Tuesday, September 20, 2011

Berkshire Hathaway at Book Value?!

OK, I really have no intention of turning this blog into a Warren Buffett fan site or a Berkshire Hathaway (BRK) information aggregation/news site or anything like that.  There are tons of those things out there and many are very well done.

BUT, having said that, I can't not mention an astounding thing going on in the market right now.  I don't think many people would have dreamed of this in a long time. 

Anyway, as I said, there are a lot of websites/blogs that talk in detail about BRK, what it's worth and all that.  Calculating the intrinsic value of BRK seems to be a miniature cottage industry on the internet.  I don't intend to jump onto that bandwagon.  I have my own thoughts on how to value BRK, but I am mostly content reading analysis by others.

I am only making this post because with BRK trading at where it is now, it doesn't take a whole lot of deep analysis to realize it's a darn good bargain

To make a long story short, BRK is now trading at very close to book value per share.  As of the end of the June 2011 quarter, BRK had total shareholders equity of $163 billion.  Shares outstanding is 1.65 billion shares, so total book value per share is $98,790/share based on the A-shares.  Book value per share would be $65.85/b-share (1,500 class b shares per class a share).

BRK-A (a-shares) is now trading at around $105,000 per share (or a slight 6.3% premium to the BPS), and BRK-B is trading at $70/share.

OK, OK, but stock prices have gone down since the end of June.  At June end, the S&P 500 index was at 1,321 but is now at 1,218, a decline of around -7.8%.  BRK had $66 billion in stock holdings (marked-to-market on the balance sheet every quarter net of taxes owed) as of the end of June.  So if the stocks fell as much as the S&P did, that would be a $5 billion decline in the net worth of BRK, or around 3%.

Subtract that from the net worth calculations above and that still leaves the stock trading at a premium of less than 10%!

Why should we care if BRK is trading at book value?

For one, I think BRK has traded at a price-to-book-value ratio of around 1.7x over the past ten years, so this is a very rare thing.  If BRK traded merely back at what it used to trade at versus book, that alone would give you a 70% return on owning this stock.

But there are reasons, of course, that it may not get back to 1.7x book.  I don't want to get into the details of accounting or anything, but there is an impact from BRK's purchase of Burlington Northern, for example.

But more important may be the age of Warren Buffett.  He is an old guy; he just turned 81.  The past performance of BRK is largely thanks to the genius of Buffett.  Can this be repeated over the next 50 years?  Highly unlikely.

Another reason is that BRK is an insurance company, although they are in many other businesses.  Insurance companies and financials are very, very out of favor right now.  Insurance and reinurance has been in a soft market for a long, long time so it has been difficult to make money in the insurance business even though BRK has been successful even in this soft market.  That's another long story that I will leave out of this post.  But trust me when I say that BRK's insurance business is very different than other listed insurance and reinsurance companies.

Also, BRK is known to hold some financial stocks.  He is a large holder of Wells Fargo, American Express, recently purchased a stake in Bank of America, bought preferred shares in General Electric and Goldman Sachs during the crisis etc...

So many people view BRK as a financial company, vulnerable to the same macro factors as any other bank or insurance company.

So it is not completely surprising that Mr. Market will bundle BRK with the other financials and throw it in the dumpster.

But let's get back to book value.  First of all, Buffett has said many times over the years that book value per share is a very good indicator of intrinsic value.  Changes in the book value per share of BRK reflects well the direction and magnitude of the change in the intrinsic value of the company. 

What's the difference between book value and intrinsic value?  I don't want to get into it too much right now, but let's just say that book value is an accounting measurement that has many inaccuracies and problems, and the concept of intrinsic value is a look at the true value of what a business is worth regardless of accounting rules and conventions.  The purpose of having the concept of intrinsic value is to eliminate or reduce the inaccuracies of accounting book value.

Anyway, the key here is that although Buffett says repeatedly that book value per share is a good indication of how BRK is doing, he says that every year, the gap between intrinsic value and book value continues to grow, and that this gap is pretty substantial.

