Friday, January 4, 2013

Berkshire Hathaway vs S&P 500

These two articles point out that Berkshire Hathaway (BRKa) outperformed the S&P 500 this past year.

That's an awfully short time frame to judge performance. Let's look at the increases to per share book value and Class A shares of Berkshire's stock over a longer -- and likely more meaningful -- time frame. We don't know year-end 2012 book value just yet, so I'll use the last reported number of $ 111,718 per share.

3rd quarter 2012 earnings

At the end of 1999, book value was more like $ 37,987 per share.

1999 Berkshire Letter

So that makes the annualized increase since 1999 to Berkshire's book value per share roughly 8.7%.

Over that same time frame, the S&P 500 (incl. dividends) increased by roughly 1.6% per year.

The end of 1999 was not long after Warren Buffett was asked to give a speech to business leaders in Sun Valley, Idaho. In that speech, he explained why the stock market was not likely to perform anything like it had over the past 17 years*. In fact, he thought stock returns over the next 17 years were likely to be rather unimpressive.

This contrasts in a big way with how favorably he has been toward stocks in more recent years.

Warren Buffett: Why stocks beat gold and bonds

Now, book value is an imperfect measure but, as Buffett has pointed out, it is a pretty good proxy for Berkshire's intrinsic value.

"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." - 2011 Berkshire Hathaway Shareholder Letter

The stock itself went from $ 56,100  to $ 134,060 per Class A share, or roughly 6.9% per year since 1999. So the stock has performed somewhat worse than the growth in book value. That's a reflection of the fact that the stock was selling for roughly 1.5x book at the end of 1999, while it was selling at more like 1.2x book at the end of 2012.

Now, that was before the bubble had burst. Let's look at the returns of S&P 500 compared to Berkshire from ten years ago -- after the bubble had burst. Again, since we don't know year-end book value for Berkshire, I'll use the last reported number of $ 111,718 per share. At the end of 2002, Berkshire's book value was $ 41,727 per share.

2002 Berkshire Letter

So that makes the annualized growth in Berkshire's book value per share roughly 10.3%.

Over that same time frame, the S&P 500 (incl. dividends) increased by about 7.0% per year.

The stock itself went from $ 72,750 to $ 134,060 or roughly 6.3% per year over the past ten years.

So, while increases to Berkshire's book value outpaced the market, the stock slightly underperformed. That, once again, is simply a reflection of the stock selling for over 1.7x book at the end of 2002 while selling at more like 1.2x book at the end of 2012. It's also a reflection of the fact that the S&P 500, even if not at all cheap at the end of 2002, had become at least more reasonably valued.

Per share book value is far from a perfect measure (of course, there's no such thing as a perfect measure of value), but I'll take it as a proxy for changes to Berkshire's intrinsic value over the market price any day.

So, whether buying a quality enterprise like Berkshire or an index that's a good representation of the market as a whole, the initial price paid will always matter.

The 1999 Sun Valley speech by Buffett that I mentioned above was covered in Chapter 2 of 'The Snowball'.

It was also covered in this 1999 Fortune article:

"Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like--anything like--they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate--repeat, aggregate--would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms."

In the speech, Buffett points out that investors were, back then, paying roughly $ 10 trillion for just $ 334 billion of profits.**

Not cheap.

A PaineWebber-Gallup poll done at that time revealed investors were expecting stocks to return something like 13-22% going forward.

I've always been somewhat amazed that so many discounted what Buffett was saying back in 1999. I've been similarly perplexed by the skepticism toward his more recent favorable views on stocks.

I mean, it's not like Buffett's giving medical advice. If there's one thing the man knows a thing or two about it is investing.

By the way, it's not that Buffett is usually correct on timing. He certainly isn't. What's cheap can, and often does, get cheaper. What's pricey does usually get even more so. Investors who buy with value in mind often buy "too early" and sell "too early". Learning to effectively judge how price compares to value -- identifying what's being mispriced -- isn't easy but doable with some work. Getting the timing consistently right is not.

Nor is it necessary.

"Picking bottoms is not our game. Pricing is our game. And that's not so difficult. Picking bottoms is, I think, impossible." - Warren Buffett back in 2009 at the Shareholder Meeting

So an investor can achieve good results if price versus value is frequently judged well (even if timing is not).

Well, at least if the investor has justifiable high levels of conviction in order to hang in there when the inevitable paper losses occur. Easier said than done. High levels of unwarranted conviction due to less than sound judgment of price versus value isn't a lucrative combination.
(Overconfidence in, and overestimation of, what the investor understands too often subtract from overall results.)

Hopefully, investors won't end up getting more comfortable with equities as they become increasingly expensive though, historically and rather unfortunately, that's what usually happens.
(It's obviously much harder to buy shares with sufficient margin of safety right now relative to not too long ago. That doesn't mean there is not some cheap individual marketable securities.)

Too often, market participants buy just when stuff starts becoming somewhat or even very expensive compared to intrinsic worth. 

Unfortunately, many will also sell (or not buy) when the headlines are awful and the chance to own part of a business is the most attractive and the lowest risk.

Adam

Long position in BRKb established at much lower than recent market prices

* The market had gone up more than 10-fold (excl. dividends...so total return was actually higher) in the prior 17 years or so (1982-1999). Stocks were extraordinarily expensive by any measure. It wasn't just tech stocks (though many of them were extremely overvalued, of course).
** Combined profits at the time for the Fortune 500 was $ 334 billion while the market value of those stocks collectively was $ 9.9 trillion.
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