Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Ahead of the Berkshire Hathaway annual meeting in early May, I'm here today with Matt Coffina--he is editor of Morningstar StockInvestor--to look at 2013's results for Berkshire and also if there are any nuggets of wisdom in [chairman Warren] Buffett's letter this year.
Matt, thanks for joining me.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: Berkshire reported full-year 2013 results a few weeks back. Can you walk us through those, was there anything surprising? How is Berkshire doing right now?
Coffina: Berkshire was really firing on all cylinders last year. Operating earnings per share were up about 20%. They have some net investment gains, derivative gains, and perhaps most importantly, book value per share was up about 18%. This is really the metric that Buffett likes to point to as the key indicator of Berkshire's intrinsic value over time. Berkshire's actual intrinsic value is almost certainly meaningfully higher than book value per share, but still, as an objective measure of how that intrinsic value is changing from year to year, this is a pretty good metric to watch. So, up 18% again on book value per share.
Glaser: But that's much lower than the S&P's over-30% of return. Do you think that says that Berkshire is too big to grow faster than the market? What do you think that means for the company?
Coffina: Berkshire has always sort of underperformed the market in the up years, but then it more than makes up for that during the down years. There are a few reasons to expect this. For one, Berkshire's assets aren't all going to be mark-to-market every year like S&P 500 companies would be. So, not all of that gain, perhaps, and intrinsic value is going to be captured in book value per share in any given year. But also, Berkshire is just a very well-diversified, very, very large, slower-moving organization, and it can't really be expected to keep up with the S&P in a year that the S&P was up more than 32%.
I think the more relevant way to look at it would be over a longer-term time horizon, and in particular, encompassing a full market cycle. If you started in 2007, for example, before the financial crisis, then Berkshire is still beating the S&P.
Over the long run, I think Berkshire is capable going forward of probably in the neighborhood of 10% annual growth in book value per share, which should do better than the S&P over the long run given where we are in terms of current valuation levels. But the relative underperformance or outperformance will probably depend more on what the S&P does, especially in any given year, rather than what Berkshire does, which is going to be, I think, a more consistent over the long run, 10% total return.
Glaser: In many ways, the annual letter from Buffett that goes along with the annual results is even more closely watched by investors. Did you see anything in that letter that really stood out to you this year or any key themes investors should keep an eye on?
Coffina: There wasn't anything really new in the letter, as there usually isn't with Buffett. He is very consistent year to year, and that's one of the reasons we love him so much. One thing I'd point out is that Ted Weschler and Todd Combs continue to take over more and more responsibility for the investment portfolio, so they're now managing about $7 billion each, which really shows that Berkshire is on track for the eventual succession whenever Warren is no longer running the show.
Besides that, Warren shared an amusing anecdote about two investments he had made over the course of the years: one, some real estate near NYU in New York and also a farmland in Nebraska. And the moral of the story, just to give you the five-second version is: one, that you don't need to worry about the macro environment. When he bought both of these properties, there were severe recessions or property downturns going on in the respective regions. But really, just think of your ownership as owning a part of a real business, focus on the fundamentals of the business.
At the time, Buffett was earning about a 10% unleveraged return on this real estate and he knew that crops would still be growing in Nebraska 50 years from then; students would still be going to NYU. So, it's just focusing on the fundamentals and ignoring a lot of the macro noise, and also just ignoring the short-term noise of prices.
Buffett gave the example of, if his neighbor in the farmland in Nebraska were to shout out a price every day of what he wanted to buy the farm for, it really had no ability to impact the value of that farmland, and if the neighbor happened to shout out a very high price, then he could sure go ahead and sell it, and if he happened to shout out a ridiculously low price, then why not just ignore it. And the key being, again, the focus on the fundamentals and think of yourself as an owner of a real business, whether you're dealing with farmland or common stocks.
Glaser: Looking at Berkshire shares then, do they look attractive right now? You said the businesses were firing on all cylinders, so does that mean that it's a good time to get in?
Coffina: I think Berkshire remains very reasonably valued. Our fair value estimate is $143 per share, and the stock is meaningfully below that. And in the current market environment it's very hard to find undervalued opportunities. So, I think Berkshire remains relatively attractive.
One thing I would point out is that Berkshire's book value per share is at about $90 on the Class B share right now, and Buffett has said that he's willing to repurchase shares at up to 120% of book value, which would be about a $108 per Class B share, because that represents a meaningful discount to Berkshire's intrinsic value.
In anything but an extreme market downturn, I think it's pretty unlikely that Berkshire would trade below that $108 a share. If it did, Berkshire itself will start repurchasing a lot of shares. So that puts a psychological floor under the stock, not that far below where we are currently. And then given that our analyst thinks it's worth substantially more, more like a 160% of book value, I think that it's very likely that Berkshire will outperform the S&P over a long time horizon, call it 10-plus years into the future.
Glaser: Matt, thanks for your thought on Buffett and Berkshire today.
Coffina: Thanks for having me, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.
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