INTRODUCTION
So in order to do the valuation of our firm, our first section will be analyzing the firm
fundamentally so that we can know that how stable our firm is historically, how our
company evolved over time and how it is performing in the market and then afterwards
using its forecasted figures we will value the firm through discounted cash flow model.
In the end we will come up with our conclusion that whether the firm is
overvalued/undervalued or fairly valued according in the market. The company that we
have chosen for our analysis is Berkshire Hathaway and it is overvalued.
BERKSHIRE HATHAWAY
Berkshire Hathaway is a holding company for a multitude of businesses, run by its famous
Chairman and CEO, Warren Buffett. Berkshire Hathaway is headquartered in Omaha,
Nebraska, and began as a group of textile milling plants. When Buffett became the
controlling shareholder in the mid-1960s, he began a progressive strategy of diverting
cash flows from the core business into other investments. In 2017, Berkshire Hathaway
had a market capitalization of close to $488 billion, one of the top five largest publicly
traded companies worldwide (Investo Contributors, 2018)
Because of Berkshire Hathaway's long history of operating success and keen stock market
investments, the company has grown to be one of the largest in the world in terms of
market capitalization. Berkshire stock trades on the New York Stock Exchange in two
classes, A shares and B shares. The A shares are noted for their very high prices – in excess
of $250,000 per share in 2017.
Early in his career Buffett came across the novel idea to use the "float" from his insurance
subsidiaries to invest elsewhere, mainly into focused stock picks that would be held for the
long term. Buffett has long eschewed a diversified stock portfolio in favor of a handful of
trusted investments that would be overweighed in order to leverage the anticipated
return. Over time, Buffet’s investing prowess became so noted that Berkshire's annual
shareholder meetings became a mecca for value investing proponents and the focus of
intense media scrutiny.
In 2017, Berkshire Hathaway subsidiaries included GEICO, Dairy Queen, BNSF Railway,
Lubrizol, Fruit of the Loom, Helzberg Diamonds, Long & Foster, Flight Safety International,
Pampered Chef, and NetJets. In addition the holding company has a 38.6% stake in Pilot
Flying, a 26.7% stake in the Kraft Heinz Company, a ~17% minority holding in American
Express, 9.4% minority stake in The Coca-Cola Company (9.4%), and 2.5% minority stake in
Apple, among other well-known firms.
The Future of Berkshire Hathaway
Nearing his 80th birthday in May 2010, CEO and Chairman Warren Buffet announced he
would be succeeded at Berkshire Hathaway by a team, comprised of one CEO and 2-4
investment managers. In 2011, it was announced that Castle Point hedge fund manager
Todd Combs would become one of these investment managers; along with Peninsula
Capital Advisors Ted Weschler. Buffet has yet to name his CEO replacement. (Investo
Contributors, 2018)
INDUSTRY ANALYSIS:
An analysis of the competitive environment by using Porter’s Five Forces indicates the
intense competitive factors associated with the business. Since Berkshire Hathaway
operates in so many sectors the impact from new entrants is extremely high. The wide
business operations also imply that there is a large threat of substitute products and
services. Additionally, bargaining power of suppliers could cause the company to have to
raise prices, and the bargaining power of buyers could force the company to drop prices.
Considering these factors, Berkshire Hathaway operates in an extremely competitive
environment.
Threat of New Entrants
All of the businesses that Berkshire owns have high competition. If a new company has
advancements in technology or procedures, this could affect Berkshire’s financial
performance. Foreign or domestic competitors may emerge and negatively affect
Berkshire’s operational profit
Bargaining Power of Suppliers
If Fruit, Russell, and VFB (FOL) increase cost of raw materials, this may decrease production
operations of these businesses. Additionally, if weather affects the amount of raw
materials that suppliers can produce, the price of raw materials may rise, or these materials
could become unavailable. Suppliers manufacture The Pampered Chef (TPC) products, so
changes in the supply chain may negatively affect the price at which Berkshire can obtain
these goods.
Competitive Rivalry
The automobile insurance industry is extremely competitive, and this competition can lead
to decreases in market share. The railroad industry that Burlington Northern Santa Fe
Company (BNSF) operates in is also extremely competitive. FOL is also extremely
competitive, so decreases in profits could occur from this.
