The Evolution Of Berkshire’s Hurdle Rate

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In their recent episode of the VALUE: After Hours Podcast, Taylor, Mitchell, Brewster, and Carlisle discussed The Evolution Of Berkshire’s Hurdle Rate. Here’s an excerpt from the episode:

Jake: Now, you raised some really good points with that. I think it’s been interesting to watch the evolution of Berkshire and Buffett’s hurdle rate over time. When they were smaller, and it was earlier, and maybe you could say, better opportunity set just due to even just size constraints, they compounded it, I don’t know, 23%-ish book value for a long stretch, and then, as you’ve watched it go down over time, now he’s willing to take a 8% to 10% regulatory return from huge deployments of capital into Mid America or Berkshire Energy, and the railroad. But then also, the other thing that’s interesting– I’ve been thinking a lot lately, I think I’m going to write about it for the next quarterly letter about how–

Actually, there’s a saying that says that he’s a better investor, because he’s a businessman, and he’s a better businessman, because it’s an investor. I think you could also say that the insurance side of things has actually made him a much better investor, and that the links between insurance assessment and investing are actually quite strong. To tie this back together, he says that they’re looking to aim for a 90% underwriting basically, especially for the super cap part of the business where it can be very difficult to match the premium today versus a really long tail of liability over time. They’re aiming for 90%, which is implied 10% hurdle. It all fits together in his mind, I think, in a similar way, where he has this 10% hurdle now for any dollar that’s in their deployment, whether it’s putting it into solar panels in Nevada, or whether it’s insurance against an earthquake in LA. It all fits together into that same 10% hurdle for him now.

Tobias: 10% feels about right, but I think that he’s always said he would buy a business at about roughly 10 times on earnings. That’s always been a private business, and then, I think he’s getting the return by assuming that they’re better businesses than what he’s paying for them at 10 times, they’re worth a little bit more than that and are likely to grow a little bit faster than that.

Mike: In fairness, if you’re putting the checks to work that he’s putting the work in and you get much more than 10%, you stole it from somebody. That’s not his MO. He does not because he wants-

Jake: Yeah, quite good then.

Mike: [crosstalk] good around. Yeah, exactly. He wants people to stick around, he wants to have minority owners, the people who sell him his business, he likes it when they keep a stake in things. Underwriting 10% and getting growth on top of that is that’s a pretty good– That’s not a bad outcome for Berkshire shareholders. But my guess is, the bigger he gets, the smaller that number is going to get over time. It certainly has been the case historically.

Tobias: It’s a difficult task in this market though. I’ve just been playing around with a little bit. I found you’ve got to creep it down to about 8% to get the answers that you want in this market.

Jake: [laughs]

Mike: Or lower, or lower.

Jake: Yeah.

Mike: 8% is a big number. I had 8% on those [unintelligible [00:24:47] and I was happy as a pig in slop. I was so happy. I was buying those things at par. Even those are six and change now, and they rerated just like that, that’s the market we’re in. In 6%, I’m like, “It’s good. Yeah, the money’s good, but that’s not 8%.”

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