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WSJ Your Money Briefing
Decoding Warren Buffett: Book Value vs. Market Value
00:09:03
Wall Street Journal Heard on the Street's Spencer Jakab explains Berkshire Hathaway CEO Warren Buffett's recent comments that he will no longer report the company's wealth creation in terms of book value.
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With your money briefing. I'm J.R. whelan at the Wall Street Journal in New York. When Warren Buffett speaks, people listen. But when the Oracle of Omaha spoke of book value versus market value last week, it caused quite a stir. We'll sort out the method behind the message in a moment. First, these money in market stories you should know. CEOs from the nation's top three credit reporting agencies went before a Democratic House panel on Tuesday as Congress considers new legislation with regard to fixing inaccuracies in consumers credit reports. A new proposed bill calls for a new right for consumers to to challenge errors in their credit reports. Also bars employers from using credit reports to screen job applicants and allows greater power for the Consumer Financial Protection Bureau to regulate the industry. The CEOs pushed back against the need for new legislation, saying they have made significant improvements to their systems and practices in recent years. The CEO of Equifax told lawmakers that since the massive 2017 data breach at the company, it has increased the technology spending by a billion dollars. The company is also investing more to help consum access their data and fix errors more easily. Meanwhile, the reopening of the government in January sparked a strong uptick in consumer confidence in February. The Conference Board, which surveys consumers, says that households outlook for jobs and pay was also generally more favorable. The so called labor differential, which shows the gap between survey participants who say that jobs are plentiful and those who indicate jobs are hard to get, hit an 18 year high in February. The report also showed that future inflation expectations continue to fall, hitting the lowest level in about 15 years, and the unemployment rate among Americans with disabilities has fallen dramatically. But the disabled remain disproportionately employed by governments and in low wage occupations. The Labor Department says the jobless rate for disabled Americans fell to 8% last year and that was the lowest rate in a decade of comparable records and well below a peak of 15% in 20. But despite the gains, people with disabilities were more likely to work in public sector jobs in low wage occupations and to be self employed. Last year, 14.1% of employed persons with disabilities worked for a government entity, compared with 13.4% of those without disabilities. Berkshire Hathaway CEO Warren Buffett sent a chill through financial circles when he announced in his annual letter to investors investors last week that he would no longer report Berkshire's wealth creation in terms of book value. But was there some method behind the move that surprised some Wall Street Journal hurt on the Street? Deputy editor Spencer Jacob joins us to discuss. So, Spencer, just to lay things out, what does book value of a company indicate?
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So book value is a by the book accounting measure. It shows the assets and the liabilities of a company and the value that accrues to shareholders. It's very hard to fudge. Market value moves up and down the whims of the market. It depends how optimistic people are about something. People were a little bit surprised because Warren Buffett has not really paid a lot of respect to the market. In other words, he's gotten rich off of the market's irrationality. People read a lot into this move to say, well, maybe now he thinks the market is more rational than accounting measures and is he losing it or is he straying from his views? And that is not the case, but it's easy to think so.
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And Buffett feels that using book value as a barometer doesn't provide always a fair or accurate reading of a company's overall value.
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That's right. So if you look at what Berkshire was and has become, you get to kind of understand it. He took it over. It was just kind of a failing textile company that he turned into an investment vehicle. And he said when he took it over, the book value of that textile company way overstated the value of the company. It wasn't realistic because textiles were not a good business even then when he took it over. But over time, as the, you know, he bought stocks and bought individual companies, bought Geico and See's Candies, bought Burlington Northern, the railroad and other insurers. Those companies have become part of Berkshire. There's no market price anymore for those, so he does invest in them. But the book value of those assets has not grown as quickly as the market value of Berkshire. To put it in round terms, the book value has grown something like a million percent during his tenure, which is pretty good. But the market value has grown something like 2 million percent since his tenure. The gap has gone in the other direction. That's why he says that it no longer reflects it. And there's some more complicated reasons as well. Now he has a pile of over $100 billion in cash that he could use to buy companies. He also uses it to buy stocks, but he also uses it to buy shares of Berkshire Hathaway, which is the investment that he knows you made that
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point in your column that it created a large gap between the book and the market value when he began to buy back the shares.
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That's right. It exacerbates the gap if he uses some of that money. He said that he has certain criteria and he has his own measure of the intrinsic value of the company. Right now, Berkshire Hathaway is trading at something like a 40 or 50% premium to its book value. He said that he has his own idea of what the real value is of Berkshire Hathaway. And when it goes below that, he might use some of that cash to buy it, but when he uses a dollar of the cash on the balance sheet to buy back those shares, then it widens that gap further. What he's saying is that that gap is just so big now that he's not going to measure your wealth creation in terms of book value anymore. He's going to use market value in terms of whenever you happen to have bought Berkshire Hathaway. If you're a shareholder, you've done well over most periods, especially over a very long period. You've become very wealthy owning it. The real wealth that it has created for you is the market value. But people did misinterpret it because they think that he's derided the market's ups and downs and whims and moods, and maybe now he's sort of embracing it more. And that is really not the case. It's just that in this specific case of his company, because it has all these operating subsidiaries that he's not going to sell. He's not going to sell his railroad. He's not going to sell geico. He's not going to sell these things and realize the full market value of whatever they may be. That gap is going to keep on growing and growing. That's why he's steering you away from looking at that.
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Decoding Warren Buffett is common activity. It's like a cottage industry. But one thing is for sure, he really has never been a big fan of chasing after ebbs and flows in the dramatic ups and downs of the market.
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That's right. He uses this allegory that he got from his mentor, Benjamin Graham, which is Mr. Market. He said, pretend that you have a business partner. His name is Mr. Market. He's mentally unbalanced. Some days he's super optimistic, and he wants to buy your share of the business for way more than you think it's worth. Then the next day he comes in and he's super pessimistic. He wants to sell you his share for way less than it really is worth. He said, you're basically doing business with someone like that in the long run, where the ebbs and flows allow you to pick things up more cheaply or sell things more dearly than the intrinsic value. That is still the case. And that is still the case even with his own company where the market sometimes is a little bit too optimistic about it and sometimes is more pessimistic. That's how you, over his tenure, he's made something like 16 times what you would have made just owning the S&P 500.
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By itself, Buffett carries a lot of credibility. And if market value readings allow him to better gauge the health of Berkshire and the subsidiaries, investors are likely to keep listening.
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I think they are. Ultimately, that's what people care about. They thought that he was a bit of a stodgy for pointing to the book value for so many years. There are not many companies that measure their shareholder wealth creation in terms of book value. They measure it just in terms of market value. And they viewed this as somewhat throwing in the towel. But what he said is that it's at least closer, it's at least a better measure of wealth creation than book value because book value is sort of, it's just moving farther and farther away. I'm not going to change. This is still largely a conglomerate that has operating businesses. It's not going to sell these businesses. It's going to keep them for a long, long time. And so that gap is going to keep on growing. And so it just is not useful anymore. And the only other measure out there, he's not going to give you a measure of intrinsic value because that's totally subjective. So the market is the only other thing out there. It's the next best thing, but it's not very good.
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All right, that's Wall Street Journal heard on the Street Deputy editor Spencer Jacob here in our studio. Spencer, thanks for stopping by.
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Sure.
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And that's your money briefing. I'm J.R. whelan in New York for the Wall Street Journal.
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