Intrinsic Business Value
Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price.
We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.
Comment: It is not easy to determine intrinsic value. The best PROXY for intrinsic value of Berkshire Hathaway is its book value. Though this closely tracks the intrinsic value of Berkshire Hathaway, it actually understates the intrinsic value of the company. Nevertheless, Buffett opines that using book value to denote intrinsic value is meaningless for most other companies.
We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time. Last year’s annual report included a table laying out results for the 42 five-year periods since we took over at Berkshire in 1965 (i.e., 1965-69, 1966-70, etc.). All showed our book value beating the S&P, and our string held for 2007-11. It will almost certainly snap, though, if the S&P 500 should put together a five-year winning streak (which it may well be on its way to doing as I write this)
Comment: Psychological forces trump the fundamental forces in the short term. In the long term, the fundamental forces always trump the psychological forces that affect the stock price of a company. Buffett looks at long term performances. He highlighted that in any given 5 year period, the percentage gains in book value of Berkshire Hathaway have beaten those offered by the S&P 500.