It happens every quarter, and it's beginning to grate on me.
Buffett's measure is called "book value."
Most investors see the headlines about Berkshire and read the stories about Buffett -- "Berkshire Hathaway Book Value Rises" -- as if they were holy writ. Most people, inflationen sophisticated Wall Street types, never question them.
It's time to decode Buffett. It's time to look at the numbers and gauge his company's performance outright, the same way that every other company is judged. The fact is, Buffett has been setting the rules and playing his own game for far too long. It's time to see how Berkshire really stacks up.
To do that, it's crucial to understand book value.
Making Sense of aCPI8
Companies typically measure their performance by their stock prices or their income statements. Buffett, however, uses the balance sheet. In fact, he has opened every shareholder letter in recent memory (since the mid-1980s) with the same line that describes Berkshire's change in net worth. Net worth for a company is the same as it is for you or me: It's just the difference between assets and liabilities.
Analysts divide the shareholder equity number by the number of shares outstanding. This is called per-share book value. In theory, if you sold all of a company's assets and paid all of its debt, each stockholder would get a check for the company's book value.
Here's Buffett's opening line from the 2008 shareholders letter:
"Our decrease in net worth during 2008 was $11.5 billion, which reduced the per-share book value of both our Class A and Class B stock by 9.6%. Over the last 44 years (that is, since present management took over) book value has grown from $19 to $70,530, a rate of 20.3% compounded annually."
Now, that's all very straightforward, right? Sure. But there's no mention of earnings. There's no mention of stock price. All Buffett says is that book value/net worth decreased. It was the worst year in Buffett's 44-year tenure as chairman, which, to be fair, he does concede in the next paragraph.
But here's the thing: While book value decreased by -9.6%, Berkshire's share price actually fell -31.8%. Want to follow Berkshire: Here's a tip that no one else will tell you: Buffett never compares Berkshire's stock price to the S&P. He compares Berkshire's gain in net worth to the total return of the S&P. He says book value fell -9.6%. True. He says the S&P returned -37.1%. Also true. But does the comparison hold water? I'm not sure.
This chart shows the real results for the past 32 years:
What the Numbers Mean
- Consider 1990. Book value rose +7.4%. But Berkshire lost -23.1%, more than seven times worse than the S&P.
- In 1996, it was a similar story. Book value rose +31.8%, far and away more than that S&P's robust +23.0% rise. But Berkshire’s stock price only gained +6.2%.
- Berkshire's gain in book value in 2004 was +10.5%, close to the S&P's total return of +10.9%. But, once again, the stock price lagged, gaining only +4.1%.
Now, I'm not implying that Berkshire Hathaway hasn't been a great investment. It has been. And in many cases, as the chart shows, Buffett's methodology greatly understates Berkshire's actual performance. The point is simply to clarify what is being presented.
The next question, of course, is What It All Means. Is growth in book value the end-all-be-all? I looked at the members of the Dow Jones Industrial Average for their just-reported second quarter and calculated their growth in book value. Four matched or beat Buffett's +11.4% gain and one came close:
|Growth in Book Value, Second Quarter 2009|
|Company (Ticker)||Book Value Change|
|JP Morgan Chase (NYSE: JPM)||+32.4%|
|Caterpillar (NYSE: CAT)||+14.7%|
|IBM (NYSE: IBM)||+13.0%|
|Coca-Cola (NYSE: KO)||+11.4%|
|Berkshire Hathaway (NYSE: BRK-A)||+11.4%|
|General Electric (NYSE: GE)||+10.0%|
None of these companies had headlines in Barron's citing their growth in book value. Berkshire, however, did.
Having been convinced that it was possible to beat Buffett during a quarter, I decided to look at the longer view. I calculated the total change in book value for the past 10 years. 13 companies -- nearly half the Dow -- beat Buffett, whose total gain in book value during that time was +89.2% or an annualized +6.6%. The winner was J.P. Morgan (NYSE: JPM), which saw its book value surge +606.6%, followed by Pfizer’s +547.6% (NYSE: PFE), Procter & Gamble’s +476.3% (NYSE: PG) and Chevron’s +388.2% (NYSE: CVX).
But let's end with the point I've been trying to make: Book value doesn't matter as much as stock price. Berkshire gained +38% from 1999 to the end of 2008. Here's who beat Buffett by Buffett's measure -- and by the rest of Wall Street's -- with their stock prices:
|Growth in Book Value, 1999-2008|
|Company (Ticker)||Growth in Book Value||Total Return|
|Chevron (NYSE: CVX)||+388.2%||+144.5%|
|United Tech. (NYSE: UTX)||+110.4%||+130.4%|
|Johnson & Johnson (NYSE: JNJ)||+162.2%||+71.8%|
|Traveler's (NYSE: TRV)||+291.2%||+70.2%|
|Procter & Gamble (NYSE: PG)||+476.3%||+65.7%|
|Hewlett-Packard (NYSE: HPQ)||+112.9%||+53.0%|
|Wal-Mart (NYSE: WMT)||+152.7%||+51.9%|
Red Auerbach once said, if you keep score, win. Winston Churchill said history would be kind to him, for he intended to write it. Buffett seems to have learned both lessons.