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Berkshire Hathaway
Re: Book Value

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By DeliLama
December 29, 2005

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In my opinion, it depends on what you're really trying to figure out. If you're trying to determine the liquidation value of a business, then you should remove intangibles that aren't likely to have any resale value. I'd throw away any goodwill on the balance sheet. Some intangibles do have value such as a set of patents which either generate license revenues or protect the owner from having the pay them. If you're not looking at a liquidation value, then you should pick a technique and stick with it for comparison purposes. But it's probably a good idea to look for cases where the asset value on the balance sheet isn't an accurate reflection of reality. Time is a good way to check this, looking back at results over long time periods.

Inventory can range anywhere from scrap to being worth more than stated value on the balance sheet. You need to know the details of the inventory to know where it stands.

Land can also be a huge wild card. Since it's usually stated on the books at cost, it can be enormously larger than it appears. If a business bought a chunk of land in downtown Manhattan in the 1950s, you'd want to do a sanity check on the carrying value; it might dwarf all the other assets in value. I've seen businesses that routinely pull equity from thin air by selling assets above book value.

For accounts receivable, you might want to take the provision for doubtful accounts and multiply it by 2 or 3 and decrease the receivables just to be safe. But you'd want to check their track record for provisions vs. write-offs (in general for all assets, look for "big bath" write-offs of assets every 5 years or so, which are signs of stuff carried on the books at too high of a value).

Property, plant, and equipment will always have some amount of depreciation associated with it. Check the depreciation rates in the notes to see if they make sense. How closely do capital expenditures match up with depreciation over the long term?

In general, what you want to do is walk through the assets portion of the balance sheet, looking at the Notes section of the financial statement (generally you'll only find this in the most recent annual report). So you end up with a list of items and values for those items. The total will likely end up smaller than what is stated on the balance sheet. You'd subtract the difference from equity, leaving the liabilities untouched (well, you'd probably want to walk through the liabilities and the Notes on them to see if any are really larger than they appear).

When it comes to dividing the common stock shareholders' equity by the share count, I use three different measures (these are not standard terms or measures). The first is "diluted shares" which is typically whatever the company claims as their diluted share count. This doesn't count stock options or warrants or convertibles which have a strike price higher than the current stock price (at the time of the statement). But if you're looking for good investments, you're typically only going to buy stocks that you expect to go up substantially in price (unless most or all of the earnings are paid out in dividends and it's a mature market).

So I generally consider "fully diluted shares" to include every stock option and warrant, even those that are "anti-dilutive" (you can usually get this information from the Notes). If you need better accuracy, you should add in the amount of cash equal to the average strike price multiplied by the number of options and warrants and convertibles outstanding (convertibles can be even more complicated if you need more precision).

If I really want to get an upper bound on the number of shares, I'll increase the "fully diluted share" count by some amount to include options and warrants and convertibles that might be issued and exercised before I end up selling the stock. Keep in mind that even the authorized maximum share count can be increased. These terms for dilution are not official terms. I just use them for my own convenience.

That's my own views on calculating book value.

DeliLama


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