Following the release of Q3 earnings, I have updated my intrinsic value estimate for Berkshire Hathaway and concluded the stock remains undervalued.  Here are the components of my intrinsic value (fair value) estimate for Berkshire:
 
1.Cash and marketable securities (Insurance) $144B
2.Bonds $18.1B
3.Equities $311B
4.Equity investments $15.5B.  For accounting purposes, equity investments are 20-50% ownership positions in other companies. Berkshire has the following equity investments:

• Kraft Heinz 26.6%
• Pilot Flying J’s Travel Centers 38.6%
• Berkadia 50%
• ETT 50%

5.  Adjustment for overvalued equities ($40B).  One thing I like to do as part of my intrinsic value estimate is to go through all of Berkshire’s top holdings and determine if any of them are meaningfully over or undervalued and make the necessary adjustment. The value for equities on Berkshire’s Q3 balance sheet is based on market values at that time.  If you believe stocks always trade at fair value, you should adjust these figures based on today’s market prices instead of market prices at the end of Q3.  Instead of using today’s market prices, I adjust them to my own intrinsic value estimates.  For example, at the end of last year I thought Kraft Heinz and Verizon were undervalued and BYD and Apple were overvalued.     
 
6.  Operating companies $358B.  Berkshire owns around 65 companies including Burlington Northern Santa Fe, GEICO, Duracell, Dairy Queen, Lubrizol, Fruit of the Loom, Net Jets, Pampered Chef, Forest River, Benjamin Moore Paint, Shaw Carpet, See’s Candies, to name a few.  Most of these companies have leadership positions in their industries and generate high returns on capital.  I calculated a weighted average P/E ratio based on the major businesses (BNSF 17/BH Energy 16/Mfg Service & Retail 18) of 17.5 which is well below the multiple of the market today.  This group of businesses has annual earning power of more than $25 billion which puts the value at $355B.  Year over year comparison are meaningless due to the pandemic, but if you compare 2021 to 2019, the operating companies increased pretax earnings 14.5% through September.
 
Total value: $806 Billion.    
 
 
 
 
Shares outstanding were 1,503,013.  Total value / shares outstanding puts the A shares intrinsic value at ~$536,000 and the B shares at ~$357.  Today, the stock is at $285 making the shares 20% undervalued.   
 
Disclosure: Long BRKB
 
 
Disclaimer: Askfinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.


 
 
 

1. Before investing anything, accumulate an emergency fund in cash that will cover six months of spending.
2. Pay off high-cost debt.  If you have any debt with interest rates above 5%, pay it off before you begin your investment program.
3. Determine your total portfolio balance.  Add up all savings accounts, checking accounts, brokerage accounts, IRAs, and 401Ks.
4. Now that you have a total portfolio balance, start thinking of investments in terms of percentages instead of dollars.  The percentages should apply to your total portfolio, not a specific account.  For example, if I come across a high-quality company at a good price, I will normally invest 5% of the portfolio into the stock.  For Mutual Funds and ETFs that cover an entire region or investment style (growth vs value) I’m very comfortable investing 10-20% of the portfolio.  Many of my deep value micro-cap investments tend to be in troubled companies that have significant upside potential buy also carry significant risks.  These are 1% bets.  Thinking in percentage terms is a better way to size your exposure to different investments.
5. Now you need to make the big decision.  Are you going to be a stock picker or a passive investor with your investments on auto pilot?  For most people, passive investing is the best choice.  Social media & CNBC make it look easy to pick stocks and get rich. The primary reason is you are only hearing about the small group of people who are doing very well, and it is normally over a short time period with small amounts of capital.  It’s very difficult to outperform the market averages over the long run.  Roughly 80% of professional investors underperform the index and only 0.5% beat the market by more than 3 pts/year over the long term.  This is why Warren Buffett recommends index funds for most people.  I would only recommend picking individual stocks if:
   1. You like researching companies.
   2. You understand accounting and financial statements.
   3. You have a basic understanding of business valuation.
   4. You have the time to dedicate to the process.

People trading stocks with none of the above are most likely speculating, not investing.  There is nothing wrong with this, but it’s better to call it what it is and limit your exposure to this type of investing.  It’s not an approach you want to take with your life savings, especially as you get older, and your nest egg grows.

