BRK Morningstar update

https://stocks.apple.com/Aci1OphcBS3-WRZ0SmgBgWw

Excerpt:

“Our fair value estimate for Berkshire is derived using a sum-of-the-parts methodology, valuing each of the company’s operating segments separately and then adding them together for the total estimate. We value the Class A shares at $535,000 and the Class B shares at $357. This is equivalent to 1.57, 1.39, and 1.27 times our estimates for Berkshire’s book value per share at the end of 2022, 2023, and 2024, respectively. For some perspective, the shares have traded at an average of 1.40 times trailing calendar quarter-end book value per share during the past five years and 1.39 times during the past 10 years. We use a 9.0% cost of equity in our valuation.“

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18% or so discount.Sure will be interesting this Saturday to see the extent of buybacks

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We value the Class A shares at $535,000 and the Class B shares at $357. This is equivalent to 1.57, 1.39,
and 1.27 times our estimates for Berkshire’s book value per share at the end of 2022, 2023, and 2024, respectively.

Those numbers imply they expect the following book values per share in nominal terms:
End 2021 $342,621 (known)
End 2022 $340,764 (they expect a drop of -0.5% this year)
End 2023 $384,892 (they expect a rise of 12.9% next year)
End 2024 $421,260 (they expect a rise of 9.4%)

That works out to a three year rate of growth of 7.13%/year minus inflation.
i.e., if inflation were to average 7% in that stretch, the forecast is for no real growth in book per share for three years.

Perhaps not the numbers I would have picked, but I admire someone who calls their shots.

Jim

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Jim,

Do you currently expect a conservative BRK value per share growth of inflation plus 7-8%/year?

Btw, forgot how crazy the BRK market price nosedived in Q2- nearly 23%! Head scratcher imo. However, I suspect many folks took advantage of your advice with P/B< 1.2. Look forward to the Saturday release.

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That works out to a three year rate of growth of 7.13%/year minus inflation.
i.e., if inflation were to average 7% in that stretch, the forecast is for no real growth in book per share for three years.

Jim, you frequently make your projections for Berkshire’s gains in intrinsic value as X% plus inflation.

Many (most?) business’ value fails to keep pace with inflation, which makes inflation so brutal to investors. As detailed in many of Buffett’s writings, particularly well in How Inflation Swindles The Equity Investor.

So I would be very appreciative if you could give your rationale as to why this seems like such an automatic feature of Berkshire. Thanks.

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Jim, you frequently make your projections for Berkshire’s gains in intrinsic value as X% plus inflation.
Many (most?) business’ value fails to keep pace with inflation, which makes inflation so brutal to investors.
As detailed in many of Buffett’s writings, particularly well in How Inflation Swindles The Equity Investor.
So I would be very appreciative if you could give your rationale as to why this seems like such an automatic feature of Berkshire. Thanks.

It’s nothing special about Berkshire.

First, you have to carve out the situation that inflation is so high that the economy simply breaks.
A broken economy is not good for any company.
We are not in that situation today.

Ignoring those rare situations, the average company’s earnings do keep up with inflation almost perfectly.
If all wages, supplies, energy, prices, revenues all rise by the same amount, so will gross margins and net profits.
This will hit different firms to differing degrees, and with different time lags.
It will hit firms with a lot of debt differently from firms with positive net currency-denominated assets.
And it will hit different firms depending on their sensitivity to the things that are rising in price faster or slower than the overall average.
But overall across the corporate sector, inflation (without a broken economy) is not a problem for real company earnings.
Neither theoretically nor empirically.

For Berkshire it’s probably more true than for most forms, simply because Berkshire is so diversified.
One division will be hit hard by (say) rising petrochemical input prices to make carpets,
but another will do particularly well because prices are rising faster than costs in some areas.
The latter aren’t always obvious, but it is the inevitable other half of the average price rise.
That latter is sometimes a bit dark from a societal point of view, since it sometimes comes from falling real wages.
From the recent peak 2020-Q2 to 2022-Q2, median usual weekly real wages in the US have fallen 8.9%.
A bummer for those employees, but a windfall for their employers who have raised their product/service prices in line with inflation or more.

Inflation certainly messes with bookkeeping in an annoying way.
It also messes with real tax rates a little bit at the margin.
0% T-bills at 0% inflation get 0% tax, but 3% T-bills at 3% inflation, the same real rate, get 0.63% tax.
But in terms of real owner earnings across the economy, inflation is just one more flavour of squiggle that disappears in the noise over time.

