Berkshire Hathaway is looking rather cheap

Currently, Berkshire A shares are trading at around $120,000 and the B shares are at approximately $80.

Book value per share (BVPS) at the end of the first quarter of 2011 was just over $97,000. Therefore the price-to-book ratio is approximately 1.24.

The average (year-end) price-to-book ratio over the period 2005-2010 was 1.44, this compares to 1.76 from 2000-2010 and 1.63 from 1985-2010.

Over the period 2005-2010, BVPS has increased at 9.9% compound, compared to 24% compound from 1990-2000. Even despite its size, Berkshire is still comfortably outperforming the S&P 500.

Realistically, I think that Berkshire will manage to return 8-9% compound for the next 3-4
years. Let’s assume 8% growth in BVPS. This would mean that the BVPS of Berkshire will be approximately $103,000 at year-end 2011, $111,000 at year-end 2012 and $120,000 at year-end 2013.

I also think that 1.44 times BVPS (the 2005-2010 average) is a realistic and not too demanding multiple for the actual stock price to trade at.

What does this give us?

It gives us an intrinsic value of approximately $148,000 for the A shares at year-end 2011, approximately $160,000 at year-end 2012 and $173,000 ($115 for the B shares) at year-end 2013.

If I’m correct here and Berkshire is trading at approximately $173,000 at year-end 2013, the compound return from now (at a current price of $120,000) will be about 15% - not bad at all.

The returns come from the ever increasing BVPS of Berkshire plus the movement in the price-to-book ratio to a more realistic 1.44.

What can go wrong?

You know the answer. Buffett is now 80 years old and no one knows how long he will remain as CEO of Berkshire (even he doesn’t know that). However, my analysis only goes to the end of 2013 which is just over 2.5 years away. I’m not looking beyond that and believe that it’s more likely than not that Buffett will still be at the helm at that time.

Even without Buffett, Berkshire will carry on with some wonderful businesses that generate vast amounts of cash (Buffett currently estimates normal earnings power of $12 billion after tax).

The majority of large American corporations trade at much more than 1.24 times BVPS and they do not have Buffett or the diversity of businesses that he has hand picked, and of course, he isn’t finished yet. You get my point.

I’ve recently bought Berkshire, so we will see how this pans out. Of course I’ve used Australian dollars to buy it and I bought at a point when the $A was trading at $1.10 to the $US. This adds another dimension to my investment which obviously US investors won’t have.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).