It's the penultimate day of 2015, and U.S. stocks are lower in early afternoon trading, with the Dow Jones Industrial Average (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) down 0.29% and 0.33%, respectively, at 12:30 p.m. EST. Shares of Warren Buffett's conglomerate Berkshire Hathaway are underperforming slightly, down 0.45%, adding to the deficit they have accumulated up relative to the S&P 500 in 2015 of nearly 14 percentage points (on a total return basis), their worst relative performance since 2009.
Berkshire's underperformance this year is inopportune, as the Financial Times noted yesterday:
The underperformance comes in Mr Buffett's Golden Anniversary year at the helm, when he told investors for the first time that they should judge his record based on Berkshire's share price, rather than just the book value of the company, which had been his preferred yardstick for decades.
However, to be fair to Buffett, he has never suggested a one-year period was an appropriate basis for comparison. Instead, he recommends shareholders evaluate him on a rolling five-year basis, and as recently as his 2012 Annual Letter, Buffett was able to write that "we've never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch."
That streak ended with 2013, and as the following graph shows, Berkshire will record another "miss" for the five-year period to the end of 2015 -- whether measured on the basis of an increase in the per share book value or the share price.
For anyone (such as this columnist) who believes reversion to the mean is real, and Berkshire Hathaway is not in structural decline, this observed underperformance spells opportunity. Indeed, at 1.33 times book value, shares now look attractively priced. Just listen to the person who is best placed to know: Warren Buffett himself.
In Sept. 2011, Berkshire Hathaway announced an unusual -- by the standards of U.S. corporations, not economic logic -- open-ended share repurchase program. Around the turn of the century, Buffett had vowed to his shareholders that "[w]e will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated." Sure enough, the share repurchase announcement confirmed that principle:
Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10% premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise.
Roughly 18 months later, the company announced it was raising the ceiling price on its buybacks to a 20% premium over book value. In other words, Buffett believed the shares were worth "considerably more" than 1.2 times book value. For him, "considerably more" means more than the current multiple 1.33. (He once quipped, "We don't like things we have to carry out to three decimal places.")
So, what is Berkshire's stock worth? In a presentation dated Nov. 9, hedge fund manager and longtime Buffett-watcher Whitney Tilson values Berkshire's at $267,000 for a class A share, equivalent to $178 for a class B share -- roughly a third above yesterday's closing price of $134.14 and a 77% premium over their book value. Tilson sees the intrinsic value increasing to $194 per B share over 12 months, which implies "6% annual growth of intrinsic value in the business plus [$5.33 per B share] in cash build."
Of course, even if you accept Tilson's intrinsic value estimates, there is no certainty the stock price will converge to its intrinsic value over the next 12 months. However, the longer your timeframe, the higher the odds this will occur.
As such, here is my prediction for the next five years: Berkshire Hathaway shares will, at minimum, outperform the S&P 500 by 20 percentage points on a cumulative basis. Five lean years, five fat years.