Berkshire Hathaway 1999 Annual Meeting Audience Question # 4

The right approach in estimating a company’s intrinsic value

Warren Buffett:

Zone 4.

Audience Member:

Hi. Dan Kurs from Bonita Springs, Florida.

You’ve given many clues to investors to help them calculate Berkshire’s intrinsic value.

I’ve attempted to calculate the intrinsic value of Berkshire using the discount of present value of its total look-through earnings.

I’ve taken Berkshire’s total look-through earnings and adjusted them for normalized earnings at GEICO, the super-cat business, and General Re.

Then I’ve assumed that Berkshire’s total look-through earnings will grow at 15 percent per annum on average for 10 years, 10 years per annum for years 11 through 20. And that earnings stop growing after year 20, resulting in a coupon equaling year 20 earnings from the 21st year onward.

Lastly, I’ve discounted those estimated earnings stream at 10 percent to get an estimate of Berkshire’s intrinsic value.

My question is, is this a sound method? Is there a risk-free interest rate, such as a 30-year Treasury, which might be the more appropriate rate to use here, given the predictable nature of your consolidated income stream? Thank you.

Warren Buffett:

Well, that is a very good question. Because that is the sort of way we think in terms of looking at other businesses.

Investment is the process of putting out money today to get more money back at some point in the future. And the question is, how far in the future, how much money, and what is the appropriate discount rate to take it back to the present day and determine how much you pay?

And I would say you’ve stated the approach… I couldn’t state it better myself. The exact figures you want to use, whether you want to use 15 percent gains in earnings or 10 percent gains in the second decade, I would… you know, I have no comment on those particular numbers.

But you have the right approach. We would probably, in terms… we would probably use a lower discount factor in evaluating any business now, under present-day interest rates.

Now, that doesn’t mean we would pay that figure once we use that discount number. But we would use that to establish comparability across investment alternatives.

So, if we were looking at 50 companies and making the sort of calculation that you just talked about, we would use a… we would probably use the long-term government rate to discount it back.

But we wouldn’t pay that number after we discounted it back. We would look for appropriate discounts from that figure.

But it doesn’t really make any difference whether you use a higher figure and then look across them or use our figure and look for the biggest discount.

You’ve got the right approach. And then all you have to do is stick in the right numbers.

And you mentioned, in terms of our clues, we try to give you all of information that we would find useful, ourselves, in evaluating Berkshire’s intrinsic value.

In our reports, you know, I can’t think of anything we leave out that, if Charlie and I had been away for a year and we were trying to figure out… look at the situation fresh, evaluate things… there’s, you know, there’s nothing, in my view, left out of our published materials.

Now, one important element in Berkshire, which is a secondary factor that gets into what you’re talking about there, is that because we retain all earnings and because we have a growth of float over time, we have a considerable amount of money to invest.

And it really is the success with which we invest those retained earnings and growth and float that will have an important fact… that will be an important factor… in how fast our intrinsic value grows.

And to an important extent, the… what happens there is out of our control. I mean, it does depend on the markets in which we operate.

So, if our earnings, plus float, growth equals $3 billion, or something like that, in a current year… whether that $3 billion gets put to terrific use, satisfactory use, or no use at all, virtually, really depends, to a big extent, on external factors.

It also depends, to some extent, on our energy and insights and so on. But the external world makes a big difference in the reinvestment rate. And, you know, your guess is as good as ours on that.

But if we run into favorable external circumstances, your calculation of intrinsic value should… would… result in a higher number than if we run into the kind of circumstances that we’ve had the last 12 months.

Charlie?

Charlie Munger:

Yeah. For many decades around here, we’ve had roughly a hundred percent… more than a hundred percent… of book net worth in marketable securities and had a lot of wonderful wholly-owned subsidiaries, to boot.

And then we’ve always had a very attractive place to put new money in as we generate it.

Well, we still got the wonderful businesses. But we’re having trouble with the new money.

But it’s not trouble, really, to have a pile of lovely money. This is not… I don’t think there should be tears in the house.

Warren Buffett:

Have you ever run into any unlovely money, Charlie?

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