Look Through Earnings

Another way to value Berkshire is to simply put a multiple on its aftertax earnings—the P/E ratio—just as one might do for any company. It's a little complex for two reasons, however: First, Berkshire 's earnings need to be adjusted for "investment and derivative gains/losses," which (from the 2008 annual report) have "no predictive value, and variations in amount from period to period have no practical analytical value." For example, in 2008 there were big mark-to-market losses on derivatives, and in 2005 there was a huge gain when Gillette was acquired by Procter & Gamble. So, net earnings for Berkshire in 2008 were $5.0 billion, to which one would add back $7.5 billion in investment and derivative losses, which equals $12.5 billion. However, it was a benign year for super-cat losses and the odds that Berkshire might have to pay out real cash on its derivatives contracts went up, so we haircut the $12.5 billion to $10 billion.

The second adjustment is that Berkshire owns large stakes in many publicly traded companies, but the pro-rata shares of those companies' retained earnings don't appear on Berkshire 's income statement, so we need to estimate what Berkshire 's shares would be. Our estimate is $2.4 billion of 2008 look-through earnings. Again, now the math is easy: $10 billion of Berkshire 's earnings plus $2.4 billion of look-through earnings equals $12.4 billion, or $8,000 per share. With the stock at $84,844,

Stock Price Intrinsic Value

Figure 7.4 Berkshire Hathaway's Share Price vs. Estimated Intrinsic Value

Source: Yahoo! Finance (http://finance.yahoo.com), T2 Partners estimates.

Figure 7.4 Berkshire Hathaway's Share Price vs. Estimated Intrinsic Value

Source: Yahoo! Finance (http://finance.yahoo.com), T2 Partners estimates.

that means Berkshire is trading at only 10.5 times earnings, a very low multiple for such a great business. We think Berkshire warrants a higher-than-market multiple; if we use 14, it translates into $112,000 per share.

Using either valuation method, we come to roughly the same intrinsic value. Figure 7.4 shows Berkshire 's stock price from 1997 through early March 2009, along with the intrinsic value each year using the first method: cash and investments plus 12 times pretax earnings until 2008, when 8 times earnings was used. Note that in most years, Berkshire 's stock at some point during the year reaches intrinsic value. If Berkshire were to do so this year, it would jump more than 30 percent.

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