No. of Recommendations: 11
Mungofitch said
"Any good long term portfolio, with a prudently varying and opportune mix of securities and cash at any given time, will be expected to have a certain long term return. Its true intrinsic value is a function of that return. I would generally estimate the value of this portfolio at its market value. (plus or minus a cyclical adjustment at valuation extremes, perhaps, but let's ignore that). Let's say intrinsic value = P1 = market value.
A portfolio of the same size which has to allocate a certain amount of assets to very short term liquidity because it is backing insurance liabilities will suffer by comparison in terms of its long run returns. If the long run returns are lower than the returns in the unconstrained portfolio above, the intrinsic value of the portfolio is lower. So I estimate that it is worth less than its face value. Call it P1 - K.
The 30% of float is just the arithmetic I use to estimate of K, being the amount to reduce the value estimate of the total investments because long run returns will be lower than long run returns from an unconstrained portfolio. K is not the amount of investments per share expected to be held in cash, but the reduction in intrinsic value of the total portfolio because of the liquidity constraints on portfolio allocation."
My understanding of valuing Berkshire continues to evolve. I like that Buffett referred to the intrinsic value of the 5th grove (insurance) as fuzzy. The future in insurance is always uncertain even for a diversified insurance book like Berkshire's. Future underwriting and investment returns are clearly not conducive to analytical certainty to any degree.
The 30% of float handicap makes sense. Having liquidity to deal with anything is central to Berkshire's objective of remaining an insurance Rock of Gibraltar. But that comes at a cost on the expected investment returns and should be factored into a conservative intrinsic value calculation.
It is interesting that your K is to handicap future investment returns rather than to provide guaranteed liquidity for claims. Buffett's $30 billion short dated end of the bond portfolio (cash) sounds more like a liquidity guarantee. But maybe they are just the other side of the same coin. 30% of float is a similar number to 30% of cash ($50 billion v $49 billion). Then again both are higher than Buffett's $30 billion number. Although that number has probably increased since last stated.
If K is to handicap the investment return, then valuing all investments at market value (Apple aside) and assuming the investments are trading at intrinsic value, then we have to wonder, does that intrinsic value of investments build in future investment returns or increases in intrinsic value. Probably not. Intrinsic value is a thing that can grow and shrink over time, as new opportunities and threats are digested. I might have wondered into unsound thinking...not sure. But my niggle in understanding is in relation to the $30 billion or $50 billion. I can see how it will not produce investment returns above short dated cash/bonds. But that does not mean it is worth zero. Yes it is worth less than the other non restricted cash which has an optionality value. Then again we are simply talking about being conservative in our estimate of intrinsic value, so it's all good. It then follows that the optionality of Berkshire allocating the excess cash is not included in the intrinsic value estimate. Good to know $115 billion of cash and counting daily could end up going into 9% return investments. That would be upside and a small reason for buying Berkshire today at around most people's conservative intrinsic value.
Do you think Berkshire will move some of the $115 billion excess cash into longer dated treasuries to lock in say 5% for a few years? Or is the optionality factor too attractive.
PS. final post on this tread as I have used up my noise credits for a few months. Having reviewed Berkshire and Fairfax through Buffett's 5 groves approach, I have learned quite a bit but there is still a thick fog, certainly with Fairfax. But with that said, I am of the opinion that Berkshire is quite a different investment than Fairfax. The striking difference is the impact that a major insurance event would likely have on each business. A $15 billion insurance loss would be unfortunate for Berkshire but it would be writing new insurance policies the next day at better prices and would have a prospect of making it back in a hard market. From a short term investment view of Berkshire, the non insurance operating earnings, combined with the quality of the investment portfolio and liquidity to pay claims, without raising capital, would make it a temporary and not huge hit to earning power and intrinsic value. The old story for investing in Berkshire is to protect the down side. You don't need to get rich twice.
A $15 billion insurance loss for Berkshire would be 9% of float. $15 billion is just a random number for illustration purposes. 9% of Fairfax's float would be $2.8 billion which would more than wipe out their earnings power in one year. Fairfax would have plenty of liquidity to pay it and would also earn it back.
It is clear Berkshire has a higher quality of earnings with less relative exposure to insurance which is often lumpy. Berkshire may well be only fairly valued currently, compared to Fairfax, which looks deeply under valued. But Berkshire is significantly less risky as an investment. That does not mean Fairfax can't double in the next two years and outperform Berkshire. It probably will. But I am much more comfortable staying on the Berkshire train in a major way. Who wants to spend their night watching the weather channel.
Not only are Berkshire's earnings higher quality (non insurance) but of course the investment side is also different. Berkshire may find it hard to move the needle due to size and current investment conditions but it has only 22% low risk, low return assets versus 67% for Fairfax. Another important question comparing the two firms is the quality of underwriting. We suspect Berkshire is really good on this front and has a long track record but that can of course change. Fairfax also has a great track record. But I personally am more familiar with Berkshire so it is less risky for me.
I appreciate all of your insights into Berkshire Hathaway. I have learned a lot from your posts, and I am grateful for your willingness to share your knowledge.
EvBigMacMeal
