Saturday, November 17, 2007

Berkshire Hathaway: Is It Overvalued?

Our valuation model for Berkshire Hathaway is suggesting that Mr. Buffett's pride and joy is modestly overvalued based on data from its recent financial report. This can be seen on the Valuation Chart at the right. The price line (in blue) is modestly above the green value bar for November 2007.
BRK/A is selling near $136,500 ($4,550 for class B) per share and the model indicates that its "normalized" value is just under $125,000 ($4, 170).
Having said this, our model's primary objective is to determine a company's probable price 12 months ahead. Plugging in our best guess for book value growth and interest rates in the year ahead, we get a price of $144,000 (4,800), shown by the green candy cane at the far right. That would put the stock approximately 7% undervalued.
In December of 2006, we arrived at a similar conclusion when we calculated that BRK was slightly overvalued on a near-term basis but undervalued based on a year ahead book value of $77,000. It now appears that BRK will end 2007 with a per share book value approaching $80,000, a remarkable performance in a tough market.
BRK/A is a great company and we have owned it for many years in our Capital Builder accounts. It's terrific performance in 2007 is a combination of its own solid results and a flight to the safety of Buffett's stable of "wonderful companies" and BRK's AAA rating.
Another driver has been Buffet's remarkable ability to find the gold in every crisis. BRK came out of 9/11 stronger than it went in. Buffett built 2007's powerful financial results partly in the aftermath of Hurricane Katrina by betting, though his insurance companies, that such devastation was an aberration and not an annual occurrence.
Since the rise of the subprime problems, he has been buying big pieces of Wells Fargo, Bank of America, and US Bancorp. He is rumored to be involved in taking positions in the municipal bond insurance crowd.
Buffett and Berkshire Hathaway have been on a powerful winning streak, and there are those who say he is due for a spectacular flop. Couple this with our Valuation model signalling that the company is fairly valued, and one might think it wise to take some profits in Berkshire Hathaway.
We are not following that plan. We think the current subprime crisis and Buffett's track record are likely to propel BRK much higher. Markets are not efficient. Greed and fear are powerful forces that do not end when valuations appear over or undervalued. They end when they exhaust themselves. To the extent that the subprime crisis stays in the headlines, BRK is likely to continue to climb. We do have a level in mind that we believe factors in all the possible good news for the next couple of years, but obviously, for the present, we are keeping it to ourselves.