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Berkshire Hathaway
A Gillette Blade Making Machine

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By EliasFardo
July 23, 2003

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Back when I was gainfully employed as an accountant, a coworker of mine once said, "Fardo, you assume that people know what you are talking about." This was back when accountants had a reputation that was slightly higher than drug dealers, international arms smugglers and politicians.

But, I know what he meant.

In accounting for transactions, we accountants often talked about this thing we called Fair Market Value. If one subsidiary sold an asset to another subsidiary, it was to be recorded at Fair Market Value. If the assets of a company were acquired, the purchase price of those assets was to be allocated over the assets based on their individual Fair Market Values. There was no reference book that would tell us what FMV was, since often these were one of a kind assets, and certainly had no quoted price.

Take Gillette. What if the assets of Gillette were sold. The purchaser would record those assets based on their FMVs. Some assets, like cash, are easy. Other assets, such as receivables and inventory, which will be converted to cash in just a few months, are a little harder. But what about a blade making machine? Gillette makes these machines, they don't buy them. They take some purchased parts, and have machinists perform the steps necessary to make this unique piece of equipment.

The market price of such a machine is almost zero. The items it produces are protected by all kinds of patents; no one else can legally produce from it. So the machine would not be worth much to a competitor. There may be parts off it that are of some value, but much of the machine is only worth scrap value. But the value to Gillette is immense. It produces a very valuable product. So what is FMV to Gillette?

One way of computing such a value is an enterprise method. What is the production of this machine worth? Another way of computing such a value is replacement cost. What would it cost Gillette's engineers to make another machine like it? If I was an Enron cost accountant, I would value it at three times the higher of those two amounts. But, being an honest accountant, I would value it at the lower of the two.

But even that doesn't get you there. What are those two amounts? I would end up talking to engineers, and maybe cost accountants, but to a great extent I would be on my own - unless we wanted to spring for some outside experts.

The same problem occurred when we were looking at an acquisition. Almost everything I saw was some private, family business. No market quotes here. You were given a set of financial statements, if you were lucky they were audited, and maybe some package from a broker or investment banker. And then you were asked, "What is this company worth?" It would be passed from person to person with that same question. Knowing that we would never pay as little as what I suggested, I always felt safe giving an opinion.

But, the desired result in what I discussed above was usually to discover market value. This is not what an asset was priced at on a market, for there was no market. It was what this asset was worth to an informed, rational buyer or seller. It was not manic/depressive market price, but a fair market value, or a rational market value, or a reasonable market value. So for me, the idea of some kind of market value, completely independent of market price, is not some abstract idea, but something that I actually lived and worked with. So, I get back to my coworker's comment. I assume that everyone has some experience with the determination of the value of an asset, when there is little or no outside pricing information.

Just today, I have discovered a new advantage from my background in accounting. I always knew that being able to read financial statements was a big plus to investors. I have prepared or helped to prepare hundreds of them, so I have a good working understanding of them. But I never imagined that being exposed to the uncertainty of asset valuations, purely for accounting purposes, had any benefit to an investor. So, for what passes for thought processes in my head, the idea of market value has all kinds of meanings, depending the circumstances and type of asset. I do not immediately think market price.

I know, to many, the common usage of the term market value is market price. But in the world I come from, there is not always a price; you are forced to determine it for yourself. In my world, value has many meanings. So, I do not habitually cede the determination of market value to the quoted prices. I go ask a cost accountant.


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