Berkshire Hathaway's Pieces Are Worth More Than The Whole

 |  About: Berkshire Hathaway Inc (BRK.A), BRK.B
by: Robert Wagner


The pieces of Berkshire Hathaway are worth more than the whole.

Berkshire Hathaway's price to book value ratio shows management is not adding value.

Shareholders of Berkshire Hathaway focus on performance and risk, not book value.

I recently wrote a semi-satirical article on Berkshire Hathaway (NYSE:BRK.A) that generated a large number of comments. I then wrote a follow-up article addressing some of the comments, and the comments on the second article inspired yet another article. The second article also inspired a fellow SA contributor to refute some of my claims. I learned from the comments that Warren Buffett has a passionate following much like gold and the Bitcoin, and that traditional measurements of risk such as standard deviation and beta don't apply to BRK.A. One of the comments quoted Warren's definition of risk as "risk comes from not knowing what you are doing." The other thing I discovered and thought was really odd was the focus on creating book value. It turns out that Warren's favorite metric to measure success is the ability to create book value per share.

In his annual letter to Berkshire Hathaway shareholders released Saturday, Warren Buffett reveals the company's per-share book value, his favored metric, increased by 18.2 percent in 2013...That strong gain, however, was dwarfed by the S&P's 32.4 percent advance, including dividends.

Personally I can't for the life of me figure out why anyone would use that as a measure of success, unless you are trying to distract investors from looking at what really matters, that being performance. I worked as a portfolio manager for over 10 years and I can't ever remember a mention of book value in any of my evaluations, but I sure can remember performance being a big part of my success or failure. Book value is an awful measurement, and is highly distorted by various depreciation measurements, age of the assets, types of assets, mark to market value of the assets and the fact that many assets on a company's books don't truly have a secondary market. Each industry has a different price to book value ratio or P/B, and wide difference exist between service and non-service industries.

P/B value is effectively a metric highlighting how efficiently management is using the assets as measured by book value. If the market places a high P/B on a company, the market is basically saying that management can generate substantial income from a given book value of assets. If the market places a low P/BV on a company, it is basically saying that management won't be generating much income from the given assets as measured by book value. Theoretically, if the assets on the books reflect at least market values, a stock should never trade materially below book value, otherwise the firm would just close up shop and liquidate its assets. Firms with P/B are usually considered take-over targets for that very reason.

What Does P/B Tell Us?
For value investors, P/B remains a tried and tested method for
finding low-priced stocks that the market has neglected. If a company is trading for less than its book value (or has a P/B less than one), it normally tells investors one of two things: either the market believes the asset value is overstated, or the company is earning a very poor (even negative) return on its assets.

If the former is true, then investors are well advised to steer clear of the company's shares because there is a chance that asset value will face a downward correction by the market, leaving investors with negative returns. If the latter is true, there is a chance that new management or new business conditions will prompt a turnaround in prospects and give strong positive returns. Even if this doesn't happen, a company trading at less than book value can be broken up for its asset value, earning shareholders a profit.

How then has Warren done when compared to his favorite metric? In a word, awful. Using the 12/31/2013 portfolio, I went back to calculate out just how well Warren is doing on a P/B analysis. What I found was that 36% of BRK.A is composed of publicly traded stocks. The weighted average P/B of those stocks in a standalone portfolio is 4.40. Adjusting that 4.40 for its weight in BRK.A gives a P/B of 0.36*4.40 = 1.58. The problem is, BRK.A has a P/B of only 1.32. That means that on the 64% of BRK.A that is totally controlled by BRK.A's management, not only don't they achieve a P/B = 1, they generate a negative P/B of -0.26 (1.58-0.26=1.32).

In other words, Warren destroys book value, he doesn't create it. BRK.A has a P/B of 1.32, which is well below what most other industries have. If BRK.A had the P/B value of the tobacco industry, BRK.A would be worth 10x what it is today. Even if BRK.A had the P/B of the low tech apparel industry, it would be worth over 2x what it is worth today. BRK.A takes companies with much higher valuations as measured by P/B, and reduces them to valuations consistent with the insurance industry. BRK.A is a value destroying machine. BRK.A shareholder should be demanding BRK.A get broken up because clearly, from Warren's own favorite metric, management has been doing a very poor job of creating wealth for its shareholders.

That being said, now may not be the best time. BRK.A is heavily weighted in the financial sector, and the financial sector should outperform the broader market as the yield curve steepens. In that case, shareholders of BRK.A may want to postpone calling for the breakup of BRK.A, but then again, I would bet a financial sector ETF will beat BRK.A during times that favor the financial sector.

