Long-term Berkshire Hathaway (BRK.A 0.52%) (BRK.B 0.48%) investors are incredibly happy. For decades, this one stock has consistently beaten the market. Since its inception, its average annual returns have been about 20% -- roughly double the performance of the S&P 500.
But is Berkshire stock still a buy today? If you want to set your portfolio up for success, keep reading.
Is Berkshire stock too expensive at $470 per share?
For years, Berkshire's chief executive officer, legendary investor Warren Buffett, described book value as a reasonable way to gauge the company's valuation. After all, the company was essentially a vast and complex conglomeration of disparate assets. By looking at the company's price-to-book ratio, you could see how the market was valuing these assets, in a very rough way.
In the past, Buffett believed that Berkshire's assets were worth at least 1.1 times book value, or the value of the assets as recorded on the balance sheet. So he initiated share buybacks whenever the valuation fell that low, arguing that buying back stock at a discount to book value was a great way to increase shareholder value. He later upped the buyback threshold to 1.2 times book value -- meaning Berkshire would buy back stock whenever the market valued the stock at less than 1.2 times the stated accounting value of its assets.
More recently, however, Buffett has ditched the price-to-book ratio threshold altogether. That's seemingly convenient give shares trade at a multi-year high valuation of 1.6 times book value. But there's good reason for the shift. Berkshire has been buying back billions of dollars in stock every quarter. These moves, while accretive to shareholder value, actually tend to suppress the stated accounting book value of the company. So it's a wise move for shareholders, but it artificially depresses book value. The result -- everything else being equal -- is that Berkshire's price-to-book ratio will rise, even though shares aren't necessarily getting more expensive.
The best way to value Berkshire Hathaway stock
So how do we value Berkshire stock today? To accomplish this, investors need to ask a different question: How long will Berkshire's business model continue to perform better than the market?
It's true that Berkshire looks expensive on a price to book basis right now. Although as we've discussed, the premium is partially inflated due to massive share buybacks. But what investors should really be paying attention to is how much money Buffett and his team are actually generating for shareholders. There's been some volatility, but in recent years, returns on equity and annual book value growth have both hovered at roughly 10%. And remember, those figures are slightly undercounted given share buybacks have negatively impacted stated book value. Yet despite that accounting headwind, returns are still at or above 10% on average.
BRK.B Price to Book Value data by YCharts
If Berkshire is able to keep returns above 10% per year despite share buyback pressures -- a feat that is very possible considering the company benefits from several structural competitive advantages -- shares are likely a buy even if the current multiple suggests shares are overvalued versus historical averages. Consider this: there has never been a bad time to buy Berkshire stock in the past. Even if you bought right before the financial crisis, the bursting of the dot-com bubble, or the pandemic flash crash, you're portfolio still would have performed very well over the long term. Paying a premium for a bluechip stock like this is a no-brainer if you're patient. That upfront premium, spread over a decade or more, becomes quickly diluted.
Is Berkshire stock expensive as it hovers around the $470 per share mark? Many would argue yes. But is it so expensive that long term shareholders should ditch the stock? Absolutely not. Whether you own the stock already or are interested in diving in, don't let the current valuation prevent you from taking a long term position.
