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.”
More on AAII.com
- Insights on Warren Buffett From His Friend and Editor – Retired Fortune editor Carol Loomis has edited Buffett’s shareholder letters for many years. In this 2013 AAII Journal interview, she shared her insights about the letters and Buffett’s approach to investing.
- Selecting a Valuation Method to Determine a Stock’s Worth – Robert Johnson, who chairs the aforementioned value investing seminar, provided useful insights on deciding which valuation metrics to focus on.
Highlights from this month’s AAII Journal
- To Beat the Market, Invest Differently Than the Market – Jim O’Shaughnessy shares the lessons he’s learned over the course of his 30-year career, including the importance of not mimicking the market.
- Revisiting the “What Works on Wall Street” Screen – AAII President John Bajkowski revisits a composite O’Shaughnessy screening strategy discussed in 2013 and lists the latest stocks to meet its criteria.
AAII Sentiment Survey
Pessimism about the short-term direction of stocks among individual investors fell to its lowest level in more than a year and is now at an unusually low level. Plus, this week’s special question asked AAII members for their opinion about the yield stocks currently trade at. More about this week’s results.
This week’s results:
- Bullish: 41.6%, up 2.3 points
- Neutral: 38.4%, up 3.1 points
- Bearish: 20%, down 5.4 points
- Bullish: 38.5%
- Neutral: 31.0%
- Bearish: 30.5%
Take the Sentiment Survey.
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The Week Ahead
Retailers will be prominent on next week’s earnings calendar, including Target Corp. (TGT) on Tuesday and Costco Wholesale Corp. (COST) on Thursday. Joining Target and Costco in reporting earnings will be eight other members of the S&P 500.
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.
Two Federal Reserve officials will make public appearances: Boston president Eric Rosengren on Tuesday and Cleveland president Loretta Mester on Wednesday.
Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!