Warren Buffett and intrinsic value
By Rob Worthington-Smith
03 March, 2014
In Berkshire-Hathaway’s annual report to shareholders, written by its legendary CEO, Warren Buffet says: “My goal, in writing this report, is to give you the information you need to estimate Berkshire’s intrinsic value.”
In that report, Buffet goes on to explain that intrinsic value is an estimate, unlike book value. You cannot publish this value in your annual report. Indeed, this is one of the critical differences between sustainability reporting (a close synonym for intrinsic value reporting) and financial reporting found in the Consolidated Financial Statements (CFS). Sustainability reporting is not yet mature enough to follow established rules and clearly defined content. And given that much of the information is qualitative rather than quantitative (employee skills, for example), there will always be an element of subjectivity and differences in perceptions.
Buffet contends that the market price of a company ought to reflect the company’s intrinsic value, but rarely does, as investors suffer from the alternate human frailties of irrational exuberance and blind panic. Annual reports can exacerbate these roller-coaster emotions through blatant bias in the review of operations and assessment of the company’s prospects.
The responsibility of the company’s management is to provide the investment community with all the facts – both the pluses and minuses – that have a bearing on the company. The aim should be for the price of the company to reflect, fairly, its intrinsic value. ‘Talking’ it either above or below this value does not serve the interests of shareholders with a long-term view.
While most observers would not associate Berkshire-Hathaway with sustainability reporting, one would be hard pressed not to give credit for the company’s economic sustainability. In terms of environmental risk, the company anticipated and survived Hurricane Katrina, despite being one of the largest insurers against this kind of catastrophe. And one of its companies, Clayton Homes, practiced conservative lending in the sub-prime housing market long before the financial crisis hit in 2008. As a consequence, loan defaults were contained and the company was able to gain considerable marketshare at the expense of its less conservative competitors.
The company boasts near the lowest turnover of management in the USA, highly satisfied customers, and has well-regarded corporate governance. But the bottom line must be that Berkshire-Hathaway has not only survived since 1965; it has also shown the best return to shareholders during that time, outperforming the S&P 500 by 54 times!
* Rob Worthington-Smith is the founder of FarSightFirms.com. The FarSight model analyses leadership maturity based on the IIRC’s Integrated Reporting Framework, an international guide designed to standardise the way companies relate their value creation story.