Wednesday, August 08, 2007

An Update on the Valuation of Berkshire Hathaway

Berkshire Hathaway, recently, released its earnings for the second quarter and the numbers were impressive, again driven by their insurance divisions. As I studied the data, it quickly dawned on me that BRK-A has had a remarkable run in earnings and book value growth since the Katrina trajedy.

I also heard the echos of Warren Buffett during those days foretelling exactly what has happened. BRK-A with it AAA bond ratings and its penchant for taking risks --at a price--that more risk averse firms could not or would not take, would become even stronger as a result of the Gulf-coast hurricanes.

Now our country is facing another crisis. This time self-inflicted. The big banks and pools of money in this country are backing away from much of the less-than-prime mortgage companies, and without funding, these companies are falling like dominoes.

Berkshire Hathaway owns lots of building related businesses, but the one that intrigues me is manufactured-homes giant, Clayton Homes. In that business, Buffett has a whole company that is used to dealing with credit issues in the subprime arena.

With all the big banks pulling the plug on the subprime loan business and with a company in his portfolio that has trained and experience people used to dealing with subprime issues, it is not a stretch to think that Mr. Buffett may show up on the scene somewhere in the current subprime mess. That is how he does things.

He was quoted once as saying that he likes to make investments that are like shooting fish in a barrel . . . with the water drained. Well, Mr. Oracle sir, in the subprime mortgage business, the water has left the tank. You do the picking and we'll go with you.

With the new earnings and book value data, I have updated our valuation model, as shown above on the chart. The year-ahead projected value shown in the green stripe is over $128,000 per class A share. That would translate into almost $4,200 per class B share.

As usual the model's prediction is based on my guesses about earnings and book value growth over the next year, but you can see that the fit has been pretty tight, over the last 15 years, between the model and the actual prices of BRK-A.

We own the stock in our Capital Builder Investment style.