it's per-share intrinsic value, not book value, that counts. Book value is an accounting term that measures the capital, including retained earnings, that has been put into a business. Intrinsic value is a present-value estimate of the cash that can be taken out of a business during its remaining life
Coca-Cola and Gillette, both large holdings of ours, enjoyed
market price increases that dramatically outpaced their earnings
From 1991 to 1993, Coke and Gillette increased their annual
operating earnings per share by 38% and 37% respectively, but
their market prices moved up only 11% and 6%. In other words,
the companies overperformed their stocks, a result that no doubt
partly reflects Wall Street's new apprehension about brand names.
Whatever the reason, what will count over time is the earnings
performance of these companies.
Coke went public in 1919 at $40 per share. By the end of 1920 the market, coldly reevaluating Coke's future prospects, had battered the stock down
by more than 50%, to $19.50. At yearend 1993, that single share,
with dividends reinvested, was worth more than $2.1 million. As
Ben Graham said: "In the short-run, the market is a voting
machine - reflecting a voter-registration test that requires only
money, not intelligence or emotional stability - but in the long-
run, the market is a weighing machine."
look-through earnings consist of: (1) the operating earnings reported in the previous section, plus; (2) the retained operating earnings of major
investees that, under GAAP accounting, are not reflected in our
profits, less; (3) an allowance for the tax that would be paid by
Berkshire if these retained earnings of investees had instead been
distributed to us. The "operating earnings" of which we speak here
exclude capital gains, special accounting items and major
Employing data bases and statistical skills, these academics compute with precision the "beta" of a stock - its relative volatility in the past - and then build arcane investment and capital-allocation theories around this calculation. In their hunger for a single statistic to measure
risk, however, they forget a fundamental principle: It is better
to be approximately right than precisely wrong.
In our opinion, the real risk that an investor must assess is
whether his aggregate after-tax receipts from an investment
(including those he receives on sale) will, over his prospective
holding period, give him at least as much purchasing power as he
had to begin with, plus a modest rate of interest on that initial
As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: "Competition may prove hazardous to human wealth."
The competitive strengths of a Coke or Gillette are obvious to
even the casual observer of business. Yet the beta of their stocks
is similar to that of a great many run-of-the-mill companies who
possess little or no competitive advantage. Should we conclude
from this similarity that the competitive strength of Coke and
Gillette gains them nothing when business risk is being measured?
Or should we conclude that the risk in owning a piece of a company
- its stock - is somehow divorced from the long-term risk inherent
in its business operations? We believe neither conclusion makes
sense and that equating beta with investment risk also makes no
Another situation requiring wide diversification occurs when
an investor who does not understand the economics of specific
businesses nevertheless believes it in his interest to be a long-
term owner of American industry. That investor should both own a
large number of equities and space out his purchases. By
periodically investing in an index fund, for example, the know-
nothing investor can actually out-perform most investment
professionals. Paradoxically, when "dumb" money acknowledges its
limitations, it ceases to be dumb.
On the other hand, if you are a know-something investor, able
to understand business economics and to find five to ten sensibly-
priced companies that possess important long-term competitive
advantages, conventional diversification makes no sense for you.