 Good day fellow investors. So one of the most requested companies to analyze is Berkshire and the key is to get to its intrinsic value. When you get to an intrinsic value you can compare it to the current stock price if it's undervalued in relation to your required return it is a buy. So in this video we will discuss intrinsic value, how to get it and use Berkshire as an example. At the end of the video you will see what are the most likely long-term returns coming from Berkshire, why it is better than an index fund for example and then you will see where Buffett's magic actually comes from. It's pretty simple and it's something each of us can do as Buffett does. So let's start with defining intrinsic value, discussing what is Berkshire's intrinsic value by looking at the key components that make intrinsic value, cash flows or earnings and then see whether those cash flows are distributed in dividends Berkshire's aren't. So that's again a different way of approaching intrinsic value and then at the end we will use the proper discount rate. It can be a treasure that's up to you again can be a treasury yield if you're happy with 3% if you're happy with 7%, 10%, 15% that we request on this channel that's the discount rate to use. But I'll explain everything in detail. Before we start my name is Sven Karlin, I'm a full-time market researcher and I run this YouTube channel where we do stock market news with a long-term fundamental twist on Friday, Sunday there is a big company analysis, on Tuesday we have an educational video value investing education, next Tuesday will be about long-term investing and then on Thursday we have a video about replying your comments or sector analysis or a stock analysis, let's say a random day on Thursday. So please subscribe before we start to support the channel and to improve your long-term investing mindset which is the key of this channel, which is the core of this channel, low risk, high return. Let's start with Berkshire. Defining intrinsic value. Well intrinsic value is what is the number that if you are all knowing about the future and could predict all the cash that a business would give you between now and judgment day, discounted at the proper discount rate, that number is what the intrinsic value of business is. In other words, the only reason for making investment and laying out money now is to get more money later on, right? That's what investing is all about. The cash flows aren't printed on a stock certificate, that's the job of the analyst is to print out, change that stock certificate which represents an interest in the business and change that into a bond and say, this is what I think it's going to pay out in the future. When we buy, you know, some new machine for Shaw to make carpet, that's what we're thinking about, obviously, and you all learn that in business school, but it's the same thing for a big business. If you buy Coca-Cola today, the company is selling for about $110 to $15 billion in the market. The question is, if you had $110 or $15 billion, you wouldn't be listening to me, but I'd be listening to you, incidentally. But the question is, would you lay it out today to get what the Coca-Cola company is going to deliver to you over the next two or three hundred years? The discount rate doesn't make much difference after, as you get further out. And that is a question of how much cash they're going to give you. It isn't a question of, you know, it isn't a question of how many analysts are going to recommend it or what the volume in the stock is or what the chart looks like or anything. It's a question of how much cash it's going to give you. That's the only reason. It's a true, if you're buying a farm, it's true if you're buying an apartment house. Any financial asset, oil in the ground, you're laying out cash now to get more cash back later on. And the question is, how much are you going to get, when are you going to get it, and how sure are you? And when I calculate intrinsic value of a business, when we buy businesses, and whether we're buying all of a business or a little piece of a business, I always think we're buying the whole business because that's my approach to it. I look at it and say, what will come out of this business and when? And what you really like, of course, is them to be able to use the money they earn and earn higher returns on it as you go along. Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up as the value of the businesses we own increases. We can compound it internally. But the real question is, Berkshire's selling for, we'll say, 105 or so billion now. What can we distribute from that hundred, if you're going to buy the whole company for 105 billion now, can we distribute enough cash to you soon enough to make it sensible at present interest rates to lay out that cash now? And that's what it gets out to. And if you can't answer that question, you can't buy the stock. Thank you, Warren. So to define intrinsic value, we have to estimate future cash flows from today to judgment day that will be distributed to us. Investing is a game where you give away your cash now to get more, hopefully, in the future. And you have to see how much more you will get into the