Warren Buffett Deemphasizes Book Value as a Key Metric


Warren Buffett made a notable change in his annual Berkshire Hathaway Inc. (BRK.B) shareholder letter: He deemphasized the change in the book value of the company’s shares. To those who are long-time readers of his letters—and I suggest reading Buffett’s letters for the investing insights he shares—the change marks a definitive shift. Starting in 1985, the very first paragraph of the letter discussed the change in book value. This year’s letter started by discussing the change in generally accepted accounting principles (GAAP) earnings.

Book value represents how much a company’s assets are worth after all debts and liabilities are accounted for on a given date. Earnings are the profits a company realizes over a specific period. Both are accounting figures. Herein lies why the decision not to mention book value is worthy of discussion.

Berkshire Hathaway both outright owns companies and invests in other companies. Accounting rules require the purchase prices of marketable securities—such as shares of American Express Co. (AXP) and Coca-Cola Co. (KO)—be valued at market prices, but not the operating companies Berkshire Hathaway owns—such as Geico, Burlington Northern Santa Fe Corp. (BNI), International Dairy Queen and NetJets. To the extent that Berkshire Hathaway’s operating companies remain profitable and increase in worth, the difference between what is reflected on the balance sheet and the price that a potential buyer would pay will grow. Here’s what Buffett wrote:

“The fact is that the annual change in Berkshire’s book value—which makes its farewell appearance on page 2—is a metric that has lost the relevance it once had. Three circumstances have made that so. First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie [Munger, vice chairman of Berkshire Hathaway] and I expect that reshaping to continue in an irregular manner. Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years. Third, it is likely that—over time—Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

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The week’s first economic reports will be the February motor vehicle sales and December construction spending, both of which will be released on Monday. Tuesday will feature December new home sales and the February Institute for Supply Management (ISM) non-manufacturing index. The February ADP employment report, December international trade and the Federal Reserve’s periodic Beige Book will be released on Wednesday. Thursday will feature fourth-quarter productivity and costs. February jobs data—including the changes in nonfarm payrolls and in the unemployment rate—will be released on Friday.

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