Back of the envelope 2y

There are fancy ways to take a guess on what the investment prospects are for Berkshire’s stock returns in the near future.
But here’s a simple to understand one:

The ratio of price to peak-to-date known book is a not bad measure of value, so let’s use that.
That yardstick may get less accurate in future, but to date my fancier valuation models give nearly identical results, so it will suffice for this back of the envelope exercise.

Imagine the future is not particularly worse than the past. Could be, but bear with me.
The price has never been below 1.4 times peak-to-date known book for more than 25 months.
Let’s assume that record holds, for the sake of discussion.
1.4 is also a reasonable target figure because it’s only maybe 1-2% above the valuation typical in recent years. Average, within rounding error.

The current stretch below P/B 1.2 is a bit over a month already, so if the record holds, we might reasonably expect to see P/B above 1.4 within two years.
That would be a one-time gain of 20.3% from rising multiples alone.

Value per share has grown unusually well in the last few years, roughly inflation + 10%/year in the last decade.
I think it’s reasonable to count on inflation + 7% in a typical year.
Two years of that would be a value gain of 14.5%.

Multiply in the one-time gain from valuation multiple expansion, and that’s a two year price gain of inflation + 37.7%.
That’s inflation + 17.3%/year compounded.

Limitations?
Obviously the multiple might not be higher than 1.4 on the precise anniversary, but odds probably favour that being cracked before then, or at worst not long thereafter.
We might have a couple of below-average years for value growth, but then again value generally rises faster in bear markets due to new investments–you just don’t see it right away.
The returns might arrive a bit sooner or a bit later, but we can be reasonably confident they’ll arrive.

Anyway, inflation plus 17%/yr for a couple of years is a reasonable guess.
Unfortunately can’t be more precise at this time.
We’ve run out of envelope.

Jim

21 Likes

Anyway, inflation plus 17%/yr for a couple of years is a reasonable guess.
Unfortunately can’t be more precise at this time.
We’ve run out of envelope.

Jim

based on this if you had no BRKB now, would a very safe way of acquiring BRKB would you dollar cost average in or other way of accumulating?

1 Like

based on this if you had no BRKB now, would a very safe way of acquiring BRKB would you dollar cost average in or other way of accumulating?

It depends on why one is doing DCA.
If it’s because you’re saving money each month, there isn’t much choice.
You can’t buy till the income arrives. End of post.

For those doing or considering DCA as a way to deploy an existing block of cash:

At these valuation levels, forget the DCA, just buy your whole position now.
That would be my advice for anyone contemplating starting DCA now for BRK.
Also for anyone in the middle of a DCA plan for BRK.

That’s the “very safe way” strategy because a low entry price relative to value like this gives you a margin of safety.
It’s not the safest in the sense that it’s a guarantee that prices won’t go lower.
It’s pretty likely that prices will get cheaper, but ignore that. Nobody calls the bottom, and we might already have seen it. Who knows?
Don’t let the attempt at perfection get in the way of the very good.
Most good value investors buy too early rather than too late, because they’re watching the valuation and they know they don’t know how much better it will get.
And they don’t know whether the rebound after the bottom will be instantaneous, precluding good entry prices after the bottom is in.

There are reasonable conversations that could be had about how much should be in BRK versus other things.
But BRK (not necessarily other things) is in the buy zone now. DCA would be a poor choice.

Jim

25 Likes

A lot of my comments on Berkshire’s results rely on my valuation method.
A bit of info on that—

Sometimes I use book, sometimes I use peak-to-date book per share, sometime I use my “two and a half column” method.
The last is the best: it values operating subs based on the progress of earnings, applies a cyclical adjustment to underwriting profits, and (when needed) has a haircut to big overvalued equity positions.
The last method is the best, but frankly all three have given pretty similar results.

For my model building lately I’ve been using a blended value, so I don’t have to do everything multiple times.
It’s 1/6 a multiple of most recent book per share, 1/3 using peak-to-date published book per share, and 1/2 “two and half column”.
So it dips in recessions, but very little.
Here is a graph of the real (inflation adjusted) value since the start of 2008, as a log graph.
stonewellfunds.com/ConsensusValue2008-2022.png
Pretty steady growth in value per share.

I left off the Y axis labels because the multiples are pretty arbitrary.
For my purposes, what’s important is the growth rate, and that the metric have the same meaning over long time frames.

