Warren Buffet and Book Value

Annually Warren Buffett compares Berkshire Hathaway's results with the S&P 500 returns in their annual report...One would think that the comparison would be a good benchmark against the return of one's stock returns...The interesting thing is that Warren does not show the change in his stock price annually, but he compares the S&P 500 against the increase in Berkshire's book value...Book value per share is the total capital divided by the number of shares outstanding...One can easily get the year end stock price of Berkshire and calculate the return of Berkshire, but Warren does not show this in a detailed table, like he does the book value...If you own stocks I encourage you to look at every stock's change in book value, just as you look at the change in the market value of your portfolio...

The reason, I think Warren does this (comparing book versus a market value) is that he wants long term shareholders... The market price of a stock is much more volatile than its book value...The book value increases or decreases are just the net income or net losses of the company...The book value also will increase and decrease when a company marks to market their securities...In 1979 insurance companies were required to mark their securities to the lower of cost or market...In their annual reports, Berkshire's comparisons reflect those changes...

Stock repurchases can also affect book value...When a company is buying back stock, the actual treasury stock purchase can increase or decrease book value...This depends on what the stock price is when you retire the stock...The lower the cost of the stock purchased, the more likely it will have in increasing book value...The higher the price for its repurchased stock, the more likely it can have a negative impact on the book value per share...But the repurchase of shares is normally a positive thing for a company's shares, because it increases the earnings per share or EPS...Warren would normally welcome this (the repurchase of shares of a company he owns)...However, he expects or at least would like management to know the price and value of the company, so every share repurchased will increase the intrinsic value of the company...In share repurchases one actually owns a larger portion of the company when a company is repurchasing shares (assuming you are not selling any of your shares)...The share repurchase, if bought at the right prices, can be a two fold positive...One you own a larger share of the company...Two, if bought at the right intrinsic price, your shares are worth more...

Stock options affect book value, because a company is issuing more shares...This dilutes your total ownership and is a negative to your ownership position...

Also, dividends decrease book value and since Berkshire has never paid a dividend their increase will be higher than those mature companies that do pay a dividend...Warren feels he can allocate capital (their dividends) better than the shareholder receiving the dividend can...When you look at their increase in book value AND their share price, he has been able to allocate capital very much above the average and above average investors...One needs to take this non dividend payment into consideration when looking at just the total capital numbers at each year end and comparing those to Berkshires and other companies that do not pay dividends...

Another situation, even though it is shown in net income is extraordinary losses...Extraordinary losses almost become ordinary when a company has every two, three or five years a big write down...Since extraordinary losses are not operating earnings, many research companies pull this loss out and put it in a footnote...Valueline treats the extraordinary loss this way...This extraordinary loss can have a huge impact on the book value of a company and its capital position...So be aware of this...

Warren states that in any given year book value increases are likely to be reasonably close to that years change in the intrinsic value of the company...This implies that the stock price increases over time would match up to the increase in the book value...For instance, when Berkshire was saddled with the assets of the old textile company Berkshire Hathaway, the 1964 book value might be too high for the valuation of Berkshire (in 1964)...This was because many of the assets were in textile assets, which did not have much value or future value...The thirty some years later, he stated that their book value when around $70,000 presented probably a buying opportunity...This was because the underlying assets were now many insurance companies and solid companies in Berkshire Hathaway Holdings (see link Berkshire Hathaway Holdings and also Berkshire Hathaway Stock Holdings)...In this discussion, an efficient market student might be able to determine that book values are more market efficient than stock price (and have less emotion in them, especially when you own one hundred percent of a company)...In a privately held company, one looks at the capital position regular, as well as the assets and their value...But the most important measure, is how much cash will the business make or throw off totally in the future... Warren looks at this last metric very much...

To learn something from this discussion, we must step back and look at total capital from each company we own and see what increases have happened and the total increase in capital and the percent, each of your stock holdings have increased...Just like Warren...

Comments