future. Therefore, you have to estimate the cash that will be distributed to you. With Berkshire, you have to estimate the cash you get by selling the stock somewhere in the future under the assumption, which is usually right, that over the long term, stock prices are strongly correlated with business performance. So we have to analyze the performance of Berkshire's business. And then we have to put on a discount rate to all those future cash flows or to the future cash flow when you sell the stock in this case, and then compare it to the present value. So you have to decide what is your discount rate. The easiest way is, OK, what's my expected rate of return? If you can invest in Berkshire, 7%, which is my outcome, then Berkshire is fairly valued. If you have opportunities of 10%, 15%, then Berkshire is overvalued. If you look at bonds that give you 2% for 10 years, then Berkshire is extremely undervalued. So let's start with Berkshire's return on capital. They have the capital, they don't pay dividends, so it's crucial to see, OK, what does Bafe do with that capital and what's the expected return on that reinvested capital, which is also the expected growth that you can estimate will be for Berkshire's earnings. Buffett usually looks for, at this scale, returns between 8% to 10%, and then leaves the upside to whatever happens, but he looks for a minimum 8%, and this can be seen with the last deal he made, where he lent 10 billion to Occidental at extremely favorable terms. Carl Eichen called it a travesty because Occidental could have gotten better terms elsewhere instead of an 8% yield on convertible bonds and warrants. So Warren Buffett gets no downside, 8% per year on his 10 billion for 10 years, and then the all-complete upside from converting that to stocks. Same deal he has done with Bank of America, etc., or in the past. So I really believe that Berkshire will be able to deploy all the earnings, and that's why he keeps the earnings with Berkshire not distributed in a dividend at 8%, 10%, give it a recession, give some mistakes, and I'm sure it will be 7%, and that's also the growth I will use on the earnings that are there, that are compounded over time. 10% could be, but that's something, again, I will leave as an upside, and we'll see later in the valuation model, in the intrinsic value model, how you can play with those earnings, increase it to 10% growth, and then also the present value, the intrinsic value changes. Let's continue. Then we have to focus on Berkshire's future cash flows. There are two components when it comes to Berkshire's future cash flows. The 100% owned companies, where the financial statements of those companies are fully consolidated into Berkshire's statements, and thus their earnings are fully reflected, and the equity holdings where only the dividends are reflected in Berkshire's financial statements, and that is with the insurance income. Therefore, a big part of earnings is unjustly omitted and actually not shown. Let's start with the owned companies. So if you look at the companies that Berkshire owns 100%, it's a big, big bunch of companies, all good companies that Warren Buffett acquired over time. This number will probably grow, but the dividends, the earnings are all consolidated into Berkshire's financial statements. So everything that you see, every penny that these companies make is reflected into the Berkshire financial statements and reported earnings. However, we can still estimate these into groups, as Warren Buffett said in his annual report, don't miss the forest by looking at the trees. So let's look at the forests out there. And the best way to estimate what will happen in the future is to just look at what happened in the past. In the past, over the last 15 years, Berkshire's insurance earnings were 27 billion. So what, 1.5 billion per year, a little bit more. And in the future, we can expect earnings to be along those lines with some big hits here and there due to unfortunate catastrophes in the insurance world. Add on top of that, the dividend income from the equities that are usually owned under the insurance umbrella and investment income and you are around 5 billion per year on average from the insurance business. I would attach a 6-7% growth on that thanks to the float that's also growing. And this is a big component of Berkshire's earnings because it enjoys free money. What is the float? The float is the difference between the premium Berkshire gets now and the claims it has to pay because when you pay insurance, you protect yourself against something that might happen in the future. If that doesn't happen, then the insurance company books a profit. If not, it has to keep the money for future claims. In the meantime, it can invest that money and make profits on it. And that's what Buffett does. So we have a lot of money insurance, a big business growing business, I would estimate that the 5 billion it makes per year will grow at a 6-7% rate over the long term. And we will incorporate that into our intrinsic value model. After insurance, we have from lollipops to locomotives. And that's another part of Berkshire's business. If we look at their earnings as a group, pre-tax income was 