Berkshire Hathaway: Still Cheap At All-Time Highs (NYSE:BRK.B)

Berkshire Hathaway (NYSE:BRK.B) recently hit an all-time high. On September 13, it reached the lofty price of $370.84–for those not keeping track, that’s equivalent to $556,260 in terms of the Class A shares! Certainly, you would expect a legendary investor like Warren Buffett to hit new highs every now and then. But the market conditions under which Berkshire Hathaway hit its recent all-time high were unusual. Apple (AAPL) was under pressure when the high was achieved, and crude oil prices were raising the spectre of further Fed rate hikes. Granted, Berkshire is heavily invested in oil stocks, so it should benefit from rising oil prices more than most companies do, but higher interest rates should theoretically reduce the present value of Berkshire assets like Apple stock (the company’s single largest investment).

At today’s prices, Berkshire Hathaway stock is not as cheap as the “value” names the company itself likes to buy. As I will show in the ensuing paragraphs, the stock is a little pricey compared to itself in the recent past–although not compared to the markets as a whole.

Nevertheless, Berkshire Hathaway stock is still a decent buy today, compared to what’s out there in the world of equities. Certainly, investors could do well buying treasuries, as Berkshire is doing. However, investors who went all-in on treasuries would probably miss out on the opportunities present in individual stocks, which Berkshire has historically been able to capitalize on, even in times when the markets as a whole were richly valued. So, Berkshire may, over a very long period of time, prove to be a better investment than treasury bills–which are among the safest and highest yielding high-quality assets one can buy today.

When I last covered Berkshire Hathaway, I wrote that the stock’s then-recent Q2 earnings results argued for buying it. Since then, the stock has risen 3.8%, and outperformed the S&P 500. My thesis for buying Berkshire a few months ago was vindicated, but the stock is more expensive now. So, it’s worth asking whether BRK.B is still worth buying today. In the ensuing paragraphs I explain why I not only still like Berkshire, but in fact like it more than I did when I last wrote about it, so much so that I’m upgrading my rating to ‘strong buy.’

Berkshire’s Multiples

Berkshire is basically fairly valued if you value it using multiples. In the ensuing paragraphs, I will build up Berkshire’s multiples from scratch using the company’s financial statements, then calculate the stock’s multiples based on that. In past articles I’ve mainly been content to rely on multiples from Seeking Alpha Quant, but because Berkshire Hathaway is structured a little differently from other companies, I will calculate EPS and EBIT per share by hand, just so there is no confusion as to what really constitutes these metrics. Below you will see the financial statements used to come up with my figures:

Adding up the first half 2023 earnings along with the third and fourth quarter 2022 earnings, we get the following per share revenue/earnings figures:

Click to enlarge

Berkshire Hathaway Class B shares closed at $367.86 on Friday. Using this price, we get the following multiples (P/E and price/EBIT calculated by the author, price/sales and price/book from Seeking Alpha Quant):

• P/E: 8.96.

• Price/EBIT: 24.73.

• Price/sales: 2.46.

• Price/book: 1.32.

Now, using the P/E ratio, we’d conclude that Berkshire Hathaway stock is currently extremely cheap. However, Warren Buffett and Charlie Munger have repeatedly advised investors not to use GAAP earnings when valuing Berkshire stock, because their large stock portfolio causes huge non-cash swings in earnings. Instead, they say to use EBIT in place of earnings, and going by the “price/EBIT” ratio, Berkshire is actually a little bit pricey right now, trading at 24.73 times operating earnings. According to YCharts, the S&P 500 is currently at a 23.76 P/E ratio according to YCharts. So, if we assume that EBIT for Berkshire is equivalent to net income for a company that does not own securities, then Berkshire is more expensive than the S&P 500.

However, there are two points worth keeping in mind here:

• The S&P 500’s valuation is influenced by some very cheap banks and energy companies. Most U.S. megacaps are tech stocks and those typically trade at around 30 times earnings.

• Berkshire is well below the S&P 500’s price/book ratio.

So, Berkshire is cheap compared to other mega-caps based on earnings, and very cheap compared to the markets based on assets. On the whole, this is a relatively modestly valued stock. It’s not as cheap as some banks and energy companies, but it’s definitely cheaper than big tech. In fact, if you take GAAP earnings as the best measure of earnings, then Berkshire is cheap, period, but again, management doesn’t consider that the best metric for evaluating its own stock. So, I’ll go with 24.73 as the “P/E” ratio, and say that Berkshire is modestly valued but not outright cheap.