Company  Symbol  Holdings  Mkt. price  Holding value  %BRK.A P/B Wt P/B
American Express Company AXP 151,610,700 $93.59 $14,189,245,413 4.84% 4.95 0.67
The Bank of New York Mellon Corporation BK 24,652,836 $33.32 $821,432,496 0.28% 1.11 0.01
Chicago Bridge & Iron Company N.V. CBI 9,550,755 $82.95 $792,235,127 0.27% 3.86 0.03
ConocoPhillips COP 11,079,958 $66.49 $736,706,407 0.25% 1.66 0.01
Costco Wholesale Corporation COST 4,333,363 $113.91 $493,613,379 0.17% 4.51 0.02
Deere & Company DE 3,978,767 $88.18 $350,847,674 0.12% 2.98 0.01
DIRECTV DTV 36,514,700 $79.38 $2,898,536,886 0.99% 0 -
DaVita HealthCare Partners Inc DVA 37,621,152 $68.17 $2,564,633,932 0.88% 3.05 0.07
General Electric Company GE 10,585,502 $26.01 $275,328,907 0.09% 2.16 0.01
Graham Holdings Co GHC 1,727,765 $706.01 $1,219,819,368 0.42% 0 -
General Motors Company GM 40,000,000 $36.96 $1,478,400,000 0.50% 1.55 0.02
Goldman Sachs Group Inc GS 12,631,531 $173.63 $2,193,212,728 0.75% 1.11 0.02
International Business Machines Corp. IBM 68,121,984 $186.59 $12,710,880,995 4.34% 8.68 1.05
Johnson & Johnson JNJ 327,100 $93.29 $30,515,159 0.01% 3.52 0.00
The Coca-Cola Company KO 400,000,000 $38.58 $15,432,000,000 5.27% 5.48 0.81
Kraft Foods Group Inc KRFT 192,666 $55.85 $10,760,396 0.00% 6.17 0.00
Liberty Global plc - Class A Ordinary Shares LBTYA 2,948,285 $43.39 $127,926,086 0.04% 2.92 0.00
Lee Enterprises, Incorporated LEE 88,863 $5.18 $460,310 0.00% 0 -
Liberty Media Corp LMCA 5,300,000 $131.87 $698,911,000 0.24% 1.08 0.01
Mastercard Inc MA 405,000 $77.60 $31,428,000 0.01% 13.33 0.00
Moody's Corporation MCO 24,669,778 $82.79 $2,042,410,921 0.70% 29.16 0.57
Mondelez International Inc MDLZ 578,000 $35.08 $20,276,240 0.01% 1.85 0.00
Media General, Inc. MEG 4,646,220 $17.68 $82,145,170 0.03% 1.7 0.00
M&T Bank Corporation MTB 5,382,040 $119.76 $644,553,110 0.22% 1.46 0.01
National-Oilwell Varco, Inc. NOV 8,880,000 $78.59 $697,879,200 0.24% 1.53 0.01
Precision Castparts Corp. PCP 1,977,336 $259.88 $513,870,080 0.18% 2.83 0.01
The Procter & Gamble Company PG 52,793,078 $78.55 $4,146,896,277 1.42% 3.15 0.12
Phillips 66 PSX 27,163,918 $78.40 $2,129,651,171 0.73% 2.07 0.04
Sanofi SA (ADR) SNY 3,905,875 $52.20 $203,886,675 0.07% 1.86 0.00
Starz STRZA 4,541,881 $32.68 $148,428,671 0.05% 59.14 0.08
Suncor Energy Inc. (USA) SU 13,000,000 $33.05 $429,650,000 0.15% 1.45 0.01
Torchmark Corporation TMK 4,235,818 $79.97 $338,738,365 0.12% 1.9 0.01
United Parcel Service, Inc. UPS 59,400 $98.47 $5,849,118 0.00% 14.02 0.00
U.S. Bancorp USB 79,320,901 $42.30 $3,355,274,112 1.15% 2.03 0.06
USG Corporation USG 34,890,174 $34.50 $1,203,711,003 0.41% 7.44 0.09
Visa Inc V 1,555,459 $225.51 $350,771,559 0.12% 5.29 0.02
Viacom, Inc. VIAB 7,607,200 $87.33 $664,336,776 0.23% 7.23 0.05
Verisk Analytics, Inc. VRSK 1,563,434 $62.41 $97,573,916 0.03% 20.1 0.02
Verisign, Inc. VRSN 10,961,520 $55.37 $606,939,362 0.21% 0 -
WABCO Holdings Inc. WBC 4,076,325 $103.70 $422,714,903 0.14% 4.97 0.02
Wells Fargo & Co WFC 463,458,123 $48.07 $22,278,431,973 7.60% 1.55 0.33
Wal-Mart Stores, Inc. WMT 49,483,733 $74.21 $3,672,187,826 1.25% 3.17 0.11
Exxon Mobil Corporation XOM 41,129,643 $95.07 $3,910,195,160 1.33% 2.52 0.09
Total Public $105,023,265,851 35.84% 1.58 4.40
Total Private 64.16% (0.26) (0.40)
Berkshire Hathaway BRK.A $293,000,000,000 100.00% 1.32
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Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.