Yesterday I ran a guest post on the short case for Berkshire Hathaway Inc. (NYSE:BRK.A, BRK.B) by S. Raj Rajagopal, an MBA student at Johnson Graduate School of Management at Cornell University. The post generated several requests for the valuation supporting Raj’s short thesis, which Raj has provided and I’ve reproduced below.
Here is the valuation underpinning Raj’s short case for Berkshire Hathaway Inc. (NYSE:BRK.A,BRK.B):
(Click to enlarge)
Please contact Raj if you would like to discuss his valuation or his short case.
[Full Disclosure: I do not hold a position in BRK.A or BRK.B. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]
Greenbackd 
How about this monkey wrench…..
What about Berkshire’s float? Since Berkshire is a successful underwriter, they actually make a profit on their underwriting. Thus, they have a pool of money that they are PAID to take. The present value of free money (or in this case, better than free money) is infinite. So is Berkshire’s intrinsic value infinite?
:)
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Arrgghh!
This job is so weak..
Should anyone waste his time over this?
Please don’t graduate this student: he will be another danger for financial world…
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Ok Raj the whole investment world is interested. Here’s some suggestions for how you can defend your thesis:
1/ Ring up CNBC etc and challenge Warren Buffett to a debate live on TV.
2/ Call a “Short Berkshire” meeting to be held at Omaha at the same time as the normal circus and invite some of the best Berkjshire ‘Shorts’ to give a presentation.
Anybody else got some ideas?
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I have to agree with the other posters, but would like to emphasize the following:
1) How can you not know who David Sokol and Ajit Jain are after writing a thesis on BRK? Listen/view/read previous shareholder mtgs and you’ll hear/see how much praise WB gives to both of them. Ajit has been with Berkshire since the mid-eighties and WB has praised him numberous times at shareholder meetings and within his annual letters. Mr. Sokol has been with BRK since 2000 and has also received an incredible amount of praise. Please also see WB’s opinions on Messrs. Simpson, Nicely, etc. for more examples.
2) Bailout obsession – Mr. Buffett has been offered ‘distressed’ deals over the last few decades from recent deals of GS, GE, bond insurers, etc. back to Long Term Capital Management and SB. If you’d like to learn more, Lowenstein’s book ‘The Making of an American Capitalist’ is a great read.
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LARRY: “How can you not know who David Sokol and Ajit Jain are after writing a thesis on BRK? Listen/view/read previous shareholder mtgs and you’ll hear/see how much praise WB gives to both of them.”
Can’t speak for Raj but many bears–I lean towards the bear case on Berkshire Hathaway but wouldn’t consider it wildly overvalued and a short (I’m just a newbie with a poor record for what it’s worth)–would question whether one should blindly follow what Warren Buffett has said. Like any human, he has been wrong several times (he praised Jeff Immelt of GE when in fact GE appeared to have done little to reduced its financial risk–in fact, it probably increased its risk under Immelt.) Similarly, who knows how good Ajit Jain and David Sokol are?
David Sokol is fine–his job is straightforward and no different than other CEO jobs–but I don’t think anyone knows much about Ajit Jain. The opaque nature of Berkshire Hathaway, along with some opaque characters, is surely a bearish case.
On a different note, Berkshire Hathaway probably shouldn’t trade at a discount to book value but I’m not sure it deserves its current 1.5x (approximately) multiple either. One of the arguments by bears is that conglomerates should trade at a discount. This is especially true for Berkshire Hathaway, which is more of an insurance company and is essentially a black box. Who knows what is going on in the insurance operations?
I’m not saying Berkshire has mispriced risk like several insurance companies in the last decade; instead, I’m just saying the market should discount Berkshire Hathaway slightly due to its opaque nature.
(Of course, on top of the disagreement over book value multiple, it also comes down to the actual book value. I see many Berkshire bulls argue that book value is understated. Buffett, himself, has suggested that Berkshire Hathaway holdings are worth more than reflected on the book. Even on this thread–or maybe the other one related to this–someone was arguing that Burlington Northern Santa Fe’s book value is understated by billions. But it’s difficult to say what the true book value of Berkshire Hathaway is. This is especially true for newbies like me who is not very good at accounting and I have zero confidence in trying to come up with book value for an opaque firm (As for BNSF, I don’t share the view it is severly understated. Even if the land/access rights/etc were valuable, I don’t think you can easily monetize them. Remember, Sears Holdings, a favourite of some value investors, apparently has “hidden” real estate value; but it appears virtually impossible to monetize that real estate–at least within a decade.))
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Why is Raj claiming he ‘..and Ajit went to the same undergraduate school: IIT’? This is a patently false claim.
