Lesson 7 of 7
Holding companies and their discount
Build a holding company's net asset value from its stakes, its taxes and its costs, then see why a discount to that value can persist for decades.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A holding company's net asset value is its stakes, minus the tax a sale of them would trigger, minus its own overhead and debt.
- The market price of the holding company can sit below that net asset value for years, a gap known as the discount.
- Counting only the dividends a stake pays misses the earnings it keeps, which still build the owner's value.
A holding company owns stakes in other businesses rather than running one itself. Its net asset value is what those stakes are worth, adjusted for the tax a sale would trigger and for the cost of running the holding company on top of them. The market price of the shares can sit well below that number, sometimes for decades.
Building net asset value from the stakes
- Listed stakes, at market value$800
- Private businesses, at estimated value+$400
- Deferred tax on unrealised gains−$120
- Head-office cost, capitalised−$80
- Holding-company debt−$100
- Net asset value= $900
What goes into net asset value, and what comes out of it
Listed stakes are valued at their market price; private ones need your own estimate, since no market price exists. From that sum, subtract the tax a sale of the appreciated stakes would trigger, since the holding company does not own that value free of the tax authority. Subtract the holding company's own head-office cost, capitalised as a perpetuity (for example $8 a year at a 10 percent rate is $80), since it is a recurring drag with no operating business behind it. Subtract any debt held at the holding company itself, separate from whatever debt sits inside the stakes it owns.
Turning the gap into a discount
Market value against net asset value
- Net asset value, built above$900
- Market value of the holding company · A 22.2% discount$700
Why a discount can persist for decades
A minority holder cannot force a sale. So the head-office cost is paid every year the structure lasts. The deferred tax is paid only when a stake is sold, and a buyer of the holding company inherits the low tax basis that a direct owner of the stakes would not. Add little analyst coverage, and a discount can be a lasting, rational price for a genuinely more costly way to own the same businesses, not a mispricing waiting to close. Nothing dates its end unless a catalyst appears: a sale, a break-up or a buyback of the holding company's own shares.
What a sum of stakes alone can miss
Berkshire Hathaway's 2019 shareholder letter makes a related point about its own largest stakes. The earnings a stake retains and reinvests, or uses to repurchase its own stock, still add to the holding company's economic value. This is true even though no dividend carries them across. A repurchase by one of the stakes enlarges the holding company's share of that stake's future earnings. A stake's market price already reflects this. The figure that misses it is reported operating earnings, which count only the dividends a minority stake pays. For its ten largest stock holdings, Berkshire's 2019 letter put dividends at $3,798 million against its share of their retained earnings, $8,332 million.
Check yourself
Which of these reduces a holding company's net asset value below the simple sum of what its stakes are worth?
- The dividends the stakes have already paid out
- The deferred tax a sale of the stakes would trigger
- The number of shares the holding company has outstanding
Show the answer
Answer: B.
A sale of appreciated stakes would trigger tax, so a net asset value net of that tax is lower than simply adding up the stakes' market prices.Net asset value is $900 and the holding company's market value is $700. What is the discount to net asset value?
- 28.6 percent
- 22.2 percent
- 11.1 percent
Show the answer
Answer: B.
($900 − $700) divided by $900 is 22.2 percent. Dividing by the market value instead, $200 over $700, gives the wrong figure of 28.6 percent.According to the reasoning in Berkshire Hathaway's 2019 shareholder letter, what can a holding company's dividends received fail to reflect?
- The market price of the stakes it owns
- The retained earnings a stake reinvests or uses to repurchase its own stock, which still add to the holding company's value
- Whether a stake paid a dividend at all
Show the answer
Answer: B.
A stake's retained earnings, including what it spends buying back its own stock, add to the holding company's economic interest even when none of it arrives as a dividend.Sources
- Berkshire Hathaway shareholder letter, 2019, on how a stake's own share repurchases enlarge the holding company's share of that stake's future earnings, and on dividends against retained earnings for its ten largest stock holdings.
What this leaves out
- Every figure in the waterfall and the discount, $800, $400, $120, $80, $100, $900 and $700, is a round invented number chosen so the arithmetic can be checked by hand.
- A private stake's value here has no market price to check it against; it is only ever an estimate.
- A discount to net asset value is not itself a reason to expect it to close, and some holding companies have traded at a discount for decades. Nothing here is advice about any security.