Is Berkshire a Buy at the Current Price to Book Value?

“The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another.” —Warren Buffett, Letter to Shareholders, 2011

Mr. Market’s Current View of Berkshire Hathaway

With Berkshire’s stock (NYSE: BRK.B) cnow trading at $ 129,61 down about 14% so far in 2015, it’s trading at a price to book value multiple of 1,29, not too far above the price limit of 120% of price to book value that’s used as a reference point by Warren and Charlie for when share repurchases are deemed to be favorable for continuing shareholders.

The table below shows Berkshire’s book value per B-share and price data going back ten years.

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To get a better idea of Warren’s thinking when it comes to buying back Berkshire stock, let’s turn to his letter to shareholders in 2011 and 2012, where he shares his view on this subject, i.e. share repurchases (emphasis added).

The Original Buyback Limit – 110%

In 2011 Berkshire announced that they would buy back its own shares if price falls below 110 percent of book value. In his Letter to Shareholder in 2011 Warren shared his thought on share repurchases and the established limit price.

“We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.”

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Share Repurchases

Last September, we announced that Berkshire would repurchase its shares at a price of up to 110% of book value. We were in the market for only a few days – buying $67 million of stock – before the price advanced beyond our limit. Nonetheless, the general importance of share repurchases suggests I should focus for a bit on the subject.

Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions – even serious ones – are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.)

Charlie and I have mixed emotions when Berkshire shares sell well below intrinsic value. We like making money for continuing shareholders, and there is no surer way to do that than by buying an asset – our own stock – that we know to be worth at least x for less than that – for .9x, .8x or even lower. (As one of our directors says, it’s like shooting fish in a barrel, after the barrel has been drained and the fish have quit flopping.) Nevertheless, we don’t enjoy cashing out partners at a discount, even though our doing so may give the selling shareholders a slightly higher price than they would receive if our bid was absent. When we are buying, therefore, we want those exiting partners to be fully informed about the value of the assets they are selling.

At our limit price of 110% of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower. You should know, however, that we have no interest in supporting the stock and that our bids will fade in particularly weak markets. Nor will we buy shares if our cash-equivalent holdings are below $20 billion. At Berkshire, financial strength that is unquestionable takes precedence over all else.

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This discussion of repurchases offers me the chance to address the irrational reaction of many investors to changes in stock prices. When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: “Talking our book” about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume.” (Source: Letter to Shareholders, 2011)

A Revised Buyback Limit – 120%

In his Letter to Shareholders in 2012 Warren again discussed the issue of share repurchases in light of Berkshire’s decision to increase the buyback limit to 120% of book value per share.

“One thing of which you can be certain: Whatever Berkshire’s results, my partner Charlie Munger, the company’s Vice Chairman, and I will not change yardsticks. It’s our job to increase intrinsic business value – for which we use book value as a significantly understated proxy – at a faster rate than the market gains of the S&P. If we do so, Berkshire’s share price, though unpredictable from year to year, will itself outpace the S&P over time. If we fail, however, our management will bring no value to our investors, who themselves can earn S&P returns by buying a low-cost index fund. 

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The third use of funds – repurchases – is sensible for a company when its shares sell at a meaningful discount to conservatively calculated intrinsic value. Indeed, disciplined repurchases are the surest way to use funds intelligently: It’s hard to go wrong when you’re buying dollar bills for 80¢ or less. We explained our criteria for repurchases in last year’s report and, if the opportunity presents itself, we will buy large quantities of our stock. We originally said we would not pay more than 110% of book value, but that proved unrealistic. Therefore, we increased the limit to 120% in December when a large block became available at about 116% of book value.

But never forget: In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value. The directors and I believe that continuing shareholders are benefitted in a meaningful way by purchases up to our 120% limit.” (Source: Letter to Shareholders, 2012)

Conclusion

I will leave the question about whether or nor Berkshire is a buy at the current price unanswered, because this is a decision that you have to make on your own. But, I think Berkshire’s stock price at the moment makes this a relevant question to ask: Is Berkshire a Buy at the Current Price to Book Value?

Further Reading

Bloomberg Business: Buffett Expands Buyback to Pay Up to 120% of Book Value (December 12, 2012) 

Bloomberg Business: Berkshire to Buy Back Shares as Cash Exceeds $40 Billion (September 26, 2011)

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Disclosure: I have no positions in any stocks mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments. 

