Feb 5th, 2007 by Martin Lee
Book Value, Intrinsic Value & Market Value
Let’s look at these 3 terms which are discussed at the start of this letter.
Book value is just an accounting term that measures the capital (including retained earnings) that has been put into a business.
Intrinsic value is the present-value of the cash that can be taken out of the business during it’s remaining lifespan. As there is no way we can know the performance of a company in the future, therefore this value has to be estimated.
Market value is simply a price of the share of the company that is quoted on the stock exchange.
Intrinsic value is usually unrelated to book value. Berkshire is an exception and while the two values are different, the book value can be used as a device for tracking the progress of the intrinsic value.
In the long run, the market price and intrinsic value of a company will arrive at about the same price but in the short term, these two prices could be significantly different.
As an example, Berkshire’s book value and intrinsic value both grew by about 14% in 1993, while the market value grew by 39%.
Having said that, Warren Buffett still views Berkshire’s market price as appropriate if (a very big IF) they can continue to meet Berkshire’s long term goal of increasing their intrinsic value at an average annual rate of 15% (in a world of 6-7% long term interest rates). With an ever increasing capital base, this target is getting more and more difficult to meet.