Buffett: Intrinsic Value vs Book Value
From the latest Berkshire Hathaway (BRKa) Shareholder Letter:
...we don't enjoy cashing out partners at a discount, even though our doing so may give the selling shareholders a slightly higher price than they would receive if our bid was absent. When we are buying, therefore, we want those exiting partners to be fully informed about the value of the assets they are selling.
At our limit price of 110% of book value*, repurchases clearly increase Berkshire's per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower. You should know, however, that we have no interest in supporting the stock and that our bids will fade in particularly weak markets. Nor will we buy shares if our cash-equivalent holdings are below $20 billion. At Berkshire, financial strength that is unquestionable takes precedence over all else.
In the Berkshire Hathaway Owner's Manual (pages 4-5), Buffett uses a college education to help explain the difference between book value and intrinsic value:
You can gain some insight into the differences between book value and intrinsic value by looking at one form of investment, a college education. Think of the education's cost as its "book value." If this cost is to be accurate, it should include the earnings that were foregone by the student because he chose college rather than a job.
For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day. The dollar result equals the intrinsic economic value of the education.
Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn't get his money's worth. In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed. In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.
Berkshire Hathaway's stock is currently selling at more than a 120% of book value. Well, at least what book value was at the end of the 4th quarter of 2012.
Book value is almost certainly higher now.
So stock repurchases at this time aren't going to happen, but it wouldn't take much of a drop in price (or increase in book value) for them to be buyers.
What Buffett specifically means when he says "we will likely repurchase stock aggressively" will be worth keeping an eye on if the stock price falls below 110% of per-share book value again.
* 110% of the book value or a 10% premium over the book value. It's been described both ways in different publications.