21 billion in 2018. Then there have been some adjustments, especially due to the tax that was lowered recently 2017-2018. So I would say that adding utilities to this, we can say that total earnings for those businesses will be around 20 billion per year after tax. And then okay, we can also say 6% growth over the next decade or two. This can always be higher, but that's a conservative estimation. Additionally, we have 120 billion in cash, 70 billion in the insurance business, 20 billion has to be conserved for case of catastrophes. And then we have 50 billion aside that can be invested in equities if those become cheaper. And you have about 50-60 billion on Berkshire's consolidated statement that can also be invested for acquisitions or things like that. Let's go to the next step, the earnings that are not reported because Berkshire reports only the dividends that it gets from the companies. Those earnings have also to be accounted for because that's actually why Buffett invests in other companies for the return on capital invested. Let me show you. So if we look at Berkshire's stock market portfolio, it's now around 200 billion. But the key is that only the dividends that Berkshire gets through its insurance business are reported here. Those that are not reported are very important earnings and should be accounted in when we calculate the Berkshire's earnings and future cash flows. So in order to do this, we have to look at the earnings of those companies, dividend payouts, and then subtract the dividend payouts from the earnings, look at Berkshire's share, and then see what is not reported in the financial statements of Berkshire. I did that, I looked at the market capitalization, how much Berkshire owns, what is the earnings per share, what's the dividend per share, what's the dividend yield, what's the payout ratio, what are the earnings in billions? What are what is the dividend in billions? What is the what is Berkshire's share of earnings Berkshire share of dividend subtracted Berkshire share of dividends from Berkshire's share of earnings. And the remaining earnings is what is not reported in Berkshire financial statements. But if it would be consolidated, it would be reported. And the total amount is 11 billion. So we have to add 11 billion to the 20 billion from various businesses. So the total earnings for Berkshire over the current periods would be around 40 billion on the current market capitalization. So this also changes the price earnings ratio when you look at Berkshire. Because when you look at its price earnings ratio, wherever you look, it's around 20. But we have a market capitalization of 50 billion and 25 billion in reported earnings. However, when we add the 11 billion in not reported earnings that remain with the companies, we have 36 billion, which already lowers the price earnings ratio to 13.88. If we then remove the 100 billion in cash from the calculation, then we have 36 billion on a market capitalization of 400 billion. So Berkshire's price earnings ratio is just 11. That should be the actual number you are looking at. And that should lead to a 9% long term return on investment. And then there is something very, very peculiar about Berkshire. As Warren Buffett says, investment returns are strongly correlated with the business performance. And if you look at his equity holdings, those all have high returns on invested capital and very low price earnings ratios. So if we look at the holdings, and we exclude the legacy holdings like American Express, like Coca-Cola, and Moody's, for example, then the average price earnings ratio of the businesses that represent the American economy is around 10. So Warren Buffett is investing in businesses that have a price earnings ratio of 10 and therefore an expected business return of 10%. So that's double what the SAP 500 offers. So we have Berkshire with price earnings ratio of 10, 11 investments that have a price earnings ratio of 10, and growth that I think will be around 7% conservatively over the next decade or two. On the other hand, we have a SAP 500 that has a price earnings ratio of 20 and growth expected around 4% or 5%. Therefore, Berkshire over the long term is still a much better investment than the SAP 500. Now let's go to Berkshire's intrinsic value. We have 36 billion in earnings. That's the current cash flow. I attach a conservative growth rate of 7% on that from today till judgment day. And we have to discount the present value of the future cash flow we expect to get. So business earnings are correlated to stock price performance over the long term. Therefore, we can use the current earnings times the growth rate and then give it let's say the current Berkshire price earnings ratio is 11. And I'm going to use that 10, 11 also in the future. And therefore, we get Berkshire's long term return. Later we'll apply a discount rate and then we'll see, okay, what is the outcome? So following Berkshire's current and expected earnings growth rate of 7% earnings for the company for the next 20, 30 years should go for the current 31 billion to 252 billion in 2050. If I add the price earnings ratio of 10 on those earnings, we have a market capitalization of 2.7 trillion. If