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Berkshire Hathaway: Book Value Growth Still Shines


John Engle

Warren Buffett may have been too quick to abandon one of his favorite metrics of intrinsic value

Warren Buffett (Trades, Portfolio) has been at the forefront of the investing world for decades. His consistent success at the helm of Berkshire Hathaway (BRK.A)(BRK.B) has made him a living legend to aspiring and seasoned investors alike.

As Berkshire has struggled to keep pace with the wider stock market in recent years, some commentators have begun to ask whether Buffett has lost some of his Midas touch. However, while Berkshire’s share price growth may not look all that impressive, other performance metrics, such as the growth of its book value, tell another story.

At first glance, it may seem strange for me to cite book value, a metric Buffett has himself said is no longer useful for measuring Berkshire’s value. Yet for all of Buffett’s recent negativity toward book value as an indicator of future returns for a stock, it remains a key measure of corporate value – and one that may even help convince skeptical investors of Berkshire’s continued relevance.

Buffett’s love-hate relationship with book value

According to one of Buffett’s most frequently quoted aphorisms, “Price is what you pay, value is what you get.” But what is value? Buffett long maintained that one of the best measures of a company’s real, intrinsic value is its book value, a position he reaffirmed in his 2017 letter to shareholders:

“We give you Berkshire’s book-value figures, because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire’s intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value.”

Buffett’s tune changed soon after thanks to the introduction of a new standard in the Generally Accepted Accounting Principles (GAAP) governing corporate financial reporting in 2018. In essence, the new rule required companies to include the unrealized gains and losses from their investment portfolios in their earnings. As a company with a vast portfolio of public market investments, the rule has had an outsized impact on Berkshire’s earnings, as well as its apparent book value.

In his 2019 shareholder letter, Buffett bemoaned this development on two counts. First, he noted that Berkshire’s operating companies’ book values could no longer reflect their full value. Second, Buffett contended that, under the new GAAP rule, stock repurchases will have a distorting effect on per-share book value:

“The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down.”

Consequently, Buffett declared that Berkshire would no longer report book value growth as it had previously, calling it “a metric that has lost the relevance it once had.”

Rumor of book value’s death are much exaggerated

Buffett’s seeming abandonment of book value perplexed many investors, even some who were not so dedicated to the metric. One such investor, Marc Gerstein, offered a stirring defense of book value just a few months after Buffett abjured it:

“Whether it’s a dividend stock, a patent, a Treasury note, a copyright, a piece of real estate, whatever…somehow or other the value will have to be pegged (however imprecisely that my be given that we’re all imperfect humans dealing with the unknown future) to the present value of expected future cash flows. Book value is a very conservative approach to this. It takes into account cash flows received in the past, if any, from intangibles — profits that are not paid out as dividends accumulate in an accounting entry known as ‘retained earnings’ which is a part of the ‘common equity’ section of the balance sheet, and in popular parlance, especially when discussed on a per-share basis, common equity is referred to as…you guessed it, book value. So book value for a company does not ignore intangibles.”

For all its vehemence and finality, Buffett’s rejection of book value as a useful metric for valuing Berkshire’s business seems too absolute, in my opinion. From a performance perspective, it certainly seems to undersell Berkshire’s strengths, especially in light of its recent struggles to keep pace with the S&P 500 index. As investor and analyst Christopher Bloomstran discussed on Feb. 15, on the basis of book value per share, or BVPS, Berkshire has continued to shine:

“[BRK] traded as high as 3x book in the late 90’s, rewarded for compounding book at 25% a year for three decades. Trades for 125% of BV today, so a 60% decline, yet BVPS compounded way faster than the S&P…When the stock was expensive Buffett used it as currency to buy companies. In 2020? Repurchased shares meaningfully @ 105% of BV. Growth in BVPS killed the S&P 500 by more than 3%/yr from the late 90’s, between 10-14% versus 7-10% for the index depending on the beginning year.”

My verdict

Berkshire’s continued outperformance from the perspective of book value is a testament to Buffett’s ability to build a compounding machine, one that can continue to grow profitably despite the ever vaster scale and scope of its businesses.

Ultimately, while Berkshire’s growth trajectory has certainly slowed a bit as it has aged, in my opinion that very fact may belie its true value to investors.

Disclosure: No positions.

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About the author:

John Engle

John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor’s degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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