When is it a good idea to not listen to what Warren Buffett is advising you to do?
I think the answer might be never.
Do you remember Buffett's October 16, 2008 op-ed in the New York Times advising investors to invest in American stocks?
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
He was right, we should have been buying. He didn't pick the exact bottom which was early March 2009, but he wasn't too far off.
Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefitingshareholders who retain their interest.
Again he was right, check out the chart below which shows the share price touching $100,000 per class A share near the time of this announcement and subsequent run up to $160,000 today:
That is quite a share price increase for a company of the size of Berkshire and it begs the question as to whether Berkshire is getting close to being fully valued at the current stock price?
My first instinct is to try and figure out what Buffett himself might think.
Again he gave us some help on December 12, 2012 when Berkshire raised the share repurchase limit up to 120% of book value. That tells me that Buffett thinks that Berkshire is VERY attractively valued at 120% of book.
So what is book value?
As at December 31, 2012, book value per A share for Berkshire Hathaway was $114,214 per Class A share.
120% of that is $137,000 per Berkshire A share. That is the price that we can conclude Buffett thinks is very attractive. The current share price of almost $160,000 is only 17% above that.
Being only 17% above Buffett's "very attractive" valuation wouldn't really give me an itchy trigger finger on my "sell" button.
A Slightly Different Way To Think About Berkshire's Valuation
I think about Berkshire's valuation a little differently. I like to imagine that the company is a bond that pays me an annual amount. That annual amount is the increase in book value that Berkshire creates every year. It isn't fixed, but there is certainly a fairly predictable range that the annual increase would fall within.
The past three years Berkshire's book value has increased by:
2012 - $24.1 billion (prior to share repurchases)
2011 - $6.07 billion
2010 - $27.1 billion
That is a three-year average of $19 billion.
With 1.65 million shares outstanding and a share price of $160,000, Berkshire's market capitalization is $260 billion. If a normalized level of wealth creation for Berkshire is the three-year average of $19 billion, that would be a return of $19 billion / $260 billion = 7.3% at the current share price.
I think that 7.3% "yield" is pretty attractive, especially since it is growing every year and comes with Berkshire's extraordinary financial strength.
With consideration given to Buffett's book value guidance and the current normalized "yield," I would say that Berkshire is not the "bet the farm" opportunity it was back in September 2011, but that there is also no reason to consider selling at the current share price.