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Intrinsic Value: Sell, or Hold?

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March 07, 2013 – Comments (0) | RELATED TICKERS: BRK-A

Board: Berkshire Hathaway

Author: rationalwalk

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Curious what the group thinks... Once BRK reaches what you believe to be the Intrinsic Value - should you sell this stock or continue to hold? Presumably, you believe there is no more upside for this stock, so wouldn't it make sense to cash out, lock in the value and re-deploy the $$ elsewhere into an opportunity that you believe has upside?

For purposes of this response, let's just assume that Berkshire's intrinsic value today is approximately $175,000. The question is whether a shareholder would be wise to continue holding Berkshire once the shares advance to intrinsic value.

The answer depends on a number of factors. Most importantly, the shareholder has to estimate the rate at which Berkshire is likely to compound intrinsic value going forward because that is the rate of return that can be expected over very long periods of time.

This is best illustrated through an example. Today it is possible to purchase Berkshire at $155,000 which is a $20,000 discount to intrinsic value. If the investor expects Berkshire's intrinsic value to rise by 9% per year, then in ten years intrinsic value should be around $415,000. If the market price in ten years equals intrinsic value, the shareholder buying today at $155,000 would achieve a 10.3% annualized return.

If Berkshire's price suddenly increases tomorrow to $175,000, an investor who purchases shares could expect to achieve an annualized return of 9% if intrinsic value rises at 9% and the market price equals intrinsic value in ten years.

If Berkshire's price suddenly increases tomorrow to $200,000, an investor can expect to achieve annualized returns of 7.6% over the subsequent ten years if intrinsic value rises at 9% and the market price equals intrinsic value in ten years.

In all of these examples, the most important factor is the rate of increase in intrinsic value over the ten years period. Buying at a discount improves results somewhat and buying at a premium reduces results somewhat but over long periods of time Berkshire's increase in intrinsic value dominates the end result. If we look at a 20 year timeframe the convergence of investor results with actual business results is even greater.

Back to the question: What should the investor do with Berkshire if it gets to intrinsic value? The answer depends on what the investor thinks of Berkshire's opportunity to increase intrinsic value in the years to come. If that rate of increase is above the investor's personal hurdle rate, then the shares should not be sold. If the investor has a higher hurdle rate, then it would be necessary to find higher return investments to achieve that hurdle rate ideally at a level of business risk equal to or less than Berkshire's.

The bottom line really is that "it depends" on the investor's skill in finding other opportunities.

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