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Berkshire's stock price has risen quite nicely lately, so some folks might be just starting to consider at what point they might even lighten up.
Write covered calls or something like that.
Maybe not now, but soon? Or a little after "soon"?

Today's price is 1.474 times known book. Book per share is at an all time high.
That multiple isn't high, especially as the June statements will soon bump up known book, but it's meaningfully above the average since the credit crunch, which is under 1.34.

But I wouldn't give up just yet.

One way to think of it:
Real inflation-adjusted known book per share peaked quite a while ago, at the end of February last year.

Now, book is an imperfect measure of value, maybe a peak is transient exuberance and a bit too optimistic.
Let's conservatively assume that there might have been 3-5% of value overestimation at that time using book as a proxy of value per share.
Apple stock finished 2021 at a temporary peak level, for example, flattering book value.
So, let's consider 96% of that inflation-adjusted peak as a not-bad conservative proxy yardstick for the real value of a share at the time.
In today's US dollars, that peak real book was $366747, and 96% of that is $352077.
We'll call that our "pretty darned sure it was worth that much then" figure for book.

The thing is, I am firmly of the opinion that squiggles in value metrics are pretty meaningless and true value does not stop rising just because of a bear market.
If nothing else, the cash stacks up at a rate of about a billion dollars each fortnight, which is not nothing. Plus, investments get made at better valuations.
With a sensible amount of smoothing, I think the more reasonable conclusion is that the value of a share generally just keeps rising.
I would pencil in inflation + 5%/year as sort of a floor on the rate of trend value growth, once you smooth out the unusually good and unusually bad numbers.
(this is, not entirely coincidentally, about the lowest rate indicated by my value smoothing exercise mentioned before)

That "pretty darned sure" book figure of $352077 would then rise 6.72% in 16 months to $375742, again all in today's dollars.
Think of that as today's "on trend" real book per share: smoothed, but conservatively estimated.
The price of a B share today is only 1.365 times that number, definitely not selling territory.

In fact, because I love Excel so much, I did approximately this same exercise for each day in the past, using the value smoothing method I have mentioned previously.
(basically a four year "weighted moving average" of book per share).
Looking at subsequent returns, today's valuation level has since the credit crunch been followed by average one year returns of about inflation + 10%.
Inflation is a bit of a wild card these days, but I'd turn that into a very reasonable expectation of low double digit nominal returns in the "roughly a year" time frame.
Might be better or worse than that, but I think the odds are 50:50 on that front.

So be of good cheer!
On this view, we are about to experience an above-average year, not a below-average one.

For the record, B shares at $342, CPI at 304.127.


Jim

Thanks Jim for this post.

Buffett has said that 10% returns long term for Berkshire is an aspirational goal. Why do you think that BRK would return a certain amount over inflation? It seems to me that BRK will return over time close to its ROE. Buffett has said that holding BRK does offer some modest inflation protection which certainly implies that above a certain level of inflation, the stock will not perform so well in terms of real returns.

Anyway, I think BRK from here grows high single digits in share price over the next say 20 years. This is irregardless of what inflation is over the next 20 years. Real returns will be high single digits minus whatever that level of inflation turns out to be. While the share price will be unpredictably irregular, its value per year will increase each year.

I also think BRK total returns will be similar but maybe a little better than S@P 500 but will occur in a somewhat less volatile way. Also, since for now, no dividend being paid leads to better returns from BRK in a taxable account over that 20 year period.

Cheers,

Brian

Why do you think Berkshire energy, BNSF or other Subsidiaries wouldnt be able to pass on inflation costs to customers?

For the utilities, inflation costs can be passed on but inflation also affects the infrastructure required to run the utilities. ROE stays a little over 9%.In the short term ROE can improve as many of the assets of utilities and rails are long duration. Over a l0nger period of time like 20 years, returns will be the underlying ROE. Please correct me if I am totally wrong.

Buffett has said that 10% returns long term for Berkshire is an aspirational goal. Why do you think that BRK would return a certain amount over inflation?

I consider the first sentence to be meaningless without quantifying what inflation you're talking about. Only real returns matter.
That's a trivial hurdle, or a huge hurdle, depending on the inflation regime.

As for why I think Berkshire will return a certain amount above inflation, well, because that's what companies do, in general.

If everything is going up in price at the same rate (salaries, taxes, revenues, materials), then so do after tax profits.
Consequently, the profits of the business world in aggregate adjust for inflation more or less perfectly over time.
Some firms will do better or worse than the average, or adapt to changes more or less quickly, or inflation may be concentrated in some sectors, but that's the base line assumption for the typical firm:
The general rule is that earnings rise a certain amount above inflation on average, through high and low inflation periods.

