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Berkshire Hathaway Inc. Message Board

  • jad1148 jad1148 Sep 19, 2012 9:03 AM Flag

    Book Value - continued

    This is a reply to Vensh's last post: "Re: Re: Re: Re: Re: 71.55 Book Value", which no longer has a "reply" button.

    I'm in agreement with your comments regarding book value.

    In my opinion, no one really values anything directly on book value. Without naming a specific company, ask anyone what multiple of book value they pay for it. They won't answer the question because they can't. But the very first question they'll ask is: what is it's average return on equity? Return on equity is earnings divided by book value. So, what they're actually going to perform is a valuation based on normalized earnings, and, as an afterthought, divide their guesstimate of intrinsic value by book value to report their answer as a multiple of book value. As far as I'm concerned, book value is a joke, but berkie investors love it and swear by it.

    If you think about it, the so called "Page Four - Two Column" method is really nothing more than an application of the Dividend Discount Model. For the purposes of valuation, berkies pretend that they will receive both a one time special dividend equal to the cash value of the investment portfolio AND an infinite stream of regular annual dividends generated by the operating companies. That valuation, which is based on a forecast of future dividends, has some merit, if, and only if, it is done correctly. It almost never is.

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    • Investors often use a price-to-book valuation for insurance companies because the year-to-year earnings performance tends to be somewhat volatile and unpredictable. In addition, because of the accounting methodology for the revenue (written premiums), investors know what next year's earnings will be (absent catastrophic claims and periodic loss reserve adjustments) this year. The price-to-book valuation will depend on return on equity which does sould like a variation of the price/earnings approach but actually it is more like Boo-Fay's intrinsic value model because the ROE measured is usually the long term expectation. This explains why Boo-Fay's fans like the book value approach although it is clear that there is a disconnect between some on this board that believe the past is prologue to the futue, and the broader market that is clearly suggesting that BOO-Fay's ROE going forward is set to slide along with the rest of the industry.

      Investors also tend to value closed end investment trusts on a price/book basis, again adjusting for long term ROI expectations.

      Boo-Fay, of course, is a closed-end investment trust with a very large non-life insurance component.

      Vensh is a tired old man, dismayed that the world has passed him by.

 
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