How Warren Buffett Would Calculate Your Intrinsic Value (And How You Should, Too)

Warren Buffett is cheap, dirt cheap. And if you think I’m being critical, than you got me all wrong. But to prove my point, check out his company’s website–I’ll wait. . . .

Are you back, yet? If you haven’t spent much time on his website, you should. One thing you’ll find are his letter’s to the shareholders of Berkshire Hathaway. Throw away all those “best-sellers” you find at the bookstore and just read his letters–it’s all you need.

One thing you’ll find is that he starts all his letters the same way, talking about his company’s book value. Here is the first paragraph of his last letter: “Our gain in net worth in 2006 was $16.9 billion, which increased the per-share book value of both our Class A and Class B stock by 18.4%. Over the last 42 years (that is, since present management took over) book value has grown from $19 to $70,281, a rate of 21.4% compounded annually.”

Now, if you have any question as to just how amazing that is, plug in 21.4% in a retirement calculator to see what your savings would look like in 30 years. For our purposes, though, the question is why does Mr. Buffet go right to Berkshire’s net worth? What about revenue or net income? Why not showcase whatever number happens to look best each year? Not Warren Buffett, because he knows the importance of net worth. All the other financial numbers are a means to an end–net worth.

So how would Mr. Buffett calculate your intrinsic value? By your net worth. He wouldn’t look at how much you make (at least at first) or how much you spend. He would want to know what your worth and the quality of your assets. Do your assets generate income (e.g., rental property) or increase in value (e.g., stocks), or do they only depreciate (e.g., cars)? And if you were one of his subsidiaries, each year he’d want to know by how much you increased your net worth.

If you don’t track your net worth, you should. I include only assets that go up in value, so cars, boats and furniture never find their way onto my balance sheet. And of course, all liabilities are included on the balance sheet. The result is my book value, and I compare it from year to year to see how I’m doing.

One of the big advantages of this process is it makes me think about how I can improve my net worth. I consider how each major purchase or investment will impact the bottom line. That’s how Warren Buffett thinks about his company, and it’s how we should think about our own finances.

Topics: Investing

6 Responses to “How Warren Buffett Would Calculate Your Intrinsic Value (And How You Should, Too)”

  1. Amused Peasant

    That’s all very fascinating but there are blue skies, white waves, green hills, lush forests and none of those things cost a thing. I can’t imagine why your net worth would actually matter, unless you intended to do something philanthropic with it and let’s face it, which of us mortals is going to be playing in those leagues? I’m sure your house is nice and big though. Problem is, you’re too busy spending all those hours increasing your net worth to have much time to enjoy it…

  2. Steven, you are right of course that buying the car and not including it on your balance sheet will decrease your net worth in one day. I know folks who depreciate assets as you’ve suggested, and that’s certainly another approach. I don’t follow it because it’s too much trouble and because the car will eventually be written down to a zero value anyway. I also don’t want to take any financial comfort from buying a depreciating asset by putting it on my balance sheet for a few years while it depreciates. That said, I do include the equity in my cars when calculating how much money I could generate in an emergency.

  3. Hmmmm … you don’t include depreciable assets? The trouble with that is that when you go buy that car, it would look like your net worth dropped by a big chunk in one day. That’s artificial, no? Doesn’t it make more sense to depreciate per month or quarter? Is it just too much work?

  4. Excellent. I started using the financial program Gnucash a few months ago which will automatically provide you with a balance sheet and your net worth whenever you want. Of course it’s up to you to enter all your assets, liabilities, income and expenses. I never really understood stuff like net worth and equity until I could see it for myself.

Leave a Reply