to be at the top of his game and oversaw the deployment of capital.
Berkshire Hathaway's Cash Pile and Investment Strategy
Berkshire Hathaway has a big cash pile that averages about 12% of assets. They spent 50 billion nets buying stocks and lowered their cash to 128 billion. Their biggest year on the CapEx front in a long time was last year with 75 billion spent against 30 billion in operating cash flow and depreciation expense. Berkshire increased earning power of the business by 7 billion but Chris Bloomstran thinks the company may keep cash on hand equal to one year's worth of insurance reserves, which could be as much as 90 billion, pushing trillion in assets. Berkshire is willing to put money to work and is committed to earning a high return on investment.
Berkshire Hathaway's acquisitions and valuation techniques for improving profitability.
Berkshire Hathaway's acquisition of TransRe has improved profitability as it's a better business with more valuable assets. The purchase of Allegheny by Berkshire will make more money than it would have had it stayed with Allegheny. Markel could also become more valuable inside of Berkshire. Different valuation techniques have strengths and weaknesses, and some are more relevant than others depending on circumstances. For instance, price book can be nuanced with company share buybacks affecting book value per share. Using a recent equal weighting of some of the parts basis and gap-adjusted financials suggests intrinsic value per share growth by 10.7% in 2022. Interest rates being higher offer no opportunity cost for Berkshire's uninvested cash earning 5 billion.
Techniques for Accurately Valuing Companies' Earning Power
Investment firms like Berkshire Hathaway use a two-prong approach to value businesses based on their operating earnings and marketable securities. Normalization techniques like capitalizing pre-tax operating earnings and adjusting for changes in the tax code help determine the earning power of the enterprise. Companies like Apple and Starbucks may have diminished book value due to stock buybacks, which can overstate returns on equity. The value of a stock portfolio can also change based on earnings and purchases, and needs to be considered when evaluating the earning power of the company. Overall, understanding these nuances can help investors accurately value and make informed decisions about their investments.
The Importance of Retained Earnings in a Company's Profitability.
Retained earnings are an important component of a company's earnings, and although not immediately visible, they play a crucial role in the overall profitability of the company. According to Chris Bloomstran, the retained earnings of companies like Apple, Bank of America, and American Express make up a significant portion of their overall earnings. For conservative purposes, Chris takes into account only the earnings yield of Berkshire at 5%, although the history of Berkshire's stock portfolio shows it tends to outperform earnings yield by 3-4% a year. In valuing businesses like the railroad and energy operation, granular data is available in their respective financial statements and footnotes, making it easier to calculate their worth.
Importance of Accounting Adjustments in Determining Fair Value for Berkshire
Understanding the economic nuances of tax and accounting and applying accounting adjustments are crucial in figuring out economic earnings and fair value for Berkshire. The gap adjusted financials and sum of the parts approach are useful tools to arrive at a more conservative and understated fair value. Persistence of conglomerate discount may affect the stock value, however, buying shares of anything at a cheaper price is always a smarter move. The discussion of parking cash in Berkshire's stock leads to intellectual debates regarding investing strategies and valuation. Arguments such as Berkshire having less volatile stocks and better-valuing shares compared to other investors are some of the common reasons why investors consider investing in Berkshire.
Berkshire Hathaway Stock as a Fixed Income Surrogate
Berkshire Hathaway stock is not a cash surrogate, but rather a fixed income surrogate with better earning power. The stock is a good option for long-term investors who can stomach its drawdowns. However, if an investor needs cash in the next few years, they should not park it in a long-duration asset like Berkshire. Berkshire's earning power lies in its predictable profitability and diversification across various businesses. While the company is more conservatively run, investors should not rely on it as a cash reserve. Instead, they should have cash on hand for distributions, if they are a foundation, or for unexpected expenses.
Vice Chairman of Berkshire Hathaway Investing in Company Shares
Greg Abel, the vice chairman for non-insurance operations of Berkshire Hathaway, has been buying shares and now owns shares worth $114 million. He is expected to be the next CEO of the insurance operations. Abel received $870 million for selling Berkshire Hathaway Energy in 2022 and has a compensation package of $19 million. He matches the attributes Warren Buffett believes are essential to be an effective member of the board. Chris Bloomstran, an investor, has a positive view of Abel and thinks he is a good manager. He and other Berkshire management own stock, and they've never been given the stock. Bloomstran expects Abel's position in Berkshire to double and match Ajit Jain's position.
Berkshire's Unique Governance System and Potential Future Changes
Berkshire has a unique governance system where the directors and management own significant amounts of stock and are not compensated with stock options or RSUs. This aligns their interests with the shareholders and creates a long term focus on the success of the company. This is different from other companies where management tends to be massive net sellers and focused on short term incentives like quarterly earnings and stock options. The culture at Berkshire may change after Warren and Charlie are gone, especially if CalPERS comes in and introduces ESG checkboxes and a separation of chairman and CEO roles. This could lead to dilution and shareholder uproar which Berkshire has avoided until now.
Warren Buffet's Humble Compensation and the Effective Governance of Berkshire Hathaway
Despite being a trillion-dollar asset enterprise, CEO and Chairman of Berkshire Hathaway, Warren Buffet returned $50,000 of his $100,000 compensation. The governance of the company has been done quite well. Chris Bloomstran remarks that if the CEO's pay package was diverted to stock options, it would mean way more than $19 million a year ultimately. The Semper Augustus website has an archive of their client letters from 2015. Chris Bloomstran and Stig Brodersen agree that reading these letters is a great resource. Additionally, they have a podcast tab where the listeners can find a number of recent podcasts and interviews. They also acknowledge the fact that Twitter may not be relevant in the future.