Warren Buffett explains why book value is no longer relevant


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For decades, value investors have used book value per share as a tool to assess the value potential of a stock.

This approach started with Benjamin Graham. Widely regarded as the father of value investing, Graham taught his students that all stocks trading below book value were attractive investments because companies offered a wide margin of safety and a low level of profitability. risk. To this day, many value investors rely on book value as a shorthand for calculating value.

Buffett on book value

Perhaps Graham’s best-known student is Warren Buffett (Trades, Portfolio). For years, Buffett has used book value, among other measures, to assess a company’s equity. He also used book value growth as a yardstick to calculate the value creation of Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B).

However, as early as 2000, the Oracle of Omaha began to move away from book value. He explained why at the 2000 annual meeting of Berkshire shareholders. Responding to a shareholder who asked him what he thought about using book value to track changes in intrinsic value, Buffett replied:

“The best companies, the really wonderful companies, don’t need any book value. They – and we are – we really want to buy companies that will make more and more money and don’t need to keep. money is what builds book value over time …

In our case, when we started with Berkshire, intrinsic value was less than book value. Our company had no book value at the start of 1965. You couldn’t have sold the assets at the price they were on the books, you couldn’t have – no one could do a math, in terms of future cash flows that would indicate that these assets were worth their book value. However, it is true that our companies are worth much more than their book value. And it happened gradually over time. So obviously there were a number of years where our intrinsic value exceeded our book value to get to where we are today …

Whether it’s the Washington Post, Coca-Cola or Gillette. This is a factor that we ignore. We take a look at what a business can earn on invested assets and what it can earn on additional invested assets. But the book value, we don’t think about it. “

It’s no secret that value as an investment style has underperformed growth over the past decade. There is no obvious explanation as to why this is the case, but one explanation could be that the definition of value is outdated. Buffett’s comments at the 2000 annual meeting appear to support this conclusion.

This is no longer a good measure

Book value was a great indicator of value when companies relied on large assets to generate profit. As the economy has shifted away from asset-intensive firms to more knowledge-intensive firms, book value has become increasingly irrelevant.

Also, as Buffett explained in 2000, book value does not necessarily represent intrinsic value. Just because a stock trades below its book value doesn’t necessarily mean it’s worth that book value.

The same goes for companies that negotiate with a premium on booking. The intrinsic value of this business could be significantly higher than the book value because the book value does not generally reflect intangible assets.

Investing is an art, not a science, and valuing companies is not a straightforward process. Investors cannot rely on a simple measure or a shortcut to assess value. There are many factors that contribute to intrinsic value and the growth of intrinsic value, and using book value as a proxy for intrinsic value is an outdated method. Even in Graham’s day, it wasn’t always right.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.

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