Why I sold some Berkshire Hathaway

A valuation of Berkshire Hathaway. The stock has been good to me. I learned a ton from Buffett & Munger, but the current valuation lowers prospective returns.

Given the latest meeting in Omaha I took another look at my position in Berkshire Hathaway. This lead my to significantly cut my position.

In this article I will discuss my valuation of Berkshire Hathaway and the reason for selling some of my shares.

The reason for selling was not poor past returns.

Valuation:

The way to value Berkshire Hathaway is with a some of the parts (SOTP). Book value has become less meaningful due to operating assets becoming a larger part of Berkshire. Still, you can use BV to get a rough approximation of value. Book value at end of Q1 2024 was $571B, while market cap is $891B (1.56x times).

important branches of the Berkshire valuation tree: Insurance, operating businesses, equity investments, and cash.

Insurance:

Insurance is the most important part of Berkshire Hathaway. It generates value through underwriting profit and float that can be invested.

Underwriting profits in 2023 were $5.4B, in 2022 there was a $30M loss and in 2021 profit was $870M. Underwriting profits will be volatile. Going forward I expect them to be positive on average at around $2B. Which given the volatility I will value at $20B.

Float has steadily increased and currently sits at $168B. An interest free loan that is growing in size is a good thing to have. I give Berkshire shareholders the full value for the float, but nothing for the potential growth in float. Growth of float is a very powerful engine behind Berkshire historically. Given the situation at Geico and the recent strong growth of float. I find it difficult to underwrite further growth. Depending on your views this can be too negative or too positive. $168B of float will be counted as equity.

Operating businesses

Utilities:

Berkshire Hathaway Energy (92%): Wildfire litigation created significant problems for BHE in 2023. Earnings dropped from $3.9B to $2.3B. In the first quarter of 2024 we see a clear rebound with earnings before tax increasing from $223M to $432M. A lot more information can be found BRK Energy. Given the current interest rate environment and murky regulatory situation I find it difficult to value the utilities above 15 times the earnings of 2022. This leads to a value of $58.5B.

Train transport:

BNSF has currently some problems that Buffett talked about. Net earnings dropped in 2023 from $5.9B to $5.1B. The most recent quarter delivered a decline in revenue from $6.0B to $5.7B and earnings before taxes dropped from $1.6B to $1.5B.

BNSF is most similar to UNP. UNP is listed and has a market cap of $137B at a p/e of 21.6. ($110B for BNSF).

Rail transport is a predictable business, and the US government has allowed it decent returns in recent years. This however is not 100% guaranteed going forward. This in combination with the fact that capex exceeds depreciation means that in a more negative scenario you could easily value BNSF at only 15 times earnings ($76.5B).

BHE & BNSF together also have $82B in debt. Given the industry I have included this in the operation.

Manufacturing, service & retailing

Diverse set of businesses which increased net earnings in 2023 from $12.5B to $12.8B. Mixed bag with varying degrees of quality. 15 times earnings leads to a value of $192B. This is on a debt free basis. This might be on the cheap side for a business with a US focus, but abroad you can easily get similar businesses for 15 times earnings.

Largest segments are industrial products with $5.7B in pretax earnings, building products with $4.2B, and services with $3.0B.

Equity investments

Investment in equity securities: $335.9B

Approximately 75% of the aggregate fair value was concentrated in five companies (American Express Company – $34.5 billion; Apple Inc. – $135.4 billion; Bank of America Corporation – $39.2 billion; The Coca-Cola Company – $24.5 billion and Chevron Corporation – $19.4 billion).

Equity method investments: $29.6B

Mostly Kraft Heinz $12B and Occidental Petroleum $16B.

Not really want to focus on the quality of the stock investments. I would argue they are fully valued like most of the US market. Buffett starting to sell the largest position makes this even more clear.

Cash, t bills & fixed maturities

Cash & cash equivalents: $28.9B (within insurance)

t bills: $153.4B

fixed maturities: $17.2 ($4.5B to us governments agencies, $11.0B to foreign governments, and $1.4B to companies).

Value of cash has increased due to higher interest rates. Cash in the hands of Buffett is positive optionality. Will give Berkshire full value for this. Value $199.5B.

Liabilities:

Tax liabilities

deferred tax liabilities: $95.7B. Deferring taxes is a great way to enhance returns. Taxes have to be paid when stocks are sold. New deferred taxes however can be created. Would attribute 50% to Berkshire owners. $47.9B

Insurance liabilities - float

There are more liabilities within Insurance that are not counted as float.

206.2-168 = $38.2B

debt:

$40.7B notes payable within Insurance should be subtracted in my view.

$82B of notes payable related to Energy and transportation are valued within the operating companies. You could value this differently, but this is easy and works for me.

value $40.7B

Adding it up:

Total value: 20+58.5+110+192+365.3+199.5-47.9-38.2-40.7= $818.5B

Sum might be worth more than whole. Benefit of tax credits and tax efficient investments. Primary reasons why investing in green energy makes more sense within Berkshire Hathaway. I think however that is easy to argue that the stocks in the portfolio are overvalued and the valuation for BNSF and BHE are generous. They are in line with US peers, but is this a reason to own Berkshire?

Size & age

The huge size of Berkshire Hathaway makes it harder to outperform for Buffett. The investible universe is a lot smaller, and the size makes Berkshire a lot less nimble.

Age is not on his side eighter. Charlie Munger got to 99, but Buffett at 93 is definitely a bit slower as well. Greg Abel is probably a good successor, but clearly does not have the same track record investing in equities as Buffett.

Alternatives

Buffett said that he could still get 50% returns when he was young and had only small sums to manage. I don’t think I could do this at the moment. Still some learning to do I’m afraid. I do think I can beat the prospective returns that Berkshire Hathaway has currently on offer. I find better returns in smaller companies. Especially outside the US where valuations are lower at the moment.

Place in portfolio

Berkshire Hathaway has always been one of my safer positions in my portfolio. This due to its fortress balance sheet. I really liked this fact 5 years ago. We just bought a house with 10% (normal in The Netherlands) and had fairly little cash savings. The risk in the house has declined due to mortgage payments and higher home prices. Furthermore, we built up some cash savings which I will not invest for some time.

This means I feel that I can go out a little more on the risk curve with my stock portfolio. This made the decision to sell a chunk of Berkshire Hathaway easier.

Conclusion

Good performance and a large starting position which was expanded at the right time made Berkshire Hathaway clearly the largest position in portfolio. I sold 57% of the position. I thought about selling everything but decided to keep a significant position size for now. This is mainly because Berkshire Hathaway is very well positioned for a harder insurance market in the coming years. If people have different opinions on this please let me know. The proceeds with additional funds have been invested in Mexico, Germany, and Japan.

Disclaimer: These are my ideas and not personal investment advice. I might own shares discussed and can sell those shares at all times. I don’t know your financial situation. Do your due diligence and do not blindly follow an article on the internet.