Berkshire Hathaway's B-shares should be trading higher, but the market doesn't put enough value on the contribution of the conglomerate's massive $200 billion stock portfolio, according to analysts from J. P. Morgan.
Berkshire CEO Warren Buffett, also known as one of the most successful value-style investors, has talked about the concept of "look-through earnings." Companies pay investors dividends but they also retain some of their earnings. Over time, companies invest these retained earnings at a higher rate of return and that ultimately boosts their share prices, benefiting their investors.
When evaluating investments, Buffett not only looks at the operating earnings of the companies, but also calculates what Berkshire's share of their retained earnings would be, minus taxes.
This thinking, Buffett has said, forces investors to evaluate stocks for the long term. "We continue to make more money when snoring than when active," he explained in his 1996 letter to investors. "Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire's value."
J. P. Morgan analyst Sarah DeWitt calculates that Berkshire's share of undistributed earnings from its stock portfolio is $12 billion, or about $5.19 per Berkshire B share. But the market doesn't always include this in its analysis. Ignoring the contribution of the portfolio, Berkshire's B shares look expensive at roughly 20 times EPS, DeWitt said.
But including the calculation tells another story. DeWitt's estimate for 2019 EPS is $10.25, and she says total look-through earnings are $15.44. The B shares trade around $209, or 13.6 times 2019 look-through earnings.
The 13.6 is low for Berkshire's B shares. Its historic average price-to-look-through earnings is closer to 17, the analyst noted. Her B-share Dec. 2019 price target is $250, about 19 percent above where it currently trades.
"We view Berkshire Hathaway as one of the best value plays in our coverage group," she wrote in a note to clients Wednesday.
No wonder that Buffett recently agreed to lower the bar for Berkshire Hathaway to buy back its own shares using its giant $120 billion pile of cash.
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