Why Berkshire Hathaway is worth more than its book value
Book value is a measure of a company’s equity, so it may be surprising that Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) trades for a premium of around 50% over its book value. However, if you understand what book value is and its shortcomings, this discrepancy makes perfect sense. With that in mind, here’s the reason Berkshire is worth more than its book value would lead you to believe.
What is book value?
Also known as a company’s equity, book value can be easily calculated from a company’s balance sheet. Book value is the total value of the company’s assets less its unpaid debts. Dividing the book value by the number of shares outstanding yields the book value per share, which investors often use to compare with the company’s stock price, known as the price-to-book ratio. .
Theoretically, book value is the amount of money a business would have left if it closed its doors, sold all of its assets, and paid off all of its debts. Admittedly, book value is not perfect – some of the items on a balance sheet do not perfectly reflect the value of assets, such as depreciation allowances. And many intangible elements are difficult, if not impossible, to assess with precision.
It’s not uncommon for companies to be worth more than book value
Book value is a commonly used measure in value-driven investing because it tends to give a benchmark of what a business is “worth”. For example, if you can buy a company’s stock for 80% of its book value, it can be a smart value game.
However, a company’s profitability and future potential is also factored into the share price, so it is not uncommon for shares to trade at a price significantly higher than book value. Wells fargo, for example, has always been one of the most efficient and profitable banks, so it is trading at 1.46 times its book value at the time of writing.
In addition, the carrying amount does not accurately reflect certain types of intangible assets, such as intellectual property. Therefore, companies that rely heavily on intellectual property to make products often trade for several times the book value and can still be good investments. I consider Apple to be an extremely cheap stock by most valuation methods, but the company is trading at around 6.3 times its book value, precisely because of the flaws in the method of calculating book value.
Berkshire’s book value and why the company is worth more
At the end of 2016, the book value per share of Berkshire (Class A shares) was $ 172,108, while the stock is trading at $ 265,800 as of this writing, a premium of around 54%. The simple explanation is that the difference is a result of Berkshire’s business model which focuses on acquiring entire companies.
Here is the (slightly) longer version. Until the 1990s, Berkshire’s book value and stock price were roughly the same. Indeed, Berkshire’s main objective was to invest in marketable securities (stocks), which are regularly revalued when included in the book value of the company.
On the other hand, the accounting rules for owned companies are very different. As CEO Warren Buffett explained in his last letter to shareholders, âAccounting for the companies we own requires that the book value of ‘losers’ be noted when their failures become apparent. never revalued upwards. “
In other words, Berkshire’s book value is affected whenever it finds out that it has overpaid for a business. However, when it becomes apparent that Berkshire has underpaid for a business, its book value is not adjusted upward. Over time, this has produced a significant spread between the company’s stock price and book value.
It’s also worth mentioning that Berkshire’s book value and its share price do not always move in the same direction or to a similar magnitude. For example, in 2016, Berkshire’s book value rose 10.7% while its stock price rose by more than double that rate. Conversely, Berkshire’s book value rose 6.4% in 2015, but its stock price actually fell 12.5%.
Over time, Berkshire’s stock price has risen faster than its book value, which makes sense, given the explanation of why Berkshire is worth more than book value. Over the 52-year period from 1965 to the end of 2016, Berkshire’s book value grew at an annualized rate of 19%, while its stock price rose at an even more impressive rate of 20.8%. .
This article represents the opinion of the author, who may disagree with the âofficialâ recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.