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In shareholder letters – Berkshire Hathaway Inc from 1970 until 2012, Warren Buffett mentioned the per-share investment and pre-tax. Maybe you can ask Marry Buffett what is the meaning of per-share investment? What is the financial ratio of per-share investment?
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Dear Loong,
Warren likes us to evaluate a stock holding as a company. And how much of that company you own.
The per-share relates to one share. For example, say a company has 1 million shares outstanding. If it makes $10 million a year, the per-share earnings will be $10 a year. If the entire company is worth $100 million, then the per-share worth would be $100.
ReplyWarren Buffett revealed his magical “Two-Column Valuation Method” investment process publicly on page 6 of his Berkshire Hathaway’s (BRK.A, BRK.B) 2010 Annual Report. (Buffett later republished his “Two-Column Method” on page 99 of his 2011 Annual Report, and on page 104 of his 2012 Annual Report).
I will now quickly summarize page 6 of Berkshire Hathaway’s 2010 annual report describing Buffett’s “Two-Column Valuation Method”:
BERKSHIRE HATHAWAY INC. INTRINSIC VALUE – TODAY AND TOMORROW *
Though Berkshire’s intrinsic value cannot be precisely calculated, two of its three key pillars can be measured. Charlie and I rely heavily on these measurements when we make our own estimates of Berkshire’s value.
COLUMN #1: The first component of value is our investments: stocks, bonds and cash equivalents. At yearend these totaled $158 billion at market value.
Year end
Per Share Investments
Period
Compounded Annual Increase in Per-Share Investments
1970
$66
1980
$754
1970-1980
27.5%
1990
$7,798
1980-1990
26.3%
2000
$50,229
1990-2000
20.5%
2010
$94,730
2000-2010
6.6%
COLUMN #2: Berkshire’s second component of value is earnings that come from sources other than investments and insurance underwriting.
Year end
Per Share Pre-Tax Earnings
Period
Compounded Annual Increase in Per-Share Pre-Tax Earnings
1970
$2.87
1980
$19.01
1970-1980
20.8%
1990
$102.58
1980-1990
18.4%
2000
$918.66
1990-2000
24.5%
2010
$5,926.04
2000-2010
20.5%
Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.
There is a third, more subjective, element to an intrinsic value calculation that can be either positive or negative: the efficacy with which retained earnings will be deployed in the future. Some businesses will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.
This “what-will-they-do-with-the-money” factor must always be evaluated along with the “what-do-we-have-now” calculation in order for us, or anybody, to arrive at a sensible estimate of a business’s intrinsic value. A dollar of then-value in the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar entrusted to Sam Walton.
*Reproduced from Berkshire Hathaway Inc. 2010 Annual Report.
OK. So how does Warren Buffett’s “Two-Column Valuation Method” work?
EXAMPLE #1: I will explain, and the answer is simpler than you may think. First, determine the “Per-Share Investments” amount for the most recent year. In Buffett’s 2010 Annual Report, let’s use $94,730. Next, determine the “Per-Share Pre-Tax Earnings” for the most recent year. In Buffett’s Annual Report, let’s use $5,926.04. Next, determine which multiple to apply to the “Per-Share Pre-Tax Earnings.” Choose a multiple to apply this other similar businesses show within the same sector/ industry
.
Pre-Tax Earnings can also be referred to as Operating Earnings, which are found on the Income Statement.
Pre-Tax Earnings are also referred to as EBIT, or Earnings Before Interest and Taxes.
If other businesses stock prices are currently trading at a multiple of Pre-Tax Earnings of 10; then, for this example let’s use 10 as our multiple we’ll apply to Pre-Tax Earnings.
Therefore, if Pre-Tax Earnings are $5,926.04, and we multiple this amount by our multiple of 10, then this equals $59,260.40.
$5,926.04 x 10 = $59,260.40
Next, we add the business’s Per-Share Investments to this amount. Therefore,
$94,730 + $59,260.40 = $153,990.40
EXAMPLE #2: Similarly, if we were to apply a different multiple to Berkshire Hathaway’s 2010 Pre-Tax Earnings of $5,926.04, we would arrive at a different estimated intrinsic value. For instance, if we were to use a multiple of 12 (instead of 10), then…
$5,926.04 x 12 = $71,112.48
Next, if we were to add the Berkshire’s 2010 Per-Share Investments of $94,730 to $71,112.48, Berkshire Hathaway’s estimated intrinsic value at the end of 2010 would be $165,842.48.
$94,730 + $71,112.48 = $165,842.48
Therefore, using Warren Buffett’s “Two-Column Method,” the intrinsic value of Berkshire Hathaway at the end of 2010 could be estimated to be somewhere between $153,990.40 and $165,842.48. Comparatively, Berkshire Hathaway’s stock price on December 31, 2010 closed at $120,450, well below it is underlying intrinsic value.
“Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.” Warren Buffett
“Wall Street is more concerned with correlation than valuation.” Scott Thompson
“It’s better to be approximately right, than precisely wrong.” Warren Buffett
Obviously, the key to mastering Buffett’s “Two-Column Method” is correctly calculating Per-Share Investments, selecting an appropriate multiple to apply to Pre-Tax Earnings, and accurately combining these two amounts together to arrive at an estimated intrinsic value.
