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Warren Buffett’s 2020 Letter And Berkshire Valuation

Warren’s 2020 letter stood out from previous ones in the following aspects:

Photo Credit : Reuters


For Warren and Berkshire aficionados, the last weekend of February is special. It is the weekend when Warren’s letter and Berkshire annual report is released. This year was no different. Reading Warren’s letter and going through Berkshire annual report is one of the better ways to spend our weekend!

Warren’s 2020 letter stood out from previous ones in the following aspects:

Brevity of the letter – we love reading Warren’s thoughts and this was too short!
* Warren continues to provide incremental insight into how he values Berkshire. We have a lot more to say on the valuation of Berkshire in the rest of the article.

* After many false starts, Warren bought back $24.7 Bn of Berkshire stock in 2020. In the last article on Berkshire that we published in 2019, we had mentioned that Warren is getting ready to buy back a significant amount of Berkshire stock. 2020 was the year we saw the needle move on buyback.

We expect that Warren will continue to buy a good amount of Berkshire stock in 2021 (as he has mentioned in his letter). Berkshire share continues to trade at a meaningful discount to our estimate of intrinsic value and Berkshire has plenty of cash to put to work. The one constraint could be the limited liquidity in the stock and hence the amount of stock that can be bought without impacting the stock price.

Valuing Berkshire

Warren is very reticent especially when it comes to valuing Berkshire. We are glad that he gave
us some hints about his love – Berkshire – and how he values it.

1. The most valuable business in Berkshire stable is its property-casualty insurance business. No surprises there!

2. Next in the pecking order is Berkshire's 5.4% ownership in Apple or 100% ownership in BNSF (railroad). This is a revelation because we now know the value that he assigns to BNSF!

3. Last in the pecking order is 91% ownership in BHE (Berkshire Hathaway Energy).

Our Methodology
We have valued Berkshire using the Sum of The Parts method. This method entails valuing key businesses of the group. Based on our assessment, we think Berkshire B shares are worth 328/share using very conservative assumptions. The breakdown of this valuation is as follows:

Property/Casualty Insurance business
We try to simplify our valuation of property/casualty by valuing insurance business based on its assets less “true” liabilities:

We arrive at this valuation using very conservative assumptions. The historical track record of Berkshire gives us the comfort that they have done much better than our assumptions.

100% ownership in BNSF (Railroad)
Warren has already given us the value of BNSF. It is similar to a 5.4% stake in Apple or around $120 Bn.

91% ownership in BHE (Berkshire Hathaway Energy)
We will use earnings and depreciation to derive the value of BHE.

We will apply 20x on $5.3Bn to get $106Bn of equity value. Since Berkshire owns 91% of BHE, the value of BHE for Berkshire shareholders is $106 * 91% = $96 Bn. 20x for BHE is quite conservative given the quality of the business.

Manufacturing, Services and Retail (MSR) business
MSR business is a significant part of Berkshire and contributes meaningfully to its value. Average earnings of MSR over the last 3 years is around $9.0 Bn. Given that MSR business overall return on equity has been weak we are going to apply a lower 15x multiple to give us value of $135 Bn.

Remaining businesses

We didn’t talk about equity method investments which are worth $15.3 Bn. The value of these businesses has been calculated based on the information provided in the Annual Report.

Concluding Thoughts
Berkshire stock has underperformed the S&P 500 over the last 5 years in a material manner. This underperformance against the S&P 500 along with continuous improvement in its key businesses has now made Berkshire significantly undervalued. We expect Warren will continue to take advantage of this undervaluation and buy a meaningful quantity of Berkshire while the undervaluation lasts.

Berkshire is one of the best anti-fragile businesses that we have come across. If the world were to go through another dislocation, Berkshire is likely to benefit given its strong balance sheet and significant dry powder of cash.

Disclosure: I am/we are long BRKB. I wrote this article myself, and it expresses my/our own opinions. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from the Berkshire 2020 annual report. Factual material is obtained from Berkshire 2020 annual report and is believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Rajeev Agrawal

Rajeev Agrawal is the founder of DoorDarshi Advisors, a boutique investment advisory firm working with select investors. DoorDarshi's goal is to identify mispriced opportunities that can deliver superior long-term capital appreciation.

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