This is true both theoretically and empirically. One study found a 0.93 correlation over time between rise in general prices and rise in corporate profits in the same interval.
Over very long periods it's pretty much a perfect match once the business cycle is smoothed out.
In very round numbers, the average US firm in the average year is likely to generate value somewhere in the rough vicinity of inflation plus 5% - 5.5%.
That figure tends to be relatively predictable over time in real terms, but not in nominal terms, for good solid reasons.
(Long run past US market returns have been higher than that, but then long run US market returns have included a trend of getting slowly more expensive at around 1.5%/year, give or take)

The only exception seems to be when inflation is so high that the economy breaks for a while.
A broken economy is not good for anyone's profits.
But that is not the current situation. For now it doesn't seem to be a likely situation for the foreseeable future.

Berkshire is big and diversified, so what is true about the broad market with inflation is likely to be fairly true about them, and historically has been: it generally gets passed through.
Berkshire will be at a very slight disadvantage to the median firm because it has little long term debt that is eroded in real terms by inflation.
But it is also at a slight advantage because I believe it has a slightly above-average amount of pricing power among its business units.
The coming year or two will be a good test of that thesis.

Anyway, I think BRK from here grows high single digits in share price over the next say 20 years. This is irregardless of what inflation is over the next 20 years.
You may be right.
But assuming so, it doesn't say anything useful for planning--only real returns matter to your wealth : )
That's a good outcome if inflation is (say) 2-3% or lower, a poor outcome if it's (say) 4-5% or higher.

Personally, I expect a return of inflation plus about 7-8% from Berkshire for the next 5-10 years, maybe inflation plus 6-7% thereafter.
A bit less if I'm unlucky, a bit more if I'm lucky, but I'd be surprised to be off by more than around 1%, possibly 1.5%.
I have no forecast for what US inflation might be, nor in fact much interest in it, as I don't expect it to be relevant to my real returns unless it explodes.
The most obvious downside risk is not inflation per se, but a big fall in the US dollar, not all of which would show up as US headline inflation within a reasonable time frame.
Berkshire's revenues are unusually concentrated in US dollars for a big company.
Incidentally, that's a risk no matter where you live. Most "stuff" has a global price.

Jim

Just following up on this uncharacteristically bullish post of mine from exactly a year ago

...Looking at subsequent returns, today's valuation level has since the credit crunch been followed by average one year returns of about inflation + 10%.
Inflation is a bit of a wild card these days, but I'd turn that into a very reasonable expectation of low double digit nominal returns in the "roughly a year" time frame.
Might be better or worse than that, but I think the odds are 50:50 on that front.
So be of good cheer!
On this view, we are about to experience an above-average year, not a below-average one.
For the record, B shares at $342, CPI at 304.127.

So, how'd we do?
Berkshire closed at $405.77, CPI at 314.069 so headline US inflation was 3.27% in the last year

So, one year result since the post:
Nominal price gain +18.65%
Real price gain +14.89%

It has indeed been a good year.

Jim

So, one year result since the post:
Nominal price gain +18.65%
Real price gain +14.89%

It has indeed been a good year.


Just to demonstrate that I've been paying attention, how much did the value increase in the last year?

For us long termers that's the more important number.

Thank you Jim!

I took your comments to the bank!

Real price gain +14.89%
...
Just to demonstrate that I've been paying attention, how much did the value increase in the last year?

Oh, much less.
Value per share is up less than book per share, too. I'd say real "easily observable" value per share is up mid single digits in the last year.

Of course you can estimate value in a number of different ways, so the exact number depends what method you prefer. I'll do fresh "elaborate" figures when the Q2 books come out.

But FWIW, using the specific "super smoothed real book" method mentioned in the original post of this thread, I get value per share up inflation + 5.19% from end-June last year to end-June this year*. This is fairly low because the (extremely smoothed) valuation metric is still taking into account the 7-8 quarter net flat spot in real book per share starting end 2021. The smoothed line is pulling up again now, slope is now inflation + 7.0%/year.

Jim

* I necessarily used an estimate of Q2 book, but any error in that estimate is not a very big deal because of the substantial data smoothing--the latest data point determines only 12% of the smoothed level, so even a 10% error in my Q2 book estimate would only give an error of 1.2% in the smoothed value. And I'm pretty sure my book value estimate doesn't have a 10% error margin.

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