100 Ways to Beat the Market #20: Buy Berkshire Hathaway at 1.1x book value or less

One simple way to beat the market is to buy and hold Berkshire Hathaway stock at a good price. Buffett acknowledges that it is challenging to find intelligent ways to invest Berkshire’s massive and growing cash holdings. Nevertheless, he is clear that his goal is still to beat the S&P 500 which he believes he can do, albeit at a diminished level of outperformance vis-a-vis Berkshire’s earlier halcyon days. It is worth noting that Buffett is famously conservative in his missives about his ability to continue to outperform.

Berkshire’s recent performance compared to the S&P 500 is noteworthy. Berkshire has outperformed the S&P 500 in each of the ten most recent five-year periods by an average margin of just over 7%. For the record, Berkshire has never had a five-year period where it underperformed the market.

Buffett believes that Berkshire’s stock is undervalued at 1.1x book value (or approximately $109,000 per A share). He’s right. If you net out the equity investments ($67 billion as of Q3, 2011) and use Buffett’s estimate of normalized after-tax earnings ($12 billion), Berkshire has an earnings yield of about 10%. These earnings are being generated by a diversified portfolio of high-quality businesses that includes a number of bullet-proof, growing world-class franchises such as GEICO and BNSF.

Berkshire enjoys a number of advantages which should continue to increase its intrinsic value.

  1. Berkshire has outstanding veteran managers who are unencumbered by bureaucracy or quarterly earnings numbers. They focus solely on building long-term value.
  2. Berkshire can not only purchase operating businesses, but also marketable securities. This gives it a much higher likelihood of finding attractive investments compared to the typical S&P 500 corporation which is constrained to allocate capital within its own industry. Moreover, Berkshire has advantaged access to many deals based on Berkshire’s reputation, deep pockets, and ability to act quickly.
  3. Berkshire has a shareholder-oriented culture. Board members (excluding Buffett) own over $3 billion in stock, and compensation is completely aligned with shareholder interests. Moreover, Berkshire is imbued with a culture of frugality. This means that Berkshire’s wealth will increase the value of shares rather than line the pockets of management.
  4. Berkshire enjoys cheap leverage in the form of insurance float. Although it is impossible to predict with any amount of precision, it seems likely – based on Berkshire’s track record – that float will continue to grow. Berkshire can also borrow at low rates given its strength.
  5. Buffett is still at the top of his game and getting better. The IBM purchase shows his savvy and growing circle of competence and, in my humble opinion, has a reasonable likelihood of adding $10 billion in value over the next 10 to 15 years. Todd Combs and Ted Weschler are warming up in the bull-pen and were hand picked by the same guy who spotted Lou Simpson.

Of course, not losing money should be top of mind when considering an investment. Berkshire has a fortress balance sheet with massive cash holdings as a hedge against economic disruption that puts Buffett in a position of strength to take advantage of opportunities when others are scrambling. Also, Berkshire’s commitment to repurchase shares below 1.1x book puts a floor under the stock.


8 thoughts on “100 Ways to Beat the Market #20: Buy Berkshire Hathaway at 1.1x book value or less

  1. Greg Speicher Post author

    Buffett has said that there is no limit on repurchases under 1.1x book value. These purchases would provide a floor because 1) Berkshire would be allocating large amounts of capital at a very high earnings yield under this level, 2) the purchases would mop up supply from weak holders who would be willing to sell their stock at undervalued prices and 3) it would provide a strong signal to the market that shares were undervalued at those levels thereby stimulating demand from value oriented buyers. All of these factors would tend to provide support against the stock trading too far below this level. If Berkshire did decline far below this level, it would still be a win-win for shareholders because Buffett – or his successor – would be able to repurchase shares at an even greater value.

  2. Scott Wollins

    “If Berkshire did decline far below this level, it would still be a win-win for shareholders because Buffett – or his successor – would be able to repurchase shares at an even greater value.” – was that statement totally absent from human thought? i guess if BRK went to $10 a share – it would still be win/win? the current price of BRK is not undervaluation – it is recognition that BRK’s portfolio is far from solid – not to mention the multi-billion dollar investment in BAC this year at $7 and the stock is trading near $5 – you NEVER buy an asset when the management (even warren) are warning you about ROI limitations – BRK is near book because Warren is showing signs of senility – the IBM investment is classic non-buffett – buying stock at high that after huge appreciation – he clearly knows nothing about technology and has “missed” out on real asset appreciation – where was he when Facebook, Twitter, Amazon, Ebay, etc etc needed capital – too busy focusing on P/E and book value to see where real value is being created – let him buy railroads and IBM post-tech consulting firms – the stock is 1.1x book because it is a mutual fund with questionable assets – a big balance sheet does not make a great stock – ask pitiful Microsoft…

    1. UW Husky

      I would argue his BAC pick is working out alright for him right now…but I guess he must be senile?

      Facebook has such a low barrier to entry, that’s why Buffet won’t take a risk on it now. My generation’s attention span is close to 10 seconds, look how quickly MySpace disappeared.

  3. Steve

    Saw a link to your article via MarketWatch. Very well written – thank you for sharing – looking forward to discovering the rest of your site.

  4. Jean Forgeron

    I bought the stock about a dozen years ago. Since then, the average compounded rate of return has been less than 4%. Therefore, I would have been better off buying a U.S. Savings Bond.

    1. Greg Speicher Post author

      Berkshire’s future return will be based on what you pay today and what its future prospects are. If you bought at the end of 2001, you were paying close to 2x book value. I recommend paying 1.1x or less. This will make a big difference in forward returns. For the record, the S&P 500 went nowhere during the same period. With Berkshire, you are up 50-60% with no taxes. As I written about, no matter how good the company is, the most important things is paying a good – or, better yet, a very good – price.


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