Jim

24 Likes

“It’s pretty likely that prices will get cheaper, but ignore that. Nobody calls the bottom, and we might already have seen it. Who knows?
Don’t let the attempt at perfection get in the way of the very good.”

Thanks Jim for sharing all of your data, process, experience and even your “feel” especially during times like these. I subscribe to your philosophy above.

I have received a partnership buyout and have just entered early retirement phase. I am planning on taking all of the buyout money and buying more BRK given its current discount, safety and predictable earnings and returns over time. I am also currently sitting on cash covering 3-4 years (too much, I know) of expenses and have been nibbling BRK as it has been falling. BRK is already >60% position, but it is particularly attractive down here and I must anticipate a draw down phase in a year or two.

Please feel free to share any other thoughts that come to mind given my situation and thinking. Thanks.

9 Likes

Please feel free to share any other thoughts that come to mind given my situation and thinking.

Doesn’t seem like anything crazy in there.

For those who join me in the empty room of Berkshire investors who try to predict stock markets:
My indicators of market bottoms are silent so far.
To the extent that a spreadsheet can have an opinion about emotions, it sees insufficient panic and indiscriminate selling to call it capitulation yet.
Another 2-3 days like Thursday would change its mind.

I mention it because, with the tight short term correlation between Berkshire and the S&P recently,
it seems there is a decent chance that the market bottom will be a good day to buy Berkshire.
And, by extension, the day that the market bottom detector triggers might be an above-average day to buy.
Or not, of course.

The interesting thing to me is the sector divergence, in the sense that some things have sold off enough to become cheap, others not so much.
Taken overall, US stocks still look like prices are building in a lot of optimism.
The implication is that the market might have a lot more to fall (always possible), but in this case it might also have a sensible reason to be expected to do so.
For us, the implication is that Berkshire might possibly trade way lower following the market (briefly), whether rational or not.

One metric I watch is the median price-to-sales ratio among non-financial S&P 500 firms.
P/S is a terrible metric for a single company, but for a large group it’s not so bad.
It gets rid of most of the wild cyclical variation of earnings–sales are much steadier.
And clearly earnings and value can’t rise faster than sales over long periods.
Anyway, that median figure is 3.23 right now.
It never exceeded 2.0 in all of US history prior to October 2013.
Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?
This isn’t just a few outstanding firms–this is the middle of the pack boring big company.
This metric usually gives a message pretty similar to the ratio of market cap to GDP,
but it takes out the variables of a varying fraction of private companies and the problems of exporting and importing firms.
The median P/S metric uses the same set of firms for the numerator and denominator.

FWIW, market cap to GDP gives a similar result. Despite the sell-off, it has merely fallen from
over 200% of its average since 1970 down to 162%, still higher than the pre-Covid all time high.
Maybe the “new normal” valuation level is higher, but not THAT much higher. It peaked at 140% in the tech bubble and 105% in the credit bubble.

Jim

24 Likes

Congratulations on the buyout and early retirement! Nice to see a happy result.

Question, why the VIG and VUG instead of just Berk? Honest question. Just looked at the comparative performance and VUG only beats because of this last year…Will it continue to from here, though? Seems like an aberration that will be averaged out going forward.

But what do I know?

The interesting thing to me is the sector divergence, in the sense that some things have sold off enough to become cheap, others not so much

In the past market bottoms also, some sectors (for ex: high growth, tech names) have bottomed at least 1 to 3 month ahead of Index bottom AKA market bottom. The big companies of the Index, so called generals, will bottom along with the market/ Index. I consider Berkshire/ Apple’s big, generals.

Some of the fintech names have seen the low’s of the cycle it seems. You may want to nibble those names and wait on Berkshire, Apple.

1 Like

Nice. Thanks for sharing, Jim. Gotta love that steady growth in BV/share and in estimated value/share. Just wondering, though, how your forecast changes if you use today’s approximate P/B (maybe 1.34?) rather than P/March 31 BV(1.16). Thanks.

1 Like

Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?

Jim,

As someone who rarely posts I would like to express my appreciation for your many and varied comments and thoughts.

This one is especially interesting to me as I am sure we have further to fall but unsure, of course, how much further. Your figures suggest a possible further decline that is far more than I had considered likely.

As a UK based investor the UK and other European markets are less highly priced than the US so I have that to consider but still, another 30% or so as a possible further fall is an interesting thought. I clearly need to think more about when to start nibbling away (albeit mainly at my preferred small caps).

