Book Value Oversimplifies Berkshire's Business
In Part 2 of a 5-part series, Morningstar's Gregg Warren and Drew Woodbury look at how book value can provide a rough guide to Berkshire's intrinsic value.
Ahead of Saturday's Berkshire Hathaway (BRK.A) (BRK.B) annual meeting, we're taking a closer look at the best way to value the complex company. We believe that understanding the benefits and shortfalls of different methodologies can provide valuable insight into the ways in which different investors are approaching the firm's overall valuation. Part 1 of the series, exploring some of the shortfalls of using an earnings-based multiple approach, is available here.
Book value serves as a reasonable proxy for intrinsic value but paints an oversimplified picture
While a book value multiple is undoubtedly an oversimplified picture of the relative price of a company, it is our preferred comparison metric for financials, and specifically for insurance companies. Furthermore, it tends to work well for holding companies such as Berkshire. While there are drawbacks to any simplified multiple based approach, financial companies mark most of their assets, and some of their liabilities, to prevailing market prices (or in cases where market prices are not available, to current best estimates), making book value a more meaningful metric. We'd also note that book value has been highlighted by Buffett as a useful tool for tracking changes in the company's intrinsic value, insomuch as changes in Berkshire's book value tend to track changes in the company's intrinsic value. In each of his annual letters to shareholders, Buffett starts with a chart that compares Berkshire's annual growth in book value per share with the annual appreciation of the S&P 500, allowing investors to assess the firm's relative performance. Additionally, Buffett's annual commentary about Berkshire's performance tends to begin from the lens of the firm's growth in book value.
Greggory Warren does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.