Buffett wrote the following about the group of wide-ranging businesses in his latest Berkshire shareholder letter:
"...we are getting a decent return on the capital we have deployed in this sector. Furthermore, the intrinsic value of the businesses, in aggregate, exceeds their carrying value by a good margin. Even so, the difference between intrinsic value and carrying value in the insurance and regulated industry segments is far greater. It is there that the huge winners reside."
Specific examples of businesses in this sector include (in no particular order): Benjamin Moore, Dairy Queen, Nebraska Furniture Mart, and See's Candies, Fruit of The Loom, Russel Athletic Apparel, NetJets, The Pampered Chef, Business Wire, Iscar Metalworking, The Marmon Group, McLane Company, Shaw Industries, Johns Manville, and Lubrizol among many others.
Some might be surprised to hear Buffett say that the biggest difference between intrinsic value and carry value comes from the insurance and the regulated, capital intensive businesses. A reflection of the inherent limitations of accounting.
Of course, as I've mentioned in earlier posts, how effectively capital is allocated* going forward will have a great impact on Berkshire's intrinsic value over time. The quality of future capital allocation is a significant factor over the long haul even if it may be hard to estimate in advance:
"We, as well as many other businesses, are likely to retain earnings over the next decade that will equal, or even exceed, the capital we presently employ. Some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.
This 'what-will-they-do-with-the-money' factor must always be evaluated along with the 'what-do-we-have-now' calculation in order for us, or anybody, to arrive at a sensible estimate of a company's intrinsic value." - From Page 104-105 of the 2012 Annual Report (initially seen in the letter of the 2010 Annual Report)
That something happens to be difficult to measure makes it no less important. Sometimes, the hard to quantify stuff matters a whole lot while the easier to quantity stuff matters little. It can be a big mistake to focus on what happens to be easily measurable while de-emphasizing what's tough to measure but far more important.
"Not everything that counts can be counted, and not everything that can be counted counts." - Sign hanging in Albert Einstein's office at Princeton
"...practically (1) everybody overweighs the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and (2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that." - Charlie Munger in this speech at UC Santa Barbara
Berkshire also has some value in the Finance and Financial Products sector but its contribution remains rather small. That sector includes things like XTRA, CORT, Clayton Homes, and Berkadia Commercial Mortgage.
In total, Berkshire now owns 68 different non-insurance companies.
The bulk of Berkshire's intrinsic value comes from investments (funded, in part, by cheap or often even better than free float provided by the insurance businesses and retained earnings), earnings from the non-insurance businesses**, plus the very important but more difficult to quantify "'what-will-they-do-with-the-money factor".
Check out page 104-105 of the 2012 Annual Report for Warren Buffett's complete explanation of how to think about Berkshire's intrinsic value.
Adam
Long position in Berkshire established at much lower than recent prices
* As do frictional costs. Berkshire is currently built to minimize frictional costs and, even if certain expenses seem very likely to go up, there's little reason to think their low cost ways will change in a material way going forward. Berkshire's inherently low frictional costs is no small advantage.
** Earnings from sources other than what's produced by investments and the insurance underwriting.
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