Source: Golden Ten Data
A margin of safety can be provided if shareholders' equity is sufficient relative to the company's market value.
Warren Buffett for$Berkshire Hathaway-A (BRK.A.US)$We are proud to have accumulated the largest shareholder equity in an American company. At the end of the first quarter, Berkshire's total shareholders' equity reached an astonishing $572 billion, far higher than the second-ranked$JPMorgan (JPM.US)$$337 billion. Shareholders' equity is the net value of a company's assets minus its liabilities. It is a measure of a company's net assets.
“It really shows what you can do if you save money for a long time, and there's really no need for miracles,” Berkshire CEO Buffett said at the May annual conference.
Since Buffett took over the company in 1965, Berkshire's shareholders' equity has grown from around $20 million to its current level through steady profit compounding, successful acquisitions, and smart equity investments.
Although Buffett is concerned about this indicator, most investors don't pay attention to shareholders' equity, which is also known as the company's book value. This indicator is viewed as an outdated financial indicator that deep value investors like, for companies with high profits but few shareholder rights, such as Apple (AAPL.O) and$NVIDIA (NVDA.US)$Waiting doesn't make much sense. Investors are generally concerned about profit because it is a key driver of share prices, yet shareholder equity is still relevant.
Shareholders' equity can provide a margin of safety compared to the company's market capitalization, in the terms of Buffett's mentor and legendary value investor Benjamin Graham.
Many companies, including banks, insurance companies, and Berkshire, still base their valuations on book value. For example, Berkshire's stock traded at about 1.5 times its March 31 book value. Over the past five years, the average trading price of Berkshire shares was 1.4 times the book value. Berkshire Class A shares closed at $608,816 on Wednesday.
According to data compiled by Bloomberg as of December 31, 2023, “Barron's”$S&P 500 Index (.SPX.US)$The companies with the highest absolute level of shareholders' equity among companies were selected. In the table below, we also show the net market ratio of these 10 companies.
The eight companies that followed Berkshire and J.P. Morgan in that order were$Bank of America (BAC.US)$,$Alphabet-A (GOOGL.US)$,$Exxon Mobil (XOM.US)$,$Citigroup (C.US)$,$Microsoft (MSFT.US)$,$Amazon (AMZN.US)$,$Wells Fargo & Co (WFC.US)$und$Chevron (CVX.US)$.
The tenth-ranked Chevron has $162 billion in shareholder equity.
The companies ranked second and third by market capitalization are not on the list. Apple, which ranked second, had shareholder equity of 74 billion US dollars on March 31, while Nvidia, which ranked third, was only 43 billion US dollars, accounting for only a fraction of its current market value of 2.8 trillion US dollars.
There are limitations to using shareholders' equity as a valuation indicator, and Buffett admits this. First, many investors are concerned about tangible book value, that is, shareholders' equity does not include goodwill and most other intangible assets from acquisitions. This “hard” book value is a better measure of assets such as cash, real estate, factory, and equipment, and provides a better bottom line for stocks than total shareholders' equity.
Buffett pointed out at the annual meeting that J.P. Morgan Chase's return on equity is higher than Berkshire, and the latter's return on operating profit after tax is less than 10%. Apple's return on equity is over 100%. A high return on equity is usually associated with a high price-earnings ratio.
Furthermore, large-scale share buybacks can reduce shareholders' equity and make them less important. For example, Apple has carried out one of the nation's most aggressive buyback programs in the past decade. Berkshire has also made numerous share buybacks over the past five years, and some believe book value is less relevant to the company than it used to be.
Despite its flaws, book value can still be used as a way to screen for cheaper stocks.
Notably, even if Citigroup's stock price rose 20% this year, its share price was only 60% of book value. Citi's bullish reasons are partly due to its deep discounts on book value and measures taken under CEO Jane Fraser to increase bank returns.
Both Bank of America and Wells Fargo share prices are 1.1 times their book value, even though losses of more than $100 billion on Bank of America's $600 billion bond portfolio are not reflected in their shareholders' equity according to accounting rules.
Tech giants Microsoft, Amazon, and Alphabet all trade at high net market ratios. For them, shareholder rights are no longer the focus of most investors. Despite this, a component of shareholders' equity — cash — is still highly valued by investors. All three companies have plenty of cash.
Editor/jayden