Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Berkshire Hathaway holds its annual meeting this Saturday. Joining me today to discuss what Morningstar thinks Berkshire is worth is Gregg Warren. Gregg's a senior analyst with Morningstar, and he covers Berkshire Hathaway for us. Hi Gregg. Thank you for joining us today.
Gregg Warren: Thanks for having me, Susan.
Dziubinski: Back in March, several weeks ago, we increased our fair value estimate on Berkshire. We pushed the A shares up to $440,000 fair value, and we boosted the B shares up to $293, and that represented about a 16% increase. What was behind that increase?
Warren: It was a combination of several different things. We were quick to take the fair value down when the COVID pandemic hit in March of last year, and it was right to do that. We had to see what the impact was going to be overall. Between the investment portfolio and the operating companies, we were expecting to see a fairly meaningful hit to the operations, because they do have a lot of economically sensitive businesses. But what happened or ended up happening was the second half of the year the investment portfolio did a lot better than we were hoping. We started seeing much stronger operating performance out of some of the operating companies, the railroad, the manufacturing service, retailing, stand out because they actually posted better than expected margins of profitability, even with pressure on the top line.
When the company dropped their fourth-quarter earnings at the end of February, we had a chance to dig through, see what was happening, and update all of our forecast going forward. Right now at this point, we're looking at probably more-normalized earnings this year and next. We'll have to see how much of the cost containment will carry forward, but we have always been generally conservative when we value Berkshire. It was nice to see them putting up some good solid numbers to be able to incorporate that in.
Dziubinski: Now, Berkshire will be sharing its first-quarter earnings in the next several days. Do you expect to see anything in that report that might lead us to reassess our fair value estimate again?
Warren: There's always reasons to look at things from time to time. First-quarter earnings, generally, you don't really want to look at them too deeply because you're only about a quarter of the way through the year. But that said, there are a few things we're really kind of looking for as we get through this period. One was: Has Geico returned to more normalized levels a top on growth profitability? Last year was a tough year for them. They had to give a lot of credits to customers, had to hold off on canceling policies. We'll have to see where things have panned out. The other thing we like to look at is whether or not the COVID loss reserves are done. They put away a couple of hundred billion dollars last year. We want to just make sure that they're not going to put more aside for potential losses as we move forward.
Then, we like to look at BNSF, where the stronger results we saw in the back half of the year, indication of better performance on their part. We've been critical of them the past several years, because they've not adopted precision scheduled railroading, which would be a big boost to their margins. But they actually saw a decent improvement in profitability, back half of last year, so we'll have to see where that is.
And then with the MSR, I noted just previously, they had a really, really big boost in profit margins, better than we were expecting. We'd like to see if that's going to be contained. If they can maintain margins at that level, that's a better indication about where profitability might be three, four, five years from now.
And then the real final thing we like to look at--I think a lot of investors are curious about--is: How much stock did Buffett buy back during the quarter? He picked up about $9 billion a quarter the last two quarters of last year. Run rate, they were probably doing about $4 or $5 billion through the first month or so based on what we saw. So, if they do another $9 billion here, that would just add more positive news for investors.
Dziubinski: Now we continue to assign Berkshire a wide economic moat rating. Given, the economy and the market and what we see going forward, do we feel like Berkshire's competitive advantages are stable?
Warren: Berkshire's a little bit tougher than most companies because, much like we do the valuation, we have to look at the moat on a sum-of-the-parts' basis. We have to split out the different businesses. Historically, when we look at the insurance business, that's generally been a no-moat business, overall industrywide. Berkshire tends to have some of the better players. They have the very solid, strong balance sheet, ability to underwrite things that a lot of people couldn't underwrite. But at the same time, they're very, very disciplined when it comes to underwriting. Berkshire is one of the few companies that isn't trying to make up for underwriting losses with a lot of investment gains. So from that perspective, they're pretty much a step above everybody else.
Railroad's a solid wide-moat business. We'll have to see how that pans out. There's been some talk about some consolidation of a few things as we move forward. Again, with anything with a moat, same with the valuation, we're always looking at competitive positioning as seeing: Is anything diminishing? Is anything improving? I think with the energy business, we've seen some improvements. They picked up a pipeline business last year that actually helped widen things out, but overall solid, narrow-moat business. They basically exchange excess returns for having an oligopoly, or a monopoly, in the areas in which they operate.
And then with the MSR business, pretty much solid narrow-moat firms across the board there. If, as we've seen this uptick in profitability for them as a permanent addition, that tells us something about how strong those moats really are. The ability to maintain positioning and maintain profitability, even in the face of a really, really terrible economic condition, like we saw this past year. And then as far as the moat, the wide moat overall, it really, as always, put it over the top as this ability to reallocate capital within the businesses. So, we're always looking at capital allocation opportunities. What they're doing with the cash. How they're building it up. We're happy to see, now, that they're finally starting to buy back stock. We've been pushing for them to do that for a number of years now. That'll only help returns over the long run.
Dziubinski: And then, finally, Gregg, the magic question: Where do we think Berkshire is today, pricewise? Do we think it's overvalued, undervalued, fairly valued, and why?
Warren: The shares have had a pretty good run of late. They're up about 20% year to date, I think now, and they're about 50% up over the past year. But again, that was really coming off of that March 2020 sell-off, and the stock did struggle for a few months there. But once Buffett announced that he was buying back stock, once it was clear to investors that they were actually doing that, plus putting money to work in investments and acquisitions, the shares really took off. People are reassessing and looking at it and saying, "Hey, this is a company that can continue to put a ton of cash to work, if only just in share repurchases." That would be meaningful for investors in the long run. We look at the fair value right now, where the market prices on the stock---it's trading at about a 10% discount, a little bit less than that.
So it's not as exciting as it was a few months ago, but at same time, if we look at a price/book basis, the stock right now is still trading at 1.3 times what our estimate of this year's book value will be and 1.2 times forward. Historically, it's traded about 1.4, 1.45. There's still some movement potential there. As I said, our fair value tends to be a bit more conservative. Sometimes it doesn't come up with what we see in our price/ book, multiple basis, historically, but we still think there's generally some room to run there because investors do look at it on that basis.
Dziubinski: Well, Gregg, thank you so much for your time today and your insights into Berkshire's fair value. We appreciate it.
Warren: Thank you, Susan. You have a good day, too.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.