So, the answer to why I’m sanguine in the face of the observation that many/most firms’ profits don’t keep up with inflation–
it’s because they do : )

It’s not that I don’t worry about macro effects on long run trend real profits.
As the capitalists we are, I would be much more concerned about the corporate profit shares of GDP, relative to labour and tax, in the next 15 years.
It has been a golden age recently. Golden ages don’t usually last forever.
From 1951 to 2004 US corporate profits never got above 8.5% of US GDP, averaging just under 6.1%.
It has been mostly in the range 9% to 11.5% since the credit crunch, averaging just over 10%.
https://fred.stlouisfed.org/graph/?g=1Pik
If that average figure falls, Berkshire’s very diversification will suggest that our profitability will fall just as much.
If the old norms returned, profits could fall by 30-40% and stay that low as a percentage of revenue forever.
That’s not a prediction, but one should probably be prepared for some unknown fraction of it to become true.
For Berkshire, or for any broad US equity portfolio.

Jim

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As the capitalists we are, I would be much more concerned about the corporate profit shares of GDP, relative to labour and tax, in the next 15 years. It has been a golden age recently. Golden ages don’t usually last forever. From 1951 to 2004 US corporate profits never got above 8.5% of US GDP, averaging just under 6.1%. It has been mostly in the range 9% to 11.5% since the credit crunch, averaging just over 10%.

https://fred.stlouisfed.org/graph/?g=1Pik

If that average figure falls, Berkshire’s very diversification will suggest that our profitability will fall just as much. If the old norms returned, profits could fall by 30-40% and stay that low as a percentage of revenue forever. That’s not a prediction, but one should probably be prepared for some unknown fraction of it to become true. For Berkshire, or for any broad US equity portfolio.

This is an excellent understanding of the class struggle at the core of a capitalist economy. The past 40 years, beginning with the institutionalization of neo-liberal orthodoxy under Thatcherism and Reaganism, have been a triumph for capitalists. Labor unions were broken in the UK and the USA, taxes on capital evaporated, and the commonwealth was shifted from supporting working people through social benefits and an investment in public goods to the subsidization of capital investments. Not surprisingly, corporate profit margins took off. Indeed, profit margins seem to have reset at ~10% from the 6% average we saw between 1948-1980.

The question is, will this arrangement of class forces continue or will the pendulum swing back such that the wage earning class, through its capture of the state, increases taxes on capital in order to subsidize a public investment in social goods (ie. education, health care, income subsidies, and protections of collective bargaining). Interestingly, even some republican candidates like Blake Masters are calling for the rejection of globalization and a reorientation to a more autarkic economy. Indeed some conservatives believe our national economic policy should encourage one income households with incomes sufficient to support the traditional breadwinner-homemaker family as a means of reestablishing traditional family values.

My point is that the improvement in corporate profit margins is best understood as a result of political and economic policy and not some productivity revolution in capital goods (although that can play a temporary part in firm specific profit margins). As such, the new normal in profit margins will last only as long as capitalists continue to dominate the state in a way that allows them to dictate social and economic policy. What we are seeing politically around the world today is the precarity of the political and economic hegemony of capital. Even in the Republic party, the business elites are nervously navigating the rise of untamed working class interests within the party.

PP

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Jim, thanks for the thoughtful reply.

But either you’re misunderstanding the situation, Buffett is (or at least, was), or I am.

I suspect it’s the latter.

In How Inflation Swindles The Equity Investor, Buffett said:

http://csinvesting.org/wp-content/uploads/2017/04/Inflation-…

It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms; let the politicians print money as they might…And why didn’t it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds…I know that this belief will seem eccentric to many investors. They will immediately observe that the return on a bond (the coupon?) is fixed, while the return on an equity investment (the company’s earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate that have been earned by companies during the postwar years will discover something extraordinary: The returns on equity have in fact not varied much at all.

And: Essentially, those who buy equities receive securities with an underlying fixed return—just like those who buy bonds.

Must we really view that 12 percent equity coupon as immutable? Is there any law that says the corporate return on equity capital cannot adjust itself upward in response to a permanently higher average rate of inflation?

There is no law, of course. On the other hand, corporate America cannot increase earnings by desire or decree. To raise that return on equity, corporations would need at least one of the following:
(1) an increase in turnover, i.e., in the ratio between sales and total assets employed in the business;
(2) cheaper leverage;
(3) more leverage;
(4) lower income taxes;
(5) wider operating margins on sales.
And that’s it. There simply are no other ways to increase returns on common equity.

Not sure if you’ve read that article, but if you would be so kind, I would appreciate it if someone could explain to me why what seems like a discrepancy between your (Jim) and Buffett’s views on stocks and inflation really isn’t…or if it is, who is right and why. Thanks.

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