Take one of my old spreadsheets (found elsewhere on this site), plug in BNI’s past performance, and you’ll get a per share value of $60.15. Mike and I both did it, and we were both perplexed. Did Buffett pay upwards of a 30% premium for BNI? Let’s pick it apart.
Problem 1: Negative Owner Earnings
Right off the bat, the valuation goes awry. In 1997, BNI had negative owner earnings to the tune of $368 million. Is that a problem?
Do not take yearly results too seriously. Instead, focus on four- or five-year averages.
Right. Thanks Mr. Buffett. Sometimes companies will have one or two erratic years out of ten, and it throws off our valuation. In the case of BNI, that one year-1997-throws off our owner earnings calculation and gives us a growth rate of 7%.
But let’s fudge the numbers a bit. What did BNI do if we assume no growth from 1997 to 1998, and then look at the snapshot. If we set the 1997 owner earnings to $71 million-the same as 1998-we get a new picture: 25.4% growth in owner earnings. We just went from yawn to yowsers.
Can you do that?
Why not? There was a one-year monkey wrench in the company’s past and it threw off our valuation. There is no law about using 9- or 11-year histories. There is nothing that says ten years is the magic number. Remember: Valuing a business is both art and science.
And what did I really do? I simply said, “Hey 1997, stop throwing off my valuation. Give me a 0% growth rate for 1997 to 1998, pretend that year never really happened, and let’s see what we come up with.”
The New Value
Take out the one bad year out of ten and you end up with a per share value of $126.83. But let’s be rational-let’s assume BNI can’t keep owner earnings growing at 25.4% for ten years. I feel more comfortable saying it can do so for another three years. It has a heck of a competitor barrier to entry (are you going to start a railroad?) and moat (one of the largest railroad systems in America).
After year three, I’ll assume its growth will slow by ten percent a year-that is, growth will be 20.5% in 2010, 18.5% in 2011, and so on to 10.9% in 2016. Then, 5% a year thereafter. If I’m wrong and BNI keeps owner earnings growing faster than I projected, I’ll simply make more money.
The New New Value
Using the above tweaks in the numbers, I get a value of $96.05 a share. But I’m not done yet. Is your head spinning? Put BNI in your too hard pile and move on. Otherwise…
What do railroads have a ton of? Real estate. How do you account for real estate on a balance sheet and in net worth? Carry the property at the purchase price, depreciate it, and forget about it. You don’t increase its value on the balance sheet just because the property is two, five, or fifteen years old.
BNI is real estate rich-riches that don’t reflect in its balance sheet and net worth. How rich is it? I don’t know-my valuation has to end here. Admittedly, Buffett is smarter than I when it comes to valuing a railroad. BNI is in my “too hard” pile.
Adding It Up
Based on the future owner earnings, BNI is at a 16% or so discount. Add in the hidden real estate gains, and you will likely find that it is trading at a much larger discount to its true value. How large? I don’t know, so I have to move on.
Remember than valuing a business is both art and science. The science is easy-add up all the discounted cash that can be taken out of the business and you have a value. The art-projecting that cash-well, there are no hard, fast rules for it. Unfortunately, you can’t use one spreadsheet to get a value for all companies.
All the more reason to stick with simple, understandable, predictable businesses.
Filed under: Companies Analyzed (Generals)
Related Stocks: BNI
Hmm… Seems like you are referring to the past to value its cashflows which fair enough are marginal and you would get a significantly lower value than $70 p/share.
BNI’s shareprice has been moving over the past few years as revunues have been rising. This means past preformance is not the basis of valuation, but a change in the business economics of this high capex low return business has been telegraphed.
WEB has stated that the economics which makes him baulk at high capex low return industries like railroads or utilties for the past 50 years have now changed. Perhaps his enthusiasm now stems from his macro calls on the economy which have certainly been playing out. He states that we have been through at least 3 bubbles or periods of overvaluation – in the late 90s, then in real estate, currently there is a bubble in most commodities especially metals.
You should look forward on a businesses economic characteristics and where they are now placed 5 years or so ahead as well as backwards in your analysis of companies.
Many companies hold depreciated real estate on the books from utilities like Southern to Plum Creek, but that doesn’t translate into a return – their is oversupply – the bubble is now deflating, I hold TRJ – that is prime RE well under market value, that has been going nowhere for plenty of years!
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Agreed! 100% of the value of a company lies in the future – not the past. If you think BNI will generate owner earnings at a faster rate than it has in the past, you’ll end up with a higher value. Buffett (WEB) has a much better grip on the railroad industry, and I do see railroads coming back a bit as trucking companies continue to feel the pain of rising gas prices.
In the end, BNI is too difficult for me. Still, if you have a good grasp on its future, it may be extremely attractive.
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After reading a couple of the BNSF annual reports, and knowing Buffet has done his proven valuation, I just flat out bought some at a price ranger lower than one of BRK-A’s additions. My circle of competence was – Buffet valued it and he’s usually right for a long term buy and holder, and I got some cheaper than him 
.
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I don’t remember where I read it, but I remember a statistic that said something to this effect: If you mimicked Buffett’s performance, buying and selling stocks he reported, you would have averaged some 18% for the past 20 years. That is, of course, buying and selling when he reports – a full five weeks after the quarter ends and likely longer if he purchased (or sold) earlier in that quarter.
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“Based on the future owner earnings, BNI is at a 16% or so discount. Add in the hidden real estate gains, and you will likely find that it is trading at a much larger discount to its true value. How large? I don’t know, so I have to move on.”
I understand, and totally agree, with that rationale. However, with BNI there is somethings I’m willing do to as a small time investor even if I dont understand the valuation. I’m willing to just copycat Buffet’s move if I can get in at or below BRK’s recent acquisition prices. Why? Because BRK bought SO MUCH of BNI. I mean, Buffet really loaded up on this one, now owning @ least 15% of the outstanding shares! It looked like whenever the stock got around 80 BNI or below BRK was loading up. From a Buffet-watcher position it looked like 80 was a magical number for BNI. Something in Buffet’s valuation criteria made that price range a go for another BRK purchase.
Or course, if one were to copycat Buffet’s latest moves because the market has corrected the stock for the short-term, and some can be bought at the levels berkshire paid, there is still the issue of when to sell. A copycat investor wont know when buffet sells until after it is announced. However, with BNI, the most glaring thing is how much he bought. Personally if I can get in around 80 or below I buy some. I hope the copycatting pays off. For sure, I dont worry about BNI being speculative on my part. I sleep easy knowing that BRKA bought 15% (or more) of the outstanding shares at this price level.
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Joe,
Thanks!
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