Berkshire Hathaway and Value Investors Part IIVW Staff
A frequently asked question is, “When does one recognize that an investment mistake has been made?” In other words, what quantifiable loss rate would be necessary to establish an investment thesis as fallacious? In order to explore this question, let us assume that one purchased shares of Berkshire Hathaway on December 31, 1972 at a modest 11.3% premium to stated book value.
See part I here
The investment thesis might well have been that the Berkshire approach to value investing was likely to produce substantial growth in net asset value. Furthermore, intrinsic value might have been higher than stated book value. For instance, the Berkshire investment in the Illinois Bank and Trust Co. of Rockford produced a then exceptional 2.2% return on average deposits, and Cornhusker Casualty was producing growth far in excess of industry standards. Furthermore, Berkshire Hathaway had just borrowed $20 million from twenty institutional lenders at 8% with a maturity date of March 1, 1993. One might well have anticipated the inflation that was about to significantly reduce the maturity value of this loan.
As reasonable and correct as this investment thesis obviously would have been, the investment community of that era did not agree. Berkshire Hathaway shares lost 10.1% of their value in 1973, 43.7% of their value in 1974, and another 5% of their value in 1975. It should be observed that the S&P 500 lost 14.8% in 1973, 26.4% in 1974, and produced a return of 37.2% in 1975. Thus, the hypothetical investment in Berkshire Hathaway in 1972 would have produced a 51.9% loss at the end of three years. In contradistinction, the S&P 500 recorded a 14.0% loss in the same time period.
Berkshire Hathaway stock also underperformed the S&P 500 in 1972 when the shares produced a return of 14.5% versus an 18.4% gain for the index. During this time period, Berkshire Hathaway recorded a 63.9% gain in book value. In fairness to investors of the era, the selling pressure upon Berkshire Hathaway was logical, if nevertheless incorrect. Berkshire Hathaway produced a 4.7% gain in book value in 1973 and a 5.5% gain in book value in 1974.