Assuming you decide to take the passive approach, you need to determine the best way to get invested.  The options are:    

1. Lump sum: go all in with the ETFs you have chosen.  My concern with this approach is that the U.S. market is very overvalued in my opinion.  Many argue we are in a massive bubble.  The S&P 500 trades at 38x normalized earnings compared to a long-term average of 16x.  The market would need to decline ~60% just to get back to average!  International markets are not cheap either, but their valuations are much more attractive than the U.S.  The problem you have is that if the U.S. market has a major correction, everything else falls too.
2. Stay in cash and wait for a 20-30% correction before investing.  This makes a lot of sense, but nobody knows when this correction will occur.  I’ve been anticipating it and hedging our portfolio for nearly 10 years now.
3. Dollar cost average.  Emotionally, this is probably the best option.  I’ve learned that with investing you want to minimize regret and the best way to minimize regret is to do things gradually.  I recommend investing 1/12th of your target positions every month over the next year.  If we have a big correction, you will be glad you did not go all in.  If the market continues to climb, you will be glad you have some exposure.  Regret minimization!     
4. Once you are fully invested, you should rebalance annually to get back to your target positions.  The rest of the time, enjoy life and you will probably outperform most professionals. 

 
Suggested Asset Allocation:
 
Vanguard Emerging Markets (VWO)            15%
Global Deep Value (GVAL)                            15%
Vanguard U.S. Small Cap Value (VBR)         20%
Vanguard U.S. Real Estate (VNQ)                 10%
Vanguard Int’l Real Estate (VNQI)                10%
Gold (GLD)                                                      5%
Gold Miners (GDX)                                       2.5%
Silver (SLV)                                                   2.5%
Cash                                                               20%
Total                                                              100%
 
 
 
 
 
 
Disclaimer: Askafinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.

Following the release of Q2 earnings, I have updated my intrinsic value estimate for Berkshire Hathaway and concluded the stock remains undervalued.  Here are the components of my intrinsic value (fair value) estimate for Berkshire:
 
1.Cash and marketable securities (Insurance) $140B
2.Bonds $20.5B
3.Equities $308B
4.Equity investments $16.7B.  For accounting purposes, equity investments are 20-50% ownership positions in other companies. Berkshire has the following equity investments:
1.Kraft Heinz 26.6%
2.Pilot Flying J’s Travel Centers 38.6%
3.Berkadia 50%
4.ETT 50%
5.  Adjustment for overvalued equities ($55B).  One thing I like to do as part of my intrinsic value estimate is to go through all of Berkshire’s top holdings and determine if any of them are meaningfully over or undervalued and make the necessary adjustment. The value for equities on Berkshire’s Q2 balance sheet is based on market values at that time.  If you believe stocks always trade at fair value, you should adjust these figures based on today’s market prices instead of market prices at the end of Q2.  Instead of using today’s market prices, I adjust them to my own intrinsic value estimates.  For example, at the end of last year I thought Kraft Heinz and Verizon were undervalued and BYD and Apple were overvalued.     
 
6.  Operating companies $355B.  Berkshire owns around 65 companies including Burlington Northern Santa Fe, GEICO, Duracell, Dairy Queen, Lubrizol, Fruit of the Loom, Net Jets, Pampered Chef, Forest River, Benjamin Moore Paint, Shaw Carpet, See’s Candies, to name a few.  Most of these companies have leadership positions in their industries and generate high returns on capital.  I calculated a weighted average P/E ratio based on the major businesses (BNSF 17/BH Energy 16/Mfg Service & Retail 18) of 17.5 which is well below the multiple of the market today.  This group of businesses has annual earning power of more than $20 billion which puts the value at $355B.  Year over year comparison are meaningless, but if you compare 2021 to 2019, the operating companies increased earnings 16% in the first half of 2021.
 
Total value: $785 Billion.         

Shares outstanding were 1,519,576.  Total value / shares outstanding puts the A shares intrinsic value at ~$517,000 and the B shares at ~$345.  Yesterday, the stock closed at $288 making the shares 17% undervalued.   
 