That means if you buy BRK at book value, or close to it, then you are getting a huge bargain according to Buffett's own view.  And again, Buffett is no self-promoter type.  He is as straight a shooter as you will find in the free world.   If he says BRK is worth far more than stated book value, you can take that to the bank.

Does that mean BRK is worth 1.6 to 1.7x book value?  I have no idea, actually.  But if you are buying cheap, you don't have to worry too much about that.  Maybe 1.5x book is a reasonable estimate.  Who knows.

And that isn't even that important when book value is going to grow.  BRK has grown book value per share by 20.2% from 1965 through 2010.  That's 20.2%/year for 45 years, compared to +9.4%/year including dividends for the S&P 500 index. 

OK, but this may be misleading because Buffett will not be around for the next 45 years.

But Buffett has said that he has no desire to retire.  He may be with BRK for many more years to come.  He has stated at the annual meeting that he is confident that BRK can grow book value at a pace that exceeds the S&P 500 index by several percentage points.  This really puts to rest the notion that BRK is simply too big to outperform anymore.

Again, Buffett is no self-promoting, over-promising type.  He truly feels that he can outdo the S&P 500 index by several points per year.  And he and the board is putting a lot of energy into succession to make sure that BRK will be managed well going forward.

Let's go back to the growth of book value.  People have been saying that Buffett is too old, or BRK is just too big to outperform since the 1990s. 

Many argued even in 1999/2000 that the stock market is way overvalued and that the market will crash and that there is no way Buffett is going to make money in the next decade. 

Well, let's take a look at what happened.  First of all, the bears were right.  The market did have a bear market and the S&P 500 went down 50% and the NASDAQ index did even worse declining a whopping, Nikkei-like 80%!  And then we had the worst financial crisis since the Great Depression.

Let's look at the growth of book value per share over the past five and ten years (through the end of December 2010, which includes these 100-year flood-type events).

                                                     BRK                     S&P 500 index (w/dividends)
5 year annualize return:               +10.0%                 +2.3%
10 year annualized return:           +  9.0%                 +1.4%

Notice how BRK has outperformed the S&P 500 index by 7.7% per year in the past five, horrible years and 7.6% per year in the past ten nightmare years.

Also, I should note that this period also includes some of the largest insurance/reinsurance catastrophes in history, from 9/11 to Katrina to this year's earthquake in Japan.

BRK was able to grow book value at 9-10% per year during a time that the market was flat, and had 9/11, the worst financial crisis, internet bubble/collapse/bear market, wars in Iraq and Afghanistan etc...  This sort of argues against the view that Buffett is simply a bull market genius.  He is able to make money in non-bull markets too.

How many mutual funds can we name that has done this well?  None.  And the other interesting point is that Buffett works for a small salary and does not take 'fees' out, like 1% or 2% that equity funds like to take.  Also, he doesn't take 20% of the profits as hedge funds typically do.  You get this wonderful outperformance at a very, very low cost.

The other thing to point out about the long term returns is that the BRK change in book value is actually after taxes; change in book value is net of all taxes including markups of equities owned, which is marked to market net of taxes payable on the unrealized profits.  The S&P 500 returns, however, are gross return figures and do not reflect taxes at all.

And you get all of this right now at something close to flat book value.

Any premium to book value that BRK might be worth is simply icing on the cake.  If BRK continues to grow it's book value per share, and the market valuation returns to a more normal level above book value, that is just a nice wind at your back to help your return.

If you are wondering about the long term future of BRK, Buffett has said many times that this is a primary preoccupation of his.  Most of his and his family's net worth is invested in BRK, as are many of his close friends and their families.  When he thinks about the future of BRK, he thinks about those people that depend on his decisions for their well-being.  He is not a hired gun CEO out to make a ton of money for himself and then just exercise their stock options and say good-bye (and leave others to clean up the mess).  

