Warren Buffett on Book Value v


Intrinsic value and book value are two very different numbers. Book value is often used as a shorthand for estimating the value of a business, an approach that may work under certain circumstances but has lost much of its effectiveness as the stock market has evolved over the past decades.

In particular, asset-rich companies, such as steel producers, miners and railroads, are nothing without their assets. They make a basic product and may have limited intangibles, such as brand values ​​or unique technology. Therefore, book value could still be used as a shorthand to estimate the intrinsic value of these companies.

The disadvantages of book value

I use the word “might” in the paragraph above because book value is just a number, and it’s an incredibly blunt tool. Like all intrinsic value estimates, book value only gives one digit, a number based on numbers on a company’s balance sheet. It does not give any indication of asset management, asset quality or their realistic second-hand value. Many steel mills or mines have been reduced to negligible values ​​by one operator for another operator to take over and transform the outlook for the asset.

For example, in a recent deal, mining giant Glencore (LSE: GLEN, Financial) agreed to buy its outstanding stake in a coal mine for $ 294 million. He expects a return on his investment in two or three years. This suggests an IRR of 33.33% per year. The value of the asset was clearly worth much less to the sellers than to the buyer. This example illustrates why book values ​​can be completely irrelevant and why other intrinsic value estimates may reflect real value more, although this is still very subjective.

At Berkshire Hathaway 2013 (BRK.A, Financial) (BRK.B, financial) annual meeting of shareholders,

Warren Buffett (Trades, Portfolio) provided an example of why book value can be a very misleading number. He stated:

“I should point out, incidentally, that we use book value because it’s a calculable number, and it serves as a reasonable indicator of the year-over-year change in Berkshire’s intrinsic value.

If we could really give you a number for intrinsic value, and support it, that would be the big number. As I pointed out, if we earn a million policyholders at GEICO, it actually adds a billion and a half to intrinsic value, and it doesn’t add a dime to book value. So there is a big gap, which is why we’re willing to buy stocks at 120% of book value – a big gap between the two.

But book value is a useful tracking tool.

I also have to point out – I did this in the annual report for Marmon – when we buy ISCAR stock, which we pay around $ 2 billion for, on the day we buy it, we note it in terms of value. accountant of about a billion dollars. Thus, a billion dollars emerges from our book value for a purchase that we consider to be quite satisfactory. And so there are these distortions happening. “

This quote discusses the pros and cons of book value. Yes, this can be misleading and it happens time and again that it does not reflect the real value of the business. However, it can be a useful yardstick for measuring the value of a business.

Not clear

Like so many topics in the investment world, the topics of book value and intrinsic value are unclear. Both have their uses in business valuation, but neither will ever be 100% accurate. Indeed, since intrinsic value does not have a fixed calculation, it is probably the less reliable of the two. At least the book value has some basis in the bookkeeping. One can only guess at the intrinsic value of an intangible asset like a brand. On the other hand, its construction value can more easily define the value of a factory.

So overall, book value and intrinsic value both have their uses. It may be better not to rely on a single measure and instead use a combination to try to reduce the impact of any weaknesses in the estimates.


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