This board is an island of sanity (bar a couple who are blocked) that is quite rare, even more so now than is usual. Long may it continue.

deucetoace

5 Likes

Remarkably steady!
I guess the inflation adjusted share price, suitably scaled with some multiple to fit on the graph, noisily oscillates around the trend.

Nice. Thanks for sharing, Jim. Gotta love that steady growth in BV/share and in estimated
value/share. Just wondering, though, how your forecast changes if you use today’s approximate P/B
(maybe 1.34?) rather than P/March 31 BV(1.16). Thanks.

Certainly book value will drop when the June 30 statements come out.
But I have found it doesn’t matter much. All such drops are transient.
Peak-to-date book per share, which I’ve been using, is a better predictor of forward returns than simple most-recent book per share.
More importantly:
Remember that book is just a proxy for the value of a share; the value is higher now than it was at March 31, not lower.

Of course, a formula based on book value will change.

But I also use models which include a big haircut on any overvalued positions.
The predictions are lower, but not that much lower. The general conclusion is that it’s a good time to buy.
Not the best time ever, but much better than average.

Jim

8 Likes

But I have found it doesn’t matter much. All such drops are transient.

Does in the past, Berkshire had any investment like Apple which is significant, like 40% of its equity portfolio, almost 10% of its Book? If Apple goes to < $100 and stays there for couple of years (think of post dot.com Microsoft to any number of solid tech companies), are there sufficient drivers in Berkshire portfolio (not just equity, operating business, etc) to overcome such a hit?

Separately, the word “transient” is not evoking any positive feelings. LOL.

<f Apple goes to < $100 and stays there for couple of years (think of post dot.com Microsoft to any number of solid tech companies), are there sufficient drivers in Berkshire portfolio (not just equity, operating business, etc) to overcome such a hit?>

BRK’s operating earning is about $28b in 2021, it would take about 2.5 years to make up the $70b loss if Apple stock drops to $100.

1 Like

if Apple drops to $100 I suspect Berkshire would take their position up to 10%

1 Like

Times have been good and taxes have been low, but is a dollar of sales really worth more than 1.6 times what used to constitute an all time record?


This one is especially interesting to me as I am sure we have further to fall but unsure, of course, how much further.
Your figures suggest a possible further decline that is far more than I had considered likely.

Well, the future is uncertain.
I’m not predicting such a big fall.
I rather expect some low prices in the next couple of years, but that’s not at all the same thing as predicting it. A prediction requires a justification. (for me)

Net margins are very high in the last few years in the US in particular, so profits are very much higher.
Ultimately it’s the profits that matter, not the sales, so to that extent it really is “different this time”, for now.

The difficult part is deciding how much of the increase in profitability (particularly net margins) is lasting.
Partly it’s because of lower taxes, partly it’s because labour has had to compete globally instead
of locally and so is now taking a much smaller share of the pie, and partly it’s just the business cycle.
A minuscule amount is because corporate debt service costs are very low.
How many of those are permanent effects, and how many are transient?

The #1 rule for macro is never to mistake the cycle for the trend.
I’m willing to extrapolate that microprocessors will get faster, but not that net margins will keep expanding.
After the obvious things like that, it’s a tough call. Will labour regain its mojo? Beats me.
Conservatively, given my uncertainty, I’ll pick something in the middle:
It truly is a bit different this time, so profitability and valuations will be on average higher than they averaged in the Olden Days.
But not THAT much higher.

Jim

10 Likes

If Apple goes to < $100 and stays there for couple of years…

BRK’s operating earning is about $28b in 2021, it would take about 2.5 years to make up the $70b loss if Apple stock drops to $100.

For a long term position, the question is whether the drop to $100 is a drop in price or a drop in value.
A share of Apple appears to be worth more now than it was at the beginning of the year in every meaningful way I can think of.
Higher cash balance, higher rate of trend earnings, lower share count and so on.
Does the drop in market value really matter to someone not intending to sell for years?

Sure, it’s useful to pay attention if the price is really high and you think you might sell.
Or if it’s really low and you think you might buy.
But otherwise? Nah.

The market price is just the most recent observation of the price at which one guy (or bot) sold to one other guy (or bot).
That seems much less important. The only thing we know for sure about their opinions is that they disagreed about whether the cash or the share was better to own.
At least one of them was wrong.

Now, if it’s a drop in value to under $100, that’s a big deal.
For example, say, their Chinese operations including everything from assembly to sales is nationalized for a token fee.
Berkshire would survive it, but it would be like living through a very bad bear market or a nuke-scale insurance catastrophe.