Bargaining Power of Customers
If there is a recession, buyers will have too little money to afford many of Berkshire’s
products. This will decrease the demand for Berkshire’s many companies. This decrease in
demand could lead to Berkshire having to lower prices to retain many of their customers.
Threat of Substitute Products or Services
Each aspect of Berkshire’s operations has incredibly high competition. Market and
technology changes by competitors may deteriorate Berkshire’s earnings. Many insurance
companies exist, so Berkshire Hathaway insurance companies like GEICO need to offer
lower rates than competitors. Additionally, transportation, energy, and chemical industries
consist of many substitute products and services.
FINANCIAL PERFORMANCE:
These are the few stats regarding financial performance of Berkshire:
 Berkshire Hathaway is overvalued based on assets compared to the US Diversified
Financial industry average.
 Berkshire Hathaway has not efficiently used shareholders’ funds last year (Return
on Equity less than 20%).
 Berkshire Hathaway used its assets more efficiently than the US Diversified Financial
industry average last year based on Return on Assets.
 Berkshire Hathaway's use of capital deteriorated last year versus 3 years ago
(Return on Capital Employed).
 Berkshire Hathaway is able to meet its short term (1 year) commitments with its
holdings of cash and other short term assets.
 Berkshire Hathaway's long term commitments exceed its cash and other short term
assets. (SimplyWall, 2018)
VALUATION
Following are some important calculations for this DCF model
Excess Return = (Return on Equity – Cost Of Equity) (Book Value of Equity)
Terminal Value = Excess Return / (Cost of Equity – Expected Growth Rate)
Company Valuation = Book Value of Equity + Present Value of Terminal Value
Value per Share = (Book Value of Equity + Present Value of Terminal Value) / Shares
Outstanding. (SimplyWall Analyst, 2018)
First of all we found the book value of equity per share of Berkshire i.e. $247,795.59 which
is a weighted future book value estimate from 11 analyst. Similarly we got a Stable return
on equity of 7.6%. (SimplyWall, 2018)
In order to find appropriate discount rate for the model we use CAPM with following data
Risk free rate = 10 year government US Bond rate =3% (also used as perpetual growth rate)
Equity Risk Premium (S&P Global) = 7.1%
Beta = 0.88 (S&P)
Discount rate/Cost of Equity= 3%+0.88(7.1%)
Discount rate= 9.16%
This whole data is retrieved from (Simply Wall St, 2018) and it has been provided by
Standard & Poor’s Capital IQ.
Now it’s time to perform respective calculation from above formulas
Excess Returns= (7.6%-9.16%) (247,795.59) = $-3962.91
Terminal value= -3962.91/ (9.16%-3%) = $-63,801.83
Company Value= $247795.59+ (-$63801.83) = $183993.76
Stock price of Berkshire on New York Stock exchange on 5 Dec, 2018 was $315,000 but the
intrinsic value that we calculated is $183,994. So the stock of Berkshire is overvalued.
CONCLUSION:
Considering the Porter’s Five Forces, and financial analysis Berkshire Hathaway is doing
quite well. Berkshire Hathaway and its subsidiaries operate in an intensely competitive
environment, so they must be aware of what their competitors are doing to keep an edge
on them. Fortunately, most of the financial factors of the company support that this
company is doing well. Finally, it is wise to invest in any of Berkshire Hathaway’s companies.
Bibliography
1. Investo Contributors (2018). Berkshire Hathaway. [online] Investopedia. Available
at: https://www.investopedia.com/terms/b/berkshire-hathaway.asp [Accessed 6
Dec. 2018].
2. SimplyWall (2018). Berkshire Hathaway (NYSE:BRK.A) - Share price, News &
Analysis.
[online]
Simply
Wall
St.
Available
at:
https://simplywall.st/stocks/us/diversified-financials/nyse-brk.a/berkshirehathaway [Accessed 6 Dec. 2018].
3. Simply Wall Analyst (2018). SimplyWallSt/Company-Analysis-Model. [online]
GitHub. Available at: https://github.com/SimplyWallSt/Company-AnalysisModel/blob/master/MODEL.markdown#excess-returns-model--how-is-thiscalculated [Accessed 1 Dec. 2018].