 
 
 
 
Disclosure: Long BRKB
 
 
Disclaimer: Askfinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.

 ​In July of last year, I posted a blog on Altria.  At that time the stock was trading at $39.40, and I estimated intrinsic value at $70 making the shares 44% undervalued. Today, the shares closed at $47.81 giving you one appreciation of 21.3%, or a total return of 30.7% including dividends. 
 
Altria manufactures and sells cigarettes, smokeless products, and wine in the United States. They also have a 10.2% interest in Anheuser-Busch InBev (World’s largest brewing company), a 35% interest in JUUL (#1 non-traditional smoking products company) and a 45% interest in Cronos Group (Canadian marijuana grower). Altria was founded in 1822 and is headquartered in Richmond, Virginia.
 
Although smoking has been on a steady decline for decades, Altria has delivered a 13.2% annual return over the past 25 years.  This compares to 9.8% for the S&P 500.  If you invested $10,000 in the S&P 500 25 years ago, you would have $103,500 today.  If instead you invested in Altria, you would have $221,900.
 
What I like about Altria:

• Industry leader with ~50%+ market share.
• Very impressive margins.
• 7.2% dividend yield – They have increased the dividend 54 times in the past 50 years.
• They own the Marlboro brand - #1 brand for 45 years.
• Significant pricing power – They have been able to offset roughly 80% of volume declines with higher prices.  Buffett will tell you if there is just one thing to look for in judging the quality of a business, it would be pricing power.  Very few companies have it.
• Very high returns on invested capital.
• Recession proof.  Some would argue people smoke more in a recession.
• Margin expansion.  They have increased their operating margin 13.5 points since 2014!  This is something that really impressed my when I looked at their historical financials.  Here are the historical operating margins:

 
2014    42.5%
2015    44.4
2016    46.1
2017    49.4
2018    48.4
2019    53.0
2020    52.2
2021 YTD 56.0
 
 
 
 
What I dislike about Altria:

• The industry is in a secular decline
• High legal risks
• High regulatory risks
• High excise taxes
• They overpaid for JUUL and Cronos (in my opinion).  Good news is they already took significant write downs for this.

 
What is Altria worth? 
 
Using a discounted cash flow approach with their current financials and assuming a conservative ~2.0% growth rate, Altria has an enterprise value of $136B.  This does not include the value of their investment in:
 
                              Est Value:
 
AB Inbev (BUD)   $14.3B
JUUL                        1.6B
Cronos                       1.2B
Total investments   $17.1B
 
If you add it all up:
 
Enterprise value                $136.0B
Equity Investments               17.1
Cash                                        1.9            
Less debt                             (28.2)                       
Less pension                          (0.6)
Fair value estimate             $126.2B
Shares outstanding               1849
 
Fair value estimate per share $68.25
Today’s price                           $47.81
% Undervalued                             30%                
 
 
 
Disclosure: Long MO
 
Disclaimer: Askfinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.

​(Revisiting my post from February 17th, 2020)
 
 
The market continues to be on a tear with the S&P 500 up 84% since the March low last year.  The problem with these aggressive short-term moves is we are pulling forward future returns.  Emotion tells us if returns have been great, they will be great in the future.  However, math tells us that after a period of above average returns, we will have a period of below average returns.  Before I make my case about future returns, let me be clear:
 
A)I am not predicting a date for a major correction.
B)I am not predicting the magnitude of the decline.
C)This has nothing to do with politics or my views on the economy. 
 
It’s just math.
 
The common questions are “Are we going to have a correction?”  “How bad will it be?”  “When will it happen?” “Should I be in the market or out?”  Unfortunately, nobody has the answers.  Market strategists are happy to answer these questions, not because they know, but because they are asked.  It’s difficult to justify a high salary if your answer is always “I have no idea”. 
 
In my opinion, the more appropriate way to think about markets is “can I expect to generate a good enough return over the long term (say 10 years) to compensate me for the risk I am taking?”  In March of 2009, stocks were cheap.  In fact, it was probably the buying opportunity of a lifetime.  At that time, I was projecting double digit returns for the long term.  It didn’t matter if you had a couple of awesome years followed by a couple of flat years.  The important thing was how the returns would average out over the next 10 years or more.
 
