The Financial Times Lex Column this morning highlights a trend that Berkshire Hathaway shareholders have been aware of for some time: The Price/Book Value ratio has been steadily falling over the last several years and is now at levels unseen since the early 1990s. The chart provided illustrates the long term trend:
As we discussed in July, Berkshire Hathaway’s book value is not a particularly accurate measurement of intrinsic value. However, since Warren Buffett has said in the past that the intrinsic value of Berkshire “far exceeds” book value and that changes in book value roughly approximate changes in intrinsic value, we know that the book value statistic provides clues for valuation.
At the very least, book value provides directional clues regarding Berkshire’s intrinsic value.
At the end of the third quarter, Berkshire’s book value was at a record high, but the decline in the price/book ratio means that investors are less willing to pay a premium over book value, resulting in a share price that has failed to keep up with book value progress. The reasons cited by FT include Warren Buffett’s age and potential dilution related to the Burlington Northern acquisition.
The terms of the Burlington Northern acquisition include the use of stock to fund part of the transaction (discussed in more detail in November). As a result, this is one of the rare periods when Berkshire Hathaway shareholders actually have a good reason to hope that the share price holds up in the short run since it is being used as currency for part of the transaction.
Disclosure: The author owns shares of Berkshire Hathaway.