ReplyMartin, sorry. Human error. Please refer to letter to shareholders- berkshire hathaway inc.
maybe you should shoot the question to Mary Buffett. Warren Buffett does not use the DCF method or her methodology to estimate the intrinsic value of the company.
There are NO ASSUMPTIONS in warren Buffett’s valuation.
FYI, On November 20, 2008, Alice Schrooder, author of “The Snowball: Warren Buffett and the Business of Life”, spoke at the Value Investing Conference at the Darden School of Business. She gave some fascinating insights into how Buffett invests that are not in the book. I hope you find them useful.
Much of Buffett’s success has come from training himself to practice good habits. His first and most important habit is to work hard. He dug up SEC documents long before they were online. He went to the state insurance commission to dig up facts. He was visiting companies long before he was known and persisting in the face of rejection.
He was always thinking what more he could do to get an edge on the other guy.
Schroeder rejects those who argue that working harder will not give you an edge today because so much is available online.
Buffett is a “learning machine”. This learning has been cumulative over his entire life covering thousands of businesses and many different industries. This storehouse of knowledge allows Buffett to make decisions quickly.
Schroeder uses a case study on Mid-Continent Tab Card Company in which Buffett invested privately to illustrate how Buffett invests.
In the 1950′s, IBM was forced to divest itself of the computer tab card business as part of an anti-trust settlement with the Justice Department. The computer tab card business was IBM’s most profitable business with profit margins of 50%.
Buffett was approached by some friends to invest in Mid-Continent Tab Card Company which was a start-up setup to compete in the tab card business. Buffett declined because of the real risk that the start-up could fail.
This illustrates a fundamental principle of how Buffett invests: first focus on what you can loose and then, and only then, think about return. Once Buffett concluded he could lose money, he quit thinking and said “no”. This is his first filter.
Schroder argues that most investors do just the opposite: they first focus on the upside and then give passing thought to risk.
Later, after the start-up was successfully established and competing, Buffett was again approached to invest capital to grow the business. The company needed money to purchase additional machines to make the tab cards. The business now had 40% profit margins and was making enough that a new machine could pay for itself in a year.
Schroeder points out that already in 1959, long before Buffett had established himself as an expert stock picker, people were coming to him with special deals, just like they do now with Goldman Sachs and GE. The reason is that having started so young in business he already had both capital and business knowledge/acumen.
Unlike most investors, Buffett did not create a model of the business. In fact, based on going through pretty much all of Buffett’s files, Schroder never saw that Buffett had created a model of a business.
Instead, Buffett thought like a horse handicapper. He isolated the one or two factors upon which the success of Mid American hinged. In this case, sales growth and cost advantage.
He then laid out the quarterly data for these factors for all of Mid Continent’s factories and those of its competitors, as best he could determine it, on sheets of a legal pad and intently studied the data.
He established his hurdle of a 15% return and asked himself if he could get it based on the company’s 36% profit margins and 70% growth. It was a simple yes or no decision and he determined that he could get the 15% return so he invested.
According to Schroder, 15% is what Buffett wants from day 1 on an investment and then for it to compound from there.
This is how Buffett does a discounted cash flow. There are no discounted cash flow models. Buffett simply looks at detailed long-term historical data and determines, based on the price he has to pay, if he can get at least a 15% return. (This is why Charlie Munger has said he has never seen Buffett do a discounted cash flow model.)
There was a big margin of safety in the numbers of Mid Continent.
Buffett invested $60,000 of personal money or about 20% of his net worth. It was an easy decision for him. No projections – only historical data.
He held the investment for 18 years and put another $1 million into the business over time. The investment earned 33% over the 18 years.
It was a vivid example of a Phil Fisher investment at a Ben Graham price.
Buffett is very risk averse and follows Firestone’s Law of forecasting: “Chicken Little only has to be right once.” This is why Berkshire Hathaway is not dealing with a lot of the problems other companies are dealing with because he avoids the risk of catastrophe.
He is very realistic and never tries to talk himself out of a decision if he sees that it has cat risk.
Buffett said he thought the market was attractive in the fall of 2008 because it was at 70%-80% of GDP. This gave him a margin of safety based on historical data. He is handicapping. He doesn’t care if it goes up or down in the short term. Buying at these levels stacks the odds in his favor over time.
Buffett has never advocated the concept of dollar cost averaging because it involves buying the market at regular intervals – regardless of how overvalued the market may be. This is something Buffett would never support.
Here is a link to the video: http://www.youtube.com/watch?v=PnTm2F6kiRQ
Martin, what is per-share investment? You can find it on the letters to shareholders from 1970 until now.
ReplyDear Loong,
Sorry, I don’t quite get your question. Do you mean things like per-share earnings, etc?
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I saw an interview of her on CNA recently. She seems to be simply regurgitating what followers of Warren Buffet already know.
ReplyBecause that is essentially what she teaches. The investing style of Warren Buffett. 😉
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What was there any mention of Mary Buffett’s own investing performance over years?
ReplyDear Createwealth8888,
I remember reading a short article in The Edge recently. She declined to reveal the numbers when asked by the journalist.
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