In the short-term, valuation is a lousy market timing tool.  However, in the long-run valuation makes all the difference. In March 2009, stocks were cheap with the S&P 500 trading at 666.  Although it was the buying opportunity of a lifetime, hardly anyone wanted to buy.  Funny how that works.  Today, the S&P is at xxx and stocks are expensive which means the math is not in your favor for the next 10 years.  Let’s look at the other times over the past 100 years when stocks were very expensive like they are today:
 
            Year:                                       Annual return over the next 10 Years:     
 
      1929 (Dow Jones)                                           -9.4%
      1999 (S&P 500)                                              -2.8%
      1999 (NASDAQ)                                              -7.3%
      2007 (S&P 500)                                              +5.2%
      2021 (S&P 500)                                                 ?
 
I like to break down the four components of equity returns to project what future returns are likely to be.  These components are:
 
1)Real GDP growth: 2.0%. The consensus is for above average growth in 2021 but a rate below 2% per year over the long term.  The FOMC (Federal Open Market Committee) has a long-term forecast of 1.8%.  For the past 12 years, growth has averaged around 2% per year so we will stay with that assumption.  With population growth at a fraction of a percent and productivity trending lower the past several years, it is difficult to generate much higher rates of growth.

2)Inflation: 2.4%.  This is what is currently priced into the fixed income market for the next 10 years.

3)Dividend Yield:  1.3%.  This is today’s yield on the S&P 500.

4)Change in Price/Earnings Ratio: -6.1%.  Today stocks are trading at 37.7 times normalized earnings vs. a long-term average of 16.8 times.  There has only been one time in history when stocks traded at a higher price to normalized earnings and that was during the tech bubble in 1999 prior to the NASDAQ falling 77%.  Although the long-term average price/earnings ratio is 16.8, I’m going to be optimistic and use 20 in this exercise given our low level of interest rates.
 
Add it all up and you get a projected annual return estimate of -0.4% for the next 10 years.  If price earnings multiples go back to the long-term average of 16.8, you are looking at an annual return of -2.1% over the next 10 years!  
 
Now you must ask yourself if you are willing to risk a significant decline to enjoy this annual return.  This will be a function of your age and risk tolerance, but I have found that young people don’t like losing money either.  When making this risk/return trade-off, consider whether or not earning a higher potential return will truly impact your quality-of-life vs. the life changing impact of having your retirement portfolio cut in half.
 
I understand the dilemma.  Terms such as “TINA” (There Is No Alternative), FOMO (Fear of Missing Out), YOLO (You Only Live Once) become very popular during bull markets along with talk of “never sell”.  You get attacked on social media for suggesting stocks are expensive or warning people against speculating with large portions of their portfolios. 
 
This is an incredibly challenging time to invest.  Cash is paying close to zero, high quality bonds are paying closing to zero, long term bonds & junk bonds provide some yield, but they have the added risk of losing money if interest rates climb. 
 
Personally, I think the TINA approach is a dangerous way to think about investing.  “I know stocks are significantly overvalued but I’ll buy them anyway because the alternatives are not good”.  Today’s thinking seems to be:
 
A) I can stay in cash or buy bonds and earn next to nothing or
B)Buy stocks because they have done well recently.
 
      I look at it this way:
 
A)I can preserve my capital/net worth, sleep well at night, and have plenty of dry powder to take advantage of future opportunities when prices are more attractive or
B)Risk losing xx-xx% of my capital/net worth. 
 
From the peak in October 2007 to the low in March 2009, stocks fell over 50%.  Moves of this magnitude are life changing.  Especially if you are close to retirement.
 
So, what are some other options to consider if you have decided you don’t want to be fully invested in the U.S. Stock Market:
 
1)You could raise cash levels.  It doesn’t have to be all of nothing.  In fact, we have never been 100% stocks or 100% cash.  We are talking about adjusting exposures based on risk and reward.  If you are young and stocks are cheap, you might decide to be 90% invested.  If you are young and stocks are expensive, you might be 60% invested.  If you are old and stocks are cheap, you might go with 75% exposure.  If you are old and stocks are expensive, you may want your exposure below 50%.  Keep in mind, these are not permanent exposure levels. 

