In a research note, reported on by CNBC, analyst Sarah DeWitt said Berkshire, a company that investors have historically struggled to value properly because of its many moving parts, suddenly appears to be attractively priced when factoring in all the profits made by the stocks held in its $200 billion equity portfolio into its earnings. Based on the “look-through earnings” metric, a valuation technique used by Buffett, she found that Berkshire may be undervalued by as much as nearly 20%.
“Look-through earnings” take into account current period earnings that show up in financial statements, together with other sources of earnings expected in the long run. This method is used by Buffett as a way to appreciate that companies sometimes retain earnings after paying dividends and later invest them at a higher rate of return.
DeWitt noted that standard valuation methods price Berkshire shares at roughly 20 times earnings. However, when factoring in undistributed earnings from its portfolio of stocks, calculated to be $12 billion, or about $5.19 per Berkshire B share, earnings per share (EPS) in 2019 climbs from $10.25 to $15.44. That revaluation sees the stock’s expensive rating suddenly drop to a more appealing 13.6 times forward earnings.
“We view Berkshire Hathaway as one of the best value plays in our coverage group," the analyst wrote, adding that Berkshire’s Class B shares historically trade at an average price-to-look-through earnings ratio closer to 17 times.
DeWitt responded by slapping a $250 price target on Berkshire’s Class B shares. They currently trade at $210.52, nearly 19% below the analysts target.
In the past, Buffett has stressed that “look-through earnings” are a key ingredient of Berkshire's success.
"We continue to make more money when snoring than when active," he explained in a 1996 letter to investors, according to CNBC. "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."