Berkshire Hathaway 2002 Annual Report Download - page 74

73
The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate
rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future
cash flows are revised. Two people looking at the same set of facts, moreover — and this would apply even to Charlie and
me — will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give
you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we ourselves use to
calculate this value.
Meanwhile, we regularly report our per-share book value, an easily calculable number, though one of limited use.
The limitations do not arise from our holdings of marketable securities, which are carried on our books at their current prices.
Rather the inadequacies of book value have to do with the companies we control, whose values as stated on our books may
be far different from their intrinsic values.
The disparity can go in either direction. For example, in 1964 we could state with certitude that Berkshire's per-
share book value was $19.46. However, that figure considerably overstated the company's intrinsic value, since all of the
company's resources were tied up in a sub-profitable textile business. Our textile assets had neither going-concern nor
liquidation values equal to their carrying values. Today, however, Berkshire's situation is reversed: Now, our book value far
understates Berkshire's intrinsic value, a point true because many of the businesses we control are worth much more than
their carrying value.
Inadequate though they are in telling the story, we give you Berkshire's book-value figures because they today serve
as a rough, albeit significantly understated, tracking measure for Berkshire's intrinsic value. In other words, the percentage
change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value.
You can gain some insight into the differences between book value and intrinsic value by looking at one form of
investment, a college education. Think of the education's cost as its "book value." If this cost is to be accurate, it should
include the earnings that were foregone by the student because he chose college rather than a job.
For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its
economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that
figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which
must then be discounted, at an appropriate interest rate, back to graduation day. The dollar result equals the intrinsic
economic value of the education.
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.
THE MANAGING OF BERKSHIRE
I think it's appropriate that I conclude with a discussion of Berkshire's management, today and in the future. As our
first owner-related principle tells you, Charlie and I are the managing partners of Berkshire. But we subcontract all of the
heavy lifting in this business to the managers of our subsidiaries. In fact, we delegate almost to the point of abdication:
Though Berkshire has about 45,000 employees, only 12 of these are at headquarters.
Charlie and I mainly attend to capital allocation and the care and feeding of our key managers. Most of these
managers are happiest when they are left alone to run their businesses, and that is customarily just how we leave them. That
puts them in charge of all operating decisions and of dispatching the excess cash they generate to headquarters. By sending it
to us, they don't get diverted by the various enticements that would come their way were they responsible for deploying the
cash their businesses throw off. Furthermore, Charlie and I are exposed to a much wider range of possibilities for investing
these funds than any of our managers could find in his or her own industry.
Most of our managers are independently wealthy, and it's therefore up to us to create a climate that encourages them
to choose working with Berkshire over golfing or fishing. This leaves us needing to treat them fairly and in the manner that
we would wish to be treated if our positions were reversed.
As for the allocation of capital, that's an activity both Charlie and I enjoy and in which we have acquired some
useful experience. In a general sense, grey hair doesn't hurt on this playing field: You don't need good hand-eye
coordination or well-toned muscles to push money around (thank heavens). As long as our minds continue to function
effectively, Charlie and I can keep on doing our jobs pretty much as we have in the past.