Per Wikipedia, Ajit Jain graduated from IIT Kharagpur, whereas the Raj’s resume states he graduated from IIT Bombay. Also, per Wikipedia, “All IITs are autonomous universities that draft their own curricula”. IIT Kharagpur is NOT the same school as IIT Bombay. So clearly, Raj is misrepresenting when he claims both he and Ajit graduated from the same undergraduate school. It would be as ridiculous as someone who graduated from UC Berkeley claiming they ‘went to the same undergraduate school’ as someone who graduated from UCLA. At least UC Berkeley and UCLA are located in the same state. IIT Kharagpur and IIT Bombay are in two different Indian states and are 1200 miles apart!
Also, what is the relevance of this disclosure? It seems like an ironic attempt to benefit through association with Ajit, with the logic being the following: “Buffet says Ajit,an IIT grad, is smart. I am an IIT grad too. Therefore, I must be smart too”. Such reasoning would be a classic example of the fallacy of the undistributed middle.
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Ravi addressed this well. Summarizing his #1 at rationalwalk: try normalized comprehensive income rather than eps.
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It is OK to have a contrarian view. In fact, it is a lot of times profitable and innovative to do so. However, no matter what style of investing you subscribe to, you should understand what exactly Berkshire Hathaway is and how it differs from most conglomerates. EPS is never a good tool for evaluating BRK. It is the consistent above average compounding of its book value that makes it such a valuable business. Any reasonable premiums on top of the book value should be warranted. Many intangible factors should also be noted into the valuation in the case of Berkshire, such as its conservative accounting, its cash position / reputation / lender of last resort before Fed (therefore ability to make certain unique investments in preferred / debt, or easy financing for targeted companies such as Burlington), its portfolio of excellent businesses that each commands a huge premium if they were to be sold in the market, etc.
Also, shorting is much harder to calibrate than being long. The only downside of investing Berkshire right now would be the stepping down of Buffett (which may happen later than most people think) that will result in uncertainty in Berkshire’s capital allocation department which is a very important aspect of Berkshire, and limited opportunity to keep compounding at 20% due to its size.
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I have written up a detailed response to Mr. Rajagopal’s short thesis:
http://www.rationalwalk.com/?p=5822
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I agree with Contrarian Reader that this is a marketing ploy to get a job.
My advice is this, if you’re going to evaluate a very well known and well followed company you can’t churn out a run of the mill report, you need to find something unique. Dig down into something no one else is willing or able to look at and tell us why it’s important.
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I still stand by my old comment.
Raj learned a lot at Cornell – a lot of marketing! This thing is nothing but a marketing ploy to get a job . It is being the purple cow in a crowd. If Berkshire goes down for reasons not related to his valuation, he will look good as being the one who says it. This is a simple case of being controversial – much like some artists who can’t draw put dung in sacred statues to stand out …
If it goes up, how does he stand out from the rest of the crowd who also think it will go up?
kudos to Cornell’s marketing professors !
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Clearly a marketing ploy, and, it has served its purpose.
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Hmm….
Raj forecasts an 88% increase in BRK’s book value over the next 6 years, and a 272% increase in BRK’s book value over the next 12 years.
Then he states that BRK should trade at or below book value.
These assumptions don’t seem to match.
I would say that a large stable company growing their book at greater than 11% / year is worth significantly more than their book value.
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Raj, One additional question: I don’t understand your valuation beyond 2016. Seems like a very abrupt change in trajectory – what happens from 2017 to 2021 to cause the value destruction?
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Raj, Just a few quick points and questions here regarding the valuation:
1. Berkshire’s earnings per share are nearly impossible to forecast due to volatility introduced by the timing of capital gains as well as mark to market impacts of the derivatives book. The equity derivatives are marked to market at the end of each reporting period. As noted in several of the comments before, the derivatives are hardly ticking time bombs, have minimal collateral requirements, and are not exercisable for nearly a decade. Furthermore, earnings of publicly traded stocks are not reflected in Berkshire’s EPS.
2. Question: Where did you come up with an earnings growth rate of 20% per year through 2016? Surely you cannot simply take an average of the past few years as stated in your valuation given some not-so-minor changes such as the BNSF acquisition, changes in earnings stream due to large investments in GS, GE, etc, etc … To the extent that you base your valuation on reported EPS at all (bad idea as noted above), shouldn’t you have a forward looking approach rather than just extrapolating from the past?
3. You calculate end of year book value by adding beg. of year plus EPS. This assumes that all impacts to book value run through earnings which is not the case given Berkshire’s large balance of unrealized capital gains which are not recognized in earnings each year but flow into book value.
4. Your notes state a discount rate of 8% yet you use a 9% discount rate in your calculations. Why?
5. Your estimate for each year is running at a substantial discount to book value. Do you believe that Berkshire has significant goodwill impairment? If so, in which subsidiaries are you noting such impairment and why? Note that you are making a case for a discount to book that is unprecedented – Berkshire has never traded below 1.0 Price/Book over the past decade – thus, you must at least attempt to reconcile your thesis with this.
6. Are you actually taking a short position on Berkshire based on this thesis?
I find the case to be very weak for the reasons noted above as it uses assumptions that are simply flawed, unexplained, or both — and shows a fundamental misunderstanding of the value drivers at Berkshire.
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