Each year for nearly half a century, Berkshire Hathaway (NYSE:BRK.B) has provided an annual letter to shareholders that discusses the gains it has produced for holders of its common stock. In 2012, according to its letter, that gain was $24.1 billion. Some $1.3 billion of that gain was used to repurchase Berkshire shares, leaving a $22.8 billion “increase in net worth” that the company retained. Over nearly 50 years, the company's shareholders’ equity, or book value, has grown almost 20% annually. Below, we discuss how analyzing shareholders' or owners’ equity is among the most important exercises for investors and shareholders.
What Do the Major Owners’ Equity Sections Tell an Investor?
Berkshire Hathaway’s book value growth over time has been relatively easy to measure. This figure is relatively clean, because Chief Executive Warren Buffett rarely buys back stock or issues additional shares, and he has never paid a dividend. For this reason, its growth in book value is a relatively good gauge for the returns shareholders have earned over the company’s history. At the end of 2012, the company's total shareholders’ equity grew to $191.6 billion and consisted primarily of retained earnings, which grew to $124.3 billion and is simply the earnings that have been reinvested back into the business over the years.
Berkshire Hathaway’s Shareholders’ Equity Section - 2012:
Looking at the equity section table above, analysts need to become familiar with some line items:
Statement of Changes in Owners' Equity
Another insightful financial statement that is not relied on enough is that of changes in owners' equity. As the name implies, it lets shareholders look at how owners’ equity has changed over time. For Berkshire, its 2012 statement goes back three years. It says Berkshire issued common shares that increased paid-in capital, that AOCI grew by more than $10 billion because of investment appreciation, and retained earnings increased as profits were retained. Treasury stock was purchased over the past two years, as were non-controlling interests in other businesses.
Less Common Owners’ Equity Line Items
Less common items are reflected in book value. For example, the drawing account is used for businesses that aren’t incorporated or publicly traded. The drawing account tracks any money that a business owner takes out of the business. If the business has several partners, each partner gets his or her own drawing account. Private firms can also have employee stock ownership plans (ESOP) that issue shares to employees. Loans to ESOPs, such as to fund them initially, represent a contra account and reduce the value of shareholders’ equity.
Important Items to Look Out for When Analyzing the Shareholders’ Equity Sector
Analyzing and tracking a firm’s growth in book value over time is a valuable exercise, especially for stable firms such as Berkshire Hathaway. Basically, this investigates how well (or badly) a firm is managing the capital that shareholders have invested in the company. However, it is important to note that this looks at accounting and historical cost, not market value. Market value is reflected in how well a company’s share price performs over time. Over the long haul, it should resemble book value growth as it has done for Berkshire. Warren Buffett has detailed that book value growth has been a conservative measure as Berkshire's profits are taxed over time, where shareholders can and have owned the stock for many years, avoiding taxes as unrealized long-term gains build. But there can be significant differences over the short term.
Analyzing tangible common equity also has great value. This strips out the value of goodwill and other intangible assets on the balance sheet. Tangible book is meant to more closely analyze the value for a firm if it was liquidated and the proceeds were paid out to shareholders.
Return on equity (ROE) is another important determinant of whether a company is doing its job for shareholders. An ROE in double digits basically indicates a firm is managing shareholder capital well. The higher the better. Below is an overview of Berkshire's ROE to demonstrate that it stacks up well against its insurance industry, but not as well compared to the financial sector:
|Return on Equity (TTM)||9.44||8.76||23.52|
|Return on Equity - 5 Yr. Avg.||7.13||2.87||22.43|
The Bottom Line
Analyzing owners’ equity is an important analytics tool, but it should be done in the context of other tools such as analyzing the assets and liabilities on the balance sheet, the difference of which represents book value. There is also a need to look at the income and cash flow statements for a comprehensive fundamental analysis on a firm.