Berkshire Hathaway Intrinsivaluator

What's new?
What is this?
How do I use it?
How does it work?
What if it doesn't work?

What's new?

What is this?

The "Intrinsivaluator" is a tool to help estimate the intrinsic value of Berkshire Hathaway. If you don't understand the concept of intrinsic value, you might want to visit the Berkshire Hathaway home page and read the chairman's letters and the owners manual. Intrinsic value by its nature is an estimate, meaning there is no "right" way to calculate it. In that spirit, this tool calculates intrinsic value in one particular way (although with many options) and may not correspond to your idea of how it should be done. In fact, I make no claims to its accuracy, but I would welcome feedback or suggestions for improvement. Enjoy it, but use the results at your own risk.

How do I use it?

The instrinsivaluator contains yearly data starting from year end 1981 plus current data. You can access data for a specific timeframe by selecting a "Scenario" from the pull down list box. Each scenario contains the following data:

The current investments (as best can be estimated), deferred taxes, and treasury yield are updated weekly. The weekly data is synchronized and the earnings, float, shares outstanding, and debt are updated with the quarterly and annual reports as they become available.

The intrinsivaluator acts on this data based on the values of the assumptions along the right hand side. The calculator includes 4 sets of canned assumptions that I've picked to hopefully represent a range of expectations and valuation viewpoints. You can make changes to the assumptions provided and the calculator will create a 'User' assumption set that will track your changes. Once you have a custom assumption set, you can flip back and forth from it to any of the other built in assumption sets for easy comparisons.

Here are the ideas behind the built in assumptions:

The individual assumption field definitions are as follows (see How does it work for more detail) :

Try changing the assumptions and note the impact on the intrinsic value per share. After you play around with it for awhile, pick assumptions that make sense to you. You can then see how, by using these assumptions, the intrinsic value estimate would have compared to the actual stock price for various timeframes.

How does it work?

The intrinsivaluator is based on the following formula:

IV = value of investments + value of non-investment non-insurance earnings + value of float - value of debt

Value of investments

The value of the investments is the sum of the cash, fixed maturity, financial products, Mid American Holdings, and equity valuation minus the total amount of float divided by the total shares outstanding. The float is the total of the funds have been paid by policyholders to cover future but not incurred claims and cannot be accounted as owned by Berkshire. The equity portion of the investments may be valued either via look-through earnings or at market based on the value of the investments growth specification. The fixed maturity portion of the investment pool is always valued at the market.

Value of non-investment non-insurance earnings

The value of the non-investment non-insurance earnings are valued via the perpetual annuity formula:

pv = c/(k-g) where:
c = coupon
k = discount rate
g = coupon growth rate

It should be noted that the coupon, c, that is specified in the annuity formula is for the end of year one. The calculator takes as its inputs, trailing 12 month data, which corresponds to the year zero coupon. Since we have the annual growth rate, g, we can compute the year one coupon as: c1 = c0*(1+g). Thus, the actual formula used internally by the calculator is:

pv = (c0*(1+g))/(k-g) where:
c0 = 12 month trailing coupon
k = discount rate
g = coupon growth rate

Using the annuity formula is only reasonable if the you have a steady reliable coupon. Fortunately, the subsidiary companies that make up Berkshire are of high quality and produce steady earnings without a lot of capital infusion. Pre-tax earnings are used because the discount rate is typically an interest rate metric that is also a pre-tax number. Purchase accounting adjustments are removed from the earnings because they do not reflect any economic reality. The intrinsivaluator does not discount investment earnings because they are factored into the investment value and does not discount insurance earnings because they reflect underwriting results. Underwriting results can vary widely from year to year and are best aggregated as a cost of float. Since the intrinsivaluator is valuing a perpetual annuity, growth rate inputs to the formula are perpetual as well. This means that growth greater than the long term rate of GDP growth of around 3 to 5 percent is probably optimistic.

You may also notice that as g approaches k, the future value will head toward infinity. While picking conservative values for g and placing a floor under k helps avoid this, there are legitimate cases where the growth may indeed be greater than the discount rate over shorter periods of time. In this case, the intrinsivaluator allows for a multistage growth model. For multistage growth, the "earnings" are grown each year of the stage by the growth rate and then discounted by (1+r)^y where r is the discount rate and y is the year number of the calculation. These discounted earnings are then summed and added to the terminal value which is calculated by multiplying the "investment amount" by (1+g)^y (where g is the growth per stage and y is the length of the stage in years) for each stage of the growth. The annuity formula is then applied for the terminal growth and the result is discounted back by dividing by (1+r)^Y (where r is the discount rate and Y is the sum of the length of the stages).

For more details on DCF calculations, see the Discounted Cash Flow Calculator and check out its How does it work? section.

Value of float

As mentioned above, the float is money that Berkshire can make use of, but does not own - it must be reserved for payment of future claims. However, Berkshire gets to keep the results of any earnings obtained from the float. This means the results of investing the float are essentially transferred from the insurance business to the investment business. The intrinsivaluator values these results again by using the perpetual annuity formula optionally augmented with a multistage growth formula. The annuity formula is appropriate as long as the float can be assumed to be constant or growing, and as long as the coupon is reliable. In this case, the coupon is derived by using the float return assumption against the float. The process of generating the float has a cost which can be either positive or negative. This cost reflects the average underwriting results of each insurance business and is deducted from the float return before the coupon is calculated. As in the case of the subsidiary earnings, limited terminal growth rates are appropriate and the float return assumptions should be tempered with an eye toward the average long term treasury bond return as this helps to ensure a reliable coupon. The float pools are valued separately because they are different types of insurance businesses and as such, may potentially have different float costs and growth rates.

Value of debt

Debt consists of deferred tax liabilities and other long term debt. Berkshire holds in its investment portfolio many positions that have unrealized capital gains. If these positions were liquidated, there would be taxes due that are reflected as the deferred tax liability. Fortunately, the major holdings are of a quality that allows a long term view and they are not likely to be disposed of anytime soon. The tax deferral assumption controls what portion of the liability that the intrinsivaluator may consider a non-liability - as some of these holdings may be perpetual. What is left over is added to the other long term debt and that sum is deducted from the intrinsic value.

What if it doesn't work?

If you find that the calculator does not show up, you may need to download the Java runtime environment to your computer. The latest versions of Windows no longer come with a Java VM installed by default and you will need to download a copy. Go to the Sun Java website and follow the download instructions (it's easy).

If you're running Netscape 4.x (Communicator) behind a firewall, the applet may fail to load due to the following error which will show up on your Java console:

Applet exception: class IV got a security violation: security. Could not resolve IP for host See the trustProxy property.

To fix this, do the following:

  1. Quit Communicator completely - this means close all instances.

  2. Edit the Preferences file. The name and location of the file varies depending on your platform:
  3. Add the line:

    user_pref("security.lower_java_network_security_by_trusting_proxies", true);
  4. Restart Communicator.

See also: Security Preferences for Communicator.

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