A book value floor for Berkshire?

by Jim Fink, contributing editor Investing Daily

At Berkshire Hathaway (BRK.B), Warren Buffett instituted the first share buyback program in 40 years.

The buyback is based on a stock price equal to or less than 110% of book value. Consequently, many investors view 110% of book value as a floor for the stock since Berkshire will be buying aggressively at that level.

Keep in mind the difference between book value and intrinsic value. Book value is an accounting concept based on historical cost and retained earnings; it says nothing about a company’s future earnings power which is the keystone of a stock’s actual (i.e., intrinsic) value.

Buffett is willing to pay 110% of book value because he believes that the actual value of Berkshire Hathaway stock is much higher than book value.

Starting with the Q2 2011 financials, I calculate Berkshire Hathaway’s book value for the past four quarters:

Q2 2011 --$72.49
Q3 2011 -- $71.04
Q4 2011 -- $73.27
Q1 2012 -- $78.18

Note that you must deduct shareholder equity from non-controlling interests from total shareholder equity to get the shareholder equity attributable to Berkshire Hathaway shareholder.

Shares outstanding are based on the average for the quarter rather than the end-of-quarter number. To get Class B book value, simply divide the Class A number by 1500.

As you can see from the table above, book value exploded higher by 6.7% in the first quarter of 2012 after stagnating over the prior two quarters. The new floor for the stock based on 110% of book value is now $78.18.

Berkshire’s stock price was up a similar 6.4%, but has often lagged significantly behind book-value increases as it did in both 2009 and 2011.

When stock price and book value move in unison, repurchases are unlikely, which may explain why Berkshire didn’t repurchase any shares during the first quarter.

In contrast, the fourth quarter of 2011 was very volatile and Berkshire’s stock price temporarily dipped below the $73.27 book-value threshold during the early-October and late-November market downdrafts.

As a result, Berkshire was able to repurchase $67 million worth of its shares in last year’s fourth quarter, but Buffett readily acknowledged in the just-filed 10Q  that $67 million is an “insignificant” amount.

Berkshire’s stock underperformance compared to the S&P 500 has continued. Since the beginning of October 2010 until the present, Berkshire stock has lost money whereas the S&P 500 has gained 19.5%:

This underperformance was a subject of conversation during the annual shareholders meeting. Glenn Tongue, who works with hedge-fund manager Whitney Tilson, asked, "Since the beginning of last year the portfolio has gone up and the stock price hasn’t budged. Is the market manic?"

Charlie Munger didn’t seem to like the question and answered rather testily: "It is nature of things that Mr. Market will do what it wants when it wants, not when you want it. You aren’t welcome in this room if the short-term orientation turns you on."

The real answer to Tongue’s question probably has to do with Buffett’s advanced age and his refusal to name his successor, even if the successor has been secretly selected already.

On the positive side, this was the first year in a long time that Wall Street insurance analysts were given time to ask real questions about Berkshire’s businesses.

Buffett’s answers were detailed and intelligent, which proves to me that he remains extremely sharp and knowledgeable about insurance and is not just a doting grandfather figure dispensing generic folksy humor.

Whitney Tilson’s updated estimate of Berkshire’s intrinsic value is $186,300 per Class A share and $124.20 per Class B share. Similarly, Barclays Capital analyst Jay Gelb told clients after the shareholders meeting that he values Class B shares at $118.

With Class B shares currently trading at only $81.87, there appears to be more than 40% upside for investors who get in now.

Learn more about this financial newsletter at Investing Daily.

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