He is determined to see that BRK is in good hands after his passing.  Also, it is important to remember that BRK is a big collection of some outstanding businesses.  It is not a mutual fund or hedge fund where the investment manager has to stay on top of the portfolio every day and make adjustments.  Much of BRK operates very well without Buffett's supervision. 

Having said that, it is silly to think that BRK stock won't go down if Buffett gets hit by a truck.  But at this price level, you are not paying a Buffett premium at all so the downside would probably be very limited.

Anyway, I tell anyone I run into who is interested in investing to read all of Berkshire Hathaway's annual reports that are posted for free at the BRK website (all annual reports going back to 1979 is posted there).  The contents of all those "letter to shareholders" is better than any book you can buy on investing or business, by far.  And it's all free! 

But I do know that even if I say that, only the hard core investors are going to actually do it.  Most will just shrug and say, oh, and never even go to the website. 

That's why I will post BRK's long term returns that is on page one of the annual report every year at the bottom of this post.  Look at it carefully and see how well Buffett has done over the years. It is absolutely, mindbogglingly amazing.

As usual, these are just my thoughts on this stock and is not necessarily a stock recommendation.  I would hate it if someone bought a stock I mentioned and lost money on it.  Whenever you read about an investment idea on the internet, you should do your own work, try to understand it and then if you like it, only then buy it.  There is nothing worse in the investing world than to just do what you read on the internet!

The figures below are:

BRK:                   percentage change in book value per share
SP 500 w/div:     Total return of S&P 500 index including dividends
difference:           difference between the two (BRK return - S&P 500 return)

The averages for the whole period for these columns are:
BRK:                    +20.2%
SP 500 w/div:       + 9.4%
difference:             +10.8%

BRK SP 500 w/dvd difference
1965 23.80% 10.00% 13.80%
1966 20.30% -11.70% 32.00%
1967 11.00% 30.90% -19.90%
1968 19.00% 11.00% 8.00%
1969 16.20% -8.40% 24.60%
1970 12.00% 3.90% 8.10%
1971 16.40% 14.60% 1.80%
1972 21.70% 18.90% 2.80%
1973 4.70% -14.80% 19.50%
1974 5.50% -26.40% 31.90%
1975 21.90% 37.20% -15.30%
1976 59.30% 23.60% 35.70%
1977 31.90% -7.40% 39.30%
1978 24.00% 6.40% 17.60%
1979 35.70% 18.20% 17.50%
1980 19.30% 32.30% -13.00%
1981 31.40% -5.00% 36.40%
1982 40.00% 21.40% 18.60%
1983 32.30% 22.40% 9.90%
1984 13.60% 6.10% 7.50%
1985 48.20% 31.60% 16.60%
1986 26.10% 18.60% 7.50%
1987 19.50% 5.10% 14.40%
1988 20.10% 16.60% 3.50%
1989 44.40% 31.70% 12.70%
1990 7.40% -3.10% 10.50%
1991 39.60% 30.50% 9.10%
1992 20.30% 7.60% 12.70%
1993 14.30% 10.10% 4.20%
1994 13.90% 1.30% 12.60%
1995 43.10% 37.60% 5.50%
1996 31.80% 23.00% 8.80%
1997 34.10% 33.40% 0.70%
1998 48.30% 28.60% 19.70%
1999 0.50% 21.00% -20.50%
2000 6.50% -9.10% 15.60%
2001 -6.20% -11.90% 5.70%
2002 10.00% -22.10% 32.10%
2003 21.00% 28.70% -7.70%
2004 10.50% 10.90% -0.40%
2005 6.40% 4.90% 1.50%
2006 18.40% 15.80% 2.60%
2007 11.00% 5.50% 5.50%
2008 -9.60% -37.00% 27.40%
2009 19.80% 26.50% -6.70%
2010 13.00% 15.10% -2.10%

1 comment:

  1. Berkshire Hathaway stock is over priced. Need to wait for its dip one day when the "People Risk" does happen.