2013: How will book value compound relative to the S&P 500?

CAROL LOOMIS: Warren, you measure Berkshire — this is from William Bernard (PH) of Colleyville, Texas.

You measure Berkshire’s corporate performance based on growth and book value per share. The table on page 103 of the annual report shows book value per share has grown at less than an average 12 percent a year for 9 of the last 11 5-year periods, yet in your last annual letter, you state, quote, “The S&P 500 earns considerably more than 12 percent on net worth,” and then you say, “That seems reasonable for Berkshire also.”

Why do you say that, given the past record showing that Berkshire has not been earning that much, or is it that you expect to earn that much, recognizing that it is not assured in the future?

WARREN BUFFETT: It certainly is not assured in the future. And the last ten or so years have not been the best for business, generally.

But if the stock market continues to behave in 2013 as it has so far, this will be the first five-year period where the gain in book value per share has fallen short of the market performance, including dividends, of the Standard & Poor’s.

And that won’t be a happy day, but it won’t be — it won’t totally discourage us because it will be a period where the market has gone up in every one of the five years. And as we’ve regularly pointed out, we’re likely to be better in down years as we did in 2008, for example, which is the year that gets dropped this year. We’re likely to do better in down years, relatively, than we do in up years.

Charlie, how do you feel about the prospects of — I should point out, incidentally, that we use book value because it’s a calculable figure, and it does serve as a reasonable proxy of the year-to-year change in the intrinsic value of Berkshire.

If we could really give you a figure for intrinsic value, and back it up, that would be the important figure.

As I pointed out, if we gain a million policyholders at GEICO, that actually adds a billion-and-a-half to intrinsic value, and it doesn’t add a dime to book value.

So, there’s a significant gap, which is why we’re willing to buy in stock at 120 percent of book value — a significant gap between the two. But book value is a useful tracking device.

I should point out also — I did this in the annual report in respect to Marmon — when we buy the ISCAR stock, which we pay about 2 billion for, the day we buy it, we mark it down in terms of our book value by roughly a billion dollars.

So a billion dollars comes off our book value for making a purchase which we regard as quite satisfactory. And so there are these distortions that occur.

But in the end, we have to do better for you than you would do in an index fund. And if we don’t, we aren’t earning our pay.

And I think we’ll do that in the future, but I don’t think we’ll do it every year, and we’ve proven that in the last few years.

Charlie?

CHARLIE MUNGER: Well, I confidently expect that Berkshire’s going to do quite well over the long term.

I don’t pay much attention to whether it’s five years or three years or — I think we have momentums in place that are going to do OK.

Of course, we won’t do as well in the future, in terms of annual gain averaged out, because our past returns were almost unbelievable.

So, we’re slowing down, but I think it’ll still be very pleasant.

WARREN BUFFETT: At 89, Charlie is not really concerned about this stuff year-to-year. I mean, he’s taking a longer-range view. (Laughter)

CHARLIE MUNGER: I’m trying to take care of my old age, which might come on at any time. (Laughter)

WARREN BUFFETT: I haven’t noticed it.