Before Buying Berkshire, Read the 'Book'

To see if you have a fever you must take your temperature. We know that 98.6 degrees is normal. If your reading is 101 or higher, there's certainly something wrong. With stocks, it's a similar process to determine if any particular issue is overheated, normal or relatively undervalued. For most companies, that is figured by comparing its current price-to-earnings, or P/E, ratio to its historically typical level. With stocks like Berkshire Hathaway , , however, it is more appropriate to compare its current Price/Book Value ratio to previously typical readings. From 2009 through 2018, BRK.B fetched an average Price/Book Value of 121.2%. That number was weighed down by the unusually low ratios hit from the Crash of 2008 through 2012. From 2014 through 2018, without those drags, Berkshire traded for an average Price/Book Value of around 131.4%. I'm willing to say that the more recent years are more indicative of what to expect in the future. Knowing that 1.31-times book value is normal for BRK.B made it easy to see why shareholders back at 2008's peak were so disappointed. Those who top-ticked BRK.B in 2008 had to wait 4 ½ years to start making money. Worse, they were forced to sit a 55.8% drawdown, from $97.20 to $44.90, along the way. Ouch. That horrible price action was worsened by the fact that Berkshire has never paid any cash dividends. Even those that held on to eventually turn profits paid a huge opportunity cost in tying up their capital, while it could have been much more productive. A similar pattern played out from December of 2014, when BRK.B hit 155% of book value, through November of 2016. Not recognizing Berkshire's fever sentenced traders to almost two years of stagnation, which could easily have been avoided. December of 2017 saw another instance of mild overvaluation as BRK.B rose to about 142% of book value. The stock hit $200.50 late in 2017. As of Aug. 26, 2019 it was available for about $198. That was 20-months wasted with no income to compensate for your time. Momentum chasers who bought last year's peak of $224.07 paid 158.5% of book value. They are still underwater well over a year later. What is the best part about selling when BRK.B gets overheated? You always get good chances to buy back much cheaper on both absolute and relative valuations (green-starred above). From 2008 through early 2013, there were four outstanding entry points for those wanting to own BRK.B. Each of those allowed purchase at from just 76.8% to 106.5% of Berkshire Hathaway's end-of-that-year book value. If you read the book, and went long, your results were fabulous. Real Money Pro subscribers were warned that Berkshire was a bit too expensive back around Labor Day of 2018. My comment was, Why buy/hold BRK.B now? with BRK.B at $208.94. Almost exactly one year later, the shares have provided negative total return. Of interest as well ... my end of Dec. 2019 projected price of $198.58 (issued on Sep. 3, 2018) has a pretty good chance of being quite accurate. It was based entirely on Berkshire reverting back to a more normalized Price/Book Value relationship. Christmas eve 2018 gave yet another confirmation that this valuation method works. BRK.B closed that day at $187.76. That was 1.34-times what turned out to have been the company's end of 2018 official book value. That 1.34-times book value was just a couple of basis points from Berkshire's 2014-2018 average price to book value of 1.31-times. What does that say about BRK.B's prospects from around $199? The shares are pretty much fairly valued based on the expected $152.75 Dec. 31, 2019 book value estimate. Value Line apparently buys into my theory. Its three to five year projected price range for the stock merely reflects the firm'sview of Berkshire's sustainable growth in book value out to 2024. Unless 2% to 8% annualized, with no income along the way, appeals to you, there are much better choices than Mr. Buffett's company right now.

Before Buying Berkshire, Read the 'Book'

When looking at Warren Buffett's Berkshire, compare its current Price/Book Value ratio to previously typical readings.

Columnist Conversation

Capitulation?

Monday Morning Fibocall for 1/24/2022

A Good Way to Take Advantage of Last Week's Selloff

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.