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Berkshire Hathaway Value Update, Year-End 2014

“As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). In our 2010 annual report, however, we laid out the three elements – one of them qualitative – that we believe are the keys to a sensible estimate of Berkshire’s intrinsic value. That discussion is reproduced in full on pages 123-124.

Here is an update of the two quantitative factors: In 2014 our per-share investments increased 8.4% to $140,123, and our earnings from businesses other than insurance and investments increased 19% to $10,847 per share.”

—Berkshire Hathaway, Annual Report 2014, p. 7

Intrinsic Business Value Update

Last weekend I read the 2014 annual report from Berkshire Hathaway. As usual I enjoyed it, and even more so this year due to the extra writings from both Warren and Charlie.

Buffett himself summed up Berkshire’s 2014 in a good way in the beginning of the shareholder letter, when he said that “It was a good year for Berkshire on all major fronts, except one.” The exception was attributable to BNSF that according to Buffett “…disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.”

The table below shows some key financial data for the prior ten-year period, including an estimate of intrinsic business value (by using the so-called “two-bucket approach”).

By using this two-bucket approach and applying a pre-tax earnings per share multiple of 10 times, results in a intrinsic business value per A share of $248,593 (or $166 per B share) at the end of 2014, and increase of 12.8% year-over-year. Book value per share increased 8.3%, from $134,973 to $146,186. The biggest change was in the price per share, increasing 27.0% year-over-year, from $177,900 to $226,000.

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The 10-year average intrinsic business value (IBV) to book value (BV) was 1.65. Price to book value and price to intrinsic business value averaged 1.38 and 0.84 respectively.

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At the moment (March 6, 2015) the A share is trading at $218,986 (or $146 per B share), giving a margin of safety of 12%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Berkshire Hathaway: Intrinsic Value (Part 1)

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Intrinsic value of Berkshire Hathaway – Today and Tomorrow

I thought I would take a look at Berkshire Hathaway and its intrinsic value to be able to compare it to the current stock price to see if there is any difference between them. The analysis of Berkshire’s intrinsic value will be divided into the following three parts:

  • Book value per share
  • Adjusted book value per share
  • Two-bucket approach

Book value per share

Warren has many times emphasized the change in book value as a proxy for the change in intrinsic value. For example, in his letter to shareholders in 2012 Warren wrote that “It’s our job to increase intrinsic business value – for which we use book value as a significantly understated proxy – at a faster rate than the market gains of the S&P.”

So, if this holds true, i.e., that book value is a significantly understated proxy of intrinsic business value, we can look to the change in book value to try to get a sense of the possible change in intrinsic value. From Berkshire Hathaway’s officially published annual reports – you find them here – book value per share in the last 10 years has been as follows in the table below. Percentage shows the change in book value per share from year to year.

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Book value per share in 2003 was $50 498 compared to $134 973 at year-end 2013, a gain of 167.3% or a 10-year compounded annual growth rate of 10.3%.

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Book value per share can be seen as another measure for a conservative estimate of intrinsic value. Remember this, and the words “a conservative one.” In the shareholder letter from 2012 Warren wrote that “The value of our float is one reason – a huge reason – why we believe Berkshire’s intrinsic business value substantially exceeds its book value.”

Book value per share at the end of the first quarter 2014 was $138,426.

This seems like a conservative measure, considering the fact that Warren is willing to buy back stock at prices of 120% of book value. Calculated from the $138,426 at the end of the first quarter 2014 120% gives a target buy back price level per share of $166,111.2.

Current stock price

Right now Berkshire, according to Google Finance, is trading at a price per share of $189,724.

Currently the Berkshire stock trades at a price to book multiple of 1.37, i.e., the stock price exceeds book value per share with 37% at the moment.

Compared to the 120% above book value where Warren is ready to buy back Berkshire stock, the current stock price is exceeding this target level with 14.2%.

Looking at the downside the current stock price would have to drop with 12.4% before Warren steps in and starts to buy back Berkshire stocks. In other words, there seems to be a pretty good downside protection at the moment.

Having looked at the book value per share and the downside scenario, in the next post I will take a look at an adjusted book value per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.