2)You could move some money out of U.S. equities into International where valuations are much more attractive…especially emerging markets.

3)Lower your expectations that stocks will deliver 10%+ per year forever.   We are living in a low return world now.  In the past, it worked well to save 10% of your income and make 10% per year on your investments.  If returns are going to be significantly lower in the future, you should consider a savings rate closer to 20%.  Much better to face this reality when you are young. 
 
 
 
 
 
 
 
 
 
 
 
 
Disclaimer: Askafinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.

​Although not popular these days, it used to be investing was all about estimating what something was worth and trying to buy below that value.  This is what we do when we buy houses, cars, or groceries; but for some reason people like buying stocks after they have gone up in price. 
 
I still approach investing the old-fashioned way where you determine what something is worth and only buy at a discount to that value.  One of the benefits to this approach is increased conviction when the markets fall.  If I own stock in a company that I think is worth $100 and the price falls to $75, I do not panic and sell.  In fact, I might even buy more.  But if you own stock in a company that is worth $100, and it trades for $300 it’s very difficult to know when to sell if it starts falling.  Momentum is great on the way up, but it works on the way down as well.
 
Recently I did some valuation work on our largest holding, Berkshire Hathaway and concluded the stock remains undervalued.  Here are the components of my intrinsic value (fair value) estimate for Berkshire:
 
1.Cash and marketable securities $135B
2.Bonds $20.4B
3.Equities $281.2B
4.Equity investments $18.7B.  For accounting purposes, equity investments are 20-50% ownership positions in other companies. Berkshire has the following equity investments:
1.Kraft Heinz 26.6%
2.Pilot Flying J’s Travel Centers 38.6%
3.Berkadia 50%
4.ETT 50%
5.  Valuation adjustment for equities ($50B).  One thing I like to do as part of my intrinsic value estimate is to go through all of Berkshire’s top holdings and determine if any of them are meaningfully over or undervalued and make the necessary adjustment. The value for equities on Berkshire’s year end balance sheet is based on market values at that time.  If you believe stocks always trade at fair value, you should adjust these figures based on today’s market prices instead of market prices at year end.  Instead of using today’s market prices, I adjust them to my own intrinsic value estimates.  For example, at the end of last year I thought Kraft Heinz and Verizon were undervalued and BYD and Apple were overvalued.  Since Buffett’s Apple stake is worth $120B, this is a pretty big deal.  Apple ended the year at $133. I think it’s worth around $95.   
 
6.  Operating companies $315B.  Berkshire owns around 65 companies including Burlington Northern Santa Fe, GEICO, Duracell, Dairy Queen, Lubrizol, Fruit of the Loom, Net Jets, Pampered Chef, Forest River, Benjamin Moore Paint, Shaw Carpet, See’s Candies, to name a few.  Most of these companies have leadership positions in their industries and generate high returns on capital.  I calculated a weighted average P/E ratio based on the major businesses (nothing too scientific) of 17.5 which is well below the multiple of the market today.  This group of businesses has annual earning power of around $18 billion which puts the value at $315B.
 
Add it all up and you get a total value of $720 Billion or $310 per share.          
  
Year-end shares outstanding were 1,557,026 and with some additional share repurchases in January/February, I estimate shares outstanding are now 1,544,570.  Total value / shares outstanding puts the A shares at ~$465,000 and the B shares at ~$310.  Yesterday the stock closed at $245 making the shares 21% undervalued.  I like a 25% discount so I would be a buyer under $233. 
 
 
 
 
 
Disclosure: Long BRKB
 
 
Disclaimer: Askfinanceguy.com is not an investment advisor, brokerage firm, or investment company.  This blog is for educational and/or entertainment purposes only. Use this information at your own risk. Do not consider anything on this page to be legal, tax, or investment advice.

​Seth Klarman is the chief executive and portfolio manager of the Baupost Group which he founded in 1982.  He is a deep value investor who has outperformed the market by a wide margin over the past 38 years.  Over the years I have read everything I can find on his investing approach and I always pay attention to what he is buying and selling when his 13-F filings are released (Feb, May, Aug, Nov). ​