For Buffett, a business is worth the cash it will hand its owners over its lifetime, discounted to today - not what its balance sheet says it cost to build. Across decades of shareholder letters he returns to the same distinction between book value (what was put in) and intrinsic value (what can be taken out), insisting the figure is all-important precisely because it can never be calculated with precision. These passages trace how he defines that number, why owner earnings matter more than reported GAAP, and how the gap between price and intrinsic value drives every buy, sell, and repurchase decision.
Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.
We believe that owner earnings are far better depicted by the reported earnings in the O column than by those in the N column. In other words, we feel owner earnings of Scott Fetzer are considerably larger than the GAAP figures that we report.
Berkshire's intrinsic value continues to exceed book value by a substantial margin. We can't tell you the exact differential because intrinsic value is necessarily an estimate; Charlie and I might, in fact, differ by 10% in our appraisals.
We define intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
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.
As Charlie Munger, Berkshire's Vice Chairman, and I have repeatedly told you, what counts at Berkshire is intrinsic value, not book value.
A company's decision to repurchase shares or to issue them should stand on its own feet. Just because stock has been issued to satisfy options - or for any other reason - does not mean that stock should be repurchased at a price above intrinsic value. Correspondingly, a stock that sells well below intrinsic value should be repurchased whether or not stock has previously been issued.
Calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base.
Buffett in his own words on camera. Transcribed from the interview; click through to watch the moment.
Intrinsic value for sure is not something that is precise to the penny. It's probably a band of ten percent or something like that. And my partner Charlie Munger, if you asked us to give you a slip of paper with intrinsic value per share on it, would not be the same figure.