Jim

6 Likes

A question for Jim (first time posting in a very long time - had to establish a new account just to do it!),

The growth rate of Berkshire has been remarkably stable for many years, as is born out by the graph that you posted a link to. My question: what is behind your thinking that growth can maintain rates that at least somewhat compare to those of the past?

I ask because those of us that are older have seen many companies fail to sustain growth at this level (over the long term especially), and as USA demographics also could start to shift in the relatively near future (e.g., less population growth, etc.), I’d love to hear your take on what will drive the continued growth of Berkshire, and how you monitor for that growth potential…

Thanks in advance for any thoughts on this.

Lee

3 Likes

My indicators of market bottoms are silent so far.
To the extent that a spreadsheet can have an opinion about emotions, it sees insufficient panic and indiscriminate selling to call it capitulation yet.
Another 2-3 days like Thursday would change its mind.

I mention it because, with the tight short term correlation between Berkshire and the S&P recently,
it seems there is a decent chance that the market bottom will be a good day to buy Berkshire.
And, by extension, the day that the market bottom detector triggers might be an above-average day to buy.
Or not, of course.

Another excellent post and I thank you for your willingness to display both sides of your thinking and not just that which supports your recent additions to the stock as it continues to edge down.

You display a remarkable lack of extreme ego that is often found on these boards.

As I have said, I do not yet hold BRK and being 60% in cash am looking for a good entry point for a significant sum of money, (for us anyway.) It sometimes is hard to resist the seemingly almost cult like conviction to buy now, particularly after the stock went sub $300 and then rose again, making me concerned that I had missed my window of opportunity. But only slightly concerned, because I have strongly felt the market in general was over valued and that the macroeconomics indicated it was poised for a strong correction. (Yes, market timing. I know you all disapprove.) Much of BRK is publicly traded stock, which yes the team bought for a reason, but over which they have little to no control. The shares not owned by BRK can be emotionally dumped along with the stock shares of companies not held by BRK, even if the strong loyalty to BRK itself keep shareholders holding BRK as the market corrects. Given their large stock holdings of other companies, why should the BRK valuation escape a downward trending market?

IP

2 Likes

A question for Jim (first time posting in a very long time - had to establish a new account just to do it!),
The growth rate of Berkshire has been remarkably stable for many years, as is born out by the graph
that you posted a link to. My question: what is behind your thinking that growth can maintain rates
that at least somewhat compare to those of the past?

The chart I posted wasn’t intended to suggest that the line will continue.
I guess it is strongly suggestive purely based on its shape, but that wasn’t my intent.
The main insight is that the value metric is pretty stable, and remains quite close to the trend line, whether the trend line is straight or not.

I have long assumed that the trend rate of growth of the value of a share will gradually slow.
I even came up with a formula, since that’s the kind of person I am:
The average US stock in the average year has historically returned about inflation + 6.5%.
Think of that as the “monkey with a dartboard” rate or return.
(nothing like that right now—that also implicitly presupposes you’re buying in a year of average stock prices! but I digress)

Let’s say Berkshire outperforms that monkey average in a typical year by 2.5% in the current era.
I assume that a certain percentage of this year’s (on trend) outperformace will be gone next year.
That gives a rate of decline in performance which asymptotically approaches the rate of return of the average stock.
Specifically, I think I picked the number 6%: that is, the lift above the monkey rate each year will be 94% of the lift the prior year, on trend.
So, if today’s “on trend” outperformance is 2.5%, then the next few years of outperformance on trend might be expected to be 2.35% 2.21% 2.08% 1.95% 1.83%…

However, it turns out this has not been a very good fit since I first proposed it about 15 years ago.
After all that fancy thinking and typing!
The rate of value growth has, so far, stubbornly failed to appear in the numbers.
The rate of growth is essentially unchanged since 1998, if anything picking up a bit lately.
However, I take each new such year as a pleasant surprise, and continue to expect a very gradual trend slowdown starting immediately.

A very short version is that I’d expect Berkshire to return inflation plus 7-8% pretty much indefinitely. Gradually falling towards 7%.
Berkshire does have some structural advantages–a strong culture of not overpaying for a good story, not smoothing earnings and so on.
That alone ought to be good for half a percent edge over the long run, setting a floor of around a real 7%.
Note that inflation plus 7-8% is a whole lot less than the recent results, which are about inflation plus 10%-10.3% over various time frames ending now.

Jim

17 Likes