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Published: August 18,
2009
It happens every quarter, and it's beginning to
grate on me.
While every other company is gauged by earnings, Warren
Buffett's Berkshire Hathaway (NYSE: BRK-A) is measured by a
different standard than the rest of the financial world.
Not only does Buffett use a different yardstick, but the Oracle
of Omaha uses one that few investors really understand. And
while Buffett's numbers are accurate, they don't tell the story
that most people think they are telling.
Buffett's measure is called "book value."
Most investors see the headlines about Berkshire and read the
stories about Buffett -- "Berkshire Hathaway Book Value Rises"
-- as if they were holy writ. Most people, even sophisticated
Wall Street types, never question them.
They should.
It's time to decode Buffett. It's time to look at the numbers
and gauge his company's performance outright, the same way that
every other company is judged. The fact is, Buffett has been
setting the rules and playing his own game for far too long.
It's time to see how Berkshire really stacks up.
To do that, it's crucial to understand book value.
Making Sense of Book Value
Companies typically measure their performance by their stock
prices or their income statements. Buffett, however, uses the
balance sheet. In fact, he has opened every shareholder letter
in recent memory (since the mid-1980s) with the same line that
describes Berkshire's change in net worth. Net worth for a
company is the same as it is for you or me: It's just the
difference between assets and liabilities.
Analysts divide the shareholder equity number by the number of
shares outstanding. This is called per-share book value. In
theory, if you sold all of a company's assets and paid all of
its debt, each stockholder would get a check for the company's
book value.
Here's Buffett's opening line from the 2008 shareholders letter:
"Our decrease in net worth during 2008 was $11.5 billion, which
reduced the per-share book value of both our Class A and Class B
stock by 9.6%. Over the last 44 years (that is, since present
management took over) book value has grown from $19 to $70,530,
a rate of 20.3% compounded annually."
Now, that's all very straightforward, right?
Sure. But there's no mention of earnings. There's no mention of
stock price. All Buffett says is that book value/net worth
decreased. It was the worst year in Buffett's 44-year tenure as
chairman, which, to be fair, he does concede in the next
paragraph.
But here's the thing: While book value decreased by -9.6%,
Berkshire's share price actually fell -31.8%. Want to follow
Berkshire: Here's a tip that no one else will tell you: Buffett
never compares Berkshire's stock price to the S&P. He compares
Berkshire's gain in net worth to the total return of the S&P. He
says book value fell -9.6%. True. He says the S&P returned
-37.1%. Also true. But does the comparison hold water? I'm not
sure.
This chart shows the real results for the past 32 years:
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What the Numbers Mean
* Consider 1990. Book value rose +7.4%. But Berkshire lost
-23.1%, more than seven times worse than the S&P.
* In 1996, it was a similar story. Book value rose +31.8%, far
and away more than that S&P's robust +23.0% rise. But
Berkshire’s stock price only gained +6.2%.
* Berkshire's gain in book value in 2004 was +10.5%, close to
the S&P's total return of +10.9%. But, once again, the stock
price lagged, gaining only +4.1%.
Now, I'm not implying that Berkshire Hathaway hasn't been a
great investment. It has been. And in many cases, as the chart
shows, Buffett's methodology greatly understates Berkshire's
actual performance. The point is simply to clarify what is being
presented.
The next question, of course, is what it all means. Is growth in
book value the end-all-be-all? I looked at the members of the
Dow Jones Industrial Average for their just-reported second
quarter and calculated their growth in book value. Four matched
or beat Buffett's +11.4% gain and one came close:
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None of these companies had headlines in Barron's citing
their growth in book value. Berkshire, however, did.
Having been convinced that it was possible to beat Buffett
during a quarter, I decided to look at the longer view. I
calculated the total change in book value for the past 10 years.
13 companies -- nearly half the Dow -- beat Buffett, whose total
gain in book value during that time was +89.2% or an annualized
+6.6%. The winner was J.P. Morgan (NYSE: JPM), which saw its
book value surge +606.6%, followed by Pfizer’s +547.6% (NYSE: PFE), Procter & Gamble’s +476.3% (NYSE: PG) and Chevron’s
+388.2% (NYSE: CVX).
But let's end with the point I've been trying to make: Book
value doesn't matter as much as stock price. Berkshire gained
+38% from 1999 to the end of 2008. Here's who beat Buffett by
Buffett's measure -- and by the rest of Wall Street's -- with
their stock prices:
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Red Auerbach once said, if you keep score, win. Winston
Churchill said history would be kind to him, for he intended to
write it. Buffett seems to have learned both lessons.
-- Andy Obermueller
Editor
Government-Driven Investing |