Discounted cash flows point in a somewhat different direction. According to Seeking Alpha Quant, Berkshire has $17,795 in free cash flow per A share, which translates to $11.87 in free cash flow per B share. If you assume no growth and discount that at the 10 year treasury yield (4%) you get only a $297 price target, which suggests that BRK.B stock right now is overvalued. Warren Buffett himself is a fan of using discounted cash flows to value stocks, so this point is worth keeping in mind. As we’ll see in the next section, though, there is reason to think that Berkshire will in fact grow.

Growth

If you’re used to looking at Berkshire Hathaway as a value stock, you might not think that it is going to deliver much growth. However, it has delivered a moderate amount of growth in recent years. According to Seeking Alpha Quant, the company’s five year CAGR growth rates in revenue, earnings, and book value are:

• Revenue: 6.81%.

• GAAP net income: 12.8%.

• Normalized net income: 33%.

• Tangible book value: 11.3%.

Truth be told, Berkshire’s growth has been pretty decent! If you go back to the discounted cash flow exercise I did in the previous section and include a 10% growth assumption for just five years, with no growth assumed after that, then the price target rises to $372, which provides a little bit of upside to today’s prices. So, even if Berkshire’s growth slows down slightly, the stock may still have a bit of room to run.

The above is the main reason why I like Berkshire stock even more than I did the last time I wrote about it, even though it’s now technically more expensive. If we assume that Berkshire grows, it’s worth the investment, and today, with oil prices rising, we know that the company’s Occidental Petroleum (OXY) and Chevron (CVX) investments are likely to report higher earnings. So, there is a catalyst currently underway that should provide the growth that investors need.

Similarly, there are long term factors that argue for Berkshire being able to achieve long term growth, such as the management team. Warren Buffett is one of the best investors of all time, with a 20% CAGR track record over six decades. Ted Weschler did over 30% CAGR over three decades in his Roth IRA. Ajit Jain built Berkshire Hathaway Specialty Insurance from the ground up–making it the only business in Berkshire History that was founded by Berkshire instead of acquired. Finally, Greg Abel holds $105 million of his own wealth in BRK.B, making him a manager with skin in the game. All these managers are great individually, to have several of them at one company is on a whole other level of excellence.

Another Berkshire advantage when it comes to growth is its reputation for doing good deals. Business owners often want to sell to Berkshire, because they believe that Buffett will keep the business instead of raiding it for various parts. This fact has enabled Berkshire to score many lucrative deals over the years, such as BNSF, which the company bought for a tiny fraction of what it’s worth today.

Risks and Challenges

As we’ve seen, Berkshire Hathaway is a stock with a roughly “average” valuation, good historical growth, and an excellent management team. The stock looks like a pretty good buy today if we assume that Buffett and his team can keep executing over the next few years. Nevertheless, there are several risks and challenges for investors to keep an eye on, including:

• Rising interest rates. Berkshire Hathaway requires growth in order to be worth the investment using a discounted cash flow based valuation. If you assume no growth, the stock is not worth the investment, even if you use the treasury yield with no risk premium as the discount rate. The higher the treasury yield goes, the more growth Berkshire stock needs in order to be worth it. So, investors will want to keep a close eye on Berkshire’s earnings in the months and years ahead. If the company’s growth falters then its stock may decline in value. Ditto if long term treasury yields rise.

• Regulatory risk. A big part of Berkshire’s business is insurance, which is a highly regulated industry. So far, insurance regulations have not harmed the company. However, it’s possible to imagine future regulations that could. Berkshire used to own whole banks just like it currently owns whole insurance companies. It was forced to sell them off when the 1970 amendments to the Bank Holding Company Act were enacted, placing restrictions on what bank holding companies could own. Were similar rules to come to “insurance holding companies” like Berkshire, then BRK.B stock would lose its engine for generating float. That would likely impede performance over the long run.

The risks and challenges above are very real. When buying a stock at an all-time high, you always need to consider the possibility it will mean revert. The risk factors above could serve as catalyst for that to happen. For this reason, you may wish to use a stop loss order on BRK.B, give the position a small weighting, or even use protective puts. Any one of these strategies would help minimize your downside risk. Personally, I’m using the “small weighting” strategy–Berkshire is only about 3% of my portfolio.

Nevertheless, Berkshire Hathaway stock is cheap enough that I believe it has considerable long term upside. The company is very profitable and is growing at an admirable pace for a firm of its size. I’m content to own BRK.B stock for the time being.