I put a discount rate of 15% and a growth rate of 7% price earnings ratio of 11, which is the lowest price earnings ratio that we have come to forward earnings, then and then when discounted, it actually comes to a very, very low number because Berkshire is a great company is a low risk company a great business but due to its scale, it will not grow at 15% over the next years. It will probably grow at 7%. So therefore, the overvaluation, if you discount it with the 15% discount rate, if I lower the discount rate to 7%, then Berkshire's present value when I add the 100 billion in cash is around 418 billion. So still a little bit below the current market capitalization, but given the ups and downs in the market, that can quickly be hit. So if you want to return off, let's say 6%, then you can buy Berkshire now and then you have a very, very low risk, long term return of 6%. If Berkshire grows earnings at a faster rate than the estimated 7% in this model, then you can expect an even higher return, but the downside is really limited over the long term because it's highly likely that Berkshire will grow at a rate in the future and that the current base will create a continuation of its excellent past performance. However, if we looked at this from an owner perspective, and we put the usual equity premium of 2% points on the current 10 year treasury yield of 1.59 and use that as a discount rate, Berkshire is strongly undervalued. My present value of future earnings, let's say cashing out in 2050, 1 trillion compared to the current market cap of 500 billion. So Berkshire is undervalued by 50% when we look at the current interest rates. Now, if you can borrow at 3%, 3.5%, you should borrow 500 billion and buy Berkshire immediately. And that's of course not possible because Warren will not sell to you. But that would be the value for an owner at this perspective. So depending on your required return on investment, the opportunities that are out there for you, if you don't see better opportunities that 7%, then Berkshire is a great investment, low risk, 7% long term return. If you have other options, then you can always compare them to Berkshire. If you can borrow a trillion at 3.5%, put it all in Berkshire, your returns will be unlimited because the return, the undervaluation of Berkshire at such a low discount rate. And that also summarizes the investment thesis. If you want a 7% conservative return, I think Buffett might do better than 7% growth. He might give returns of 10, 11% on the retained earnings. And then you have much faster growth and then everything immediately changes in the valuations. Let me show you. So if I put a discount rate of 7% and a growth rate of 10%, then the present value, let's say in 2050 is about 850 billion. So much higher than the current value. This is Buffett's magic. He will deliver probably 7, 8, 9, 10% if there is a little bit of inflation even more. So actually Berkshire is undervalued. If you have a required return of 7%, which is a very, very good return. If you put it at 15% discount, then still we are very, very overvalued. You need a growth rate of 15% to come close to the current market cap. And I don't think Warren Buffett can do that, no matter how good he is. So thank you for watching. I'll leave you with Warren Buffett's explanation from his 1999 shareholder meeting about intrinsic value that will summarize a little bit everything, the structure of how this is calculated. And I hope you enjoy it. Thank you. Don't forget to subscribe and enjoy Warren Buffett's answer. See you in the next video. Hi, Dan Kurz from Benita 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 Rhee. Then I've assumed that Berkshire's total look through earnings will grow at 15% 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% to get an estimate of Berkshire's intrinsic value. My question is, is this a sound method? Is there a risk for 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. 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 stated the approach, I couldn't state it better myself. The exact figures you want to use, whether you want to use 15% gains in earnings or 10% gains in the second decade, I would have no comment on those particular numbers, but you have the right approach. 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 the 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 in growth and float that will have an important fact, 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, if our earnings plus float growth equals $3 billion or something like that in the 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 on, to some extent, on our energy and insights and so on. But it's, 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? Yeah, for many decades around here, we've had roughly at 100%, more than 100% of book net worth in marketable securities and had a lot of wonderful holy-owned subsidiaries to boot. And, and we've always had a very attractive place to put new money in as we generated. Well, we still got the wonderful businesses, but we're having trouble with the new money. So 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. Have you ever run into any unlovely money, Charlie?