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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 212026  
Subject: Berkshire's P/B Date: 1/24/2013 9:43 AM
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It seems like a long time ago, but Berkshire's highest P/B over the past two years was 1.38 on 2/28/2011 which was the first trading day after the 2010 annual report was posted. The closing price was $131,300 and 12/31/10 book value was $95,453. With 12/31/12 book value probably in the neighborhood of $113K, shares would need to reach about $156K to achieve the same P/B that prevailed two years ago after the annual report was released.

Berkshire's P/B was in the 1.4-1.45x range in September 2010. This would imply a range of $158K to $164K based on likely 12/31/12 book value.

I would not be able to accurately predict Berkshire's stock price if my life depended on it. But I do not view the current 52 week highs to be very dramatic given the still significant advances required just to reach valuation levels that prevailed two to three years ago at a time when the economy was much more fragile than it was today and market sentiment was generally much less positive.
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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198100 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 9:49 AM
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With 12/31/12 book value probably in the neighborhood of $113K...

Incidentally, I should mention that current BV may be closed to $115K based on the YTD stock market rally's impact on the publicly traded equity portfolio and the derivatives portfolio, along with another month of earnings. Not that month-to-month changes in book value are that meaningful necessarily but something to think about when we start reading about "Berkshire reaching record highs", possibly in the not so distant future.

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Author: ssalz Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198101 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 10:23 AM
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Let's say that in the near future, the stock market "bubble" (my interpretation) bursts and that there is a 35% drop in stock market prices across the board. What does that do to the price (value?) of BRK's holdings and Book Value? While you are at it, can you price in a 50% drop?

Thanks, Dr. Steve

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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198102 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 10:52 AM
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Let's say that in the near future, the stock market "bubble" (my interpretation) bursts and that there is a 35% drop in stock market prices across the board. What does that do to the price (value?) of BRK's holdings and Book Value? While you are at it, can you price in a 50% drop?

Obviously Berkshire's book value would drop under such circumstances and Berkshire's stock price would not be immune to a broad based market decline (as 2008-2009 shows). I know that some Berkshire shareholders model Berkshire's intrinsic value not using the market value of the securities portfolio but their estimate of the intrinsic value of each of the securities that are held. I've never done that although it would be interesting to go through that exercise for the top 5 or 10 holdings.

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198103 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 11:46 AM
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Let's say that in the near future, the stock market "bubble" (my interpretation)
bursts and that there is a 35% drop in stock market prices across the board.


I'm pretty well known to be at the fairly far bearish end of the
spectrum in terms of estimating fair value for the broad US market.

Picturing a scenario of a crash to a level of severe undervaluation isn't
much use, as it wouldn't last forever--it would just be undervalued for a while.
But a drop from current levels to fair value should be considered.
Last time I did that I figured it would take about $14000 off book/share.
(not counting the reduction in deferred tax liabilities)
That blithely assumes that Berkshire's portfolio is as overvalued as the average stock,
which is probably not the case but is pretty hard to estimate.

Note that a valuation based on investments per share plus K times non-investment
related income per share would drop by 14k in this case, not a multiple of 14k.
Price book is a more primitive measure which is why at first you
think you need a multiple on the fall in portfolio value.

Jim

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Author: mildert One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198104 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 12:30 PM
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> I'm pretty well known to be at the fairly far bearish end of the

> spectrum in terms of estimating fair value for the broad US market.

Hi Jim. Yes, indeed and I've read your comments with interest before. One thing I wonder about is the impact low interest rates have on your valuations. I recall Jeremy Siegel saying that the long term avergae PE for US stocks is about 15 but in low interest rate environments, it's higher, at about 19 (fairly sure I remembered these numbers correctly though I don't have the source at hand).

I think Buffett takes the view that interest rate levels affect valuation of securities too, though he hasn't given numbers like Prof. Siegel.
I get the impression that some wouldn't agree: what's your take on that?

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Author: dividends20 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198105 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 12:55 PM
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PE for US stocks is about 15 but in low interest rate environments, it's higher, at about 19

This time its different

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Author: ssalz Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198108 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 2:38 PM
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Thanks, Dr. Steve

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Author: Manlobbi Big red star, 1000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198110 of 212026
Subject: Re: Berkshire's P/B Date: 1/24/2013 9:14 PM
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I recall Jeremy Siegel saying that the long term avergae PE for US stocks is about 15 but in low interest rate environments, it's higher, at about 19 (fairly sure I remembered these numbers correctly though I don't have the source at hand).

Siegel is careful in his analysis but is here confusing what was *common* with what was *right*.

For one year returns the so called Fed model has some small benefit, but less than say buying stocks with momentum.

10 year real returns, what we care about and where the big gains and losses are made, were lower the past century when starting from periods with lower interest rates.

Buffett made he point in his 2000 report, saying that no matter how much you shake analysts they still fall for the trap of thinking that the current environment (pointing mostly but not only to intereat rates) will continue forever.

- Manlobbi

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198112 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 12:33 AM
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I recall Jeremy Siegel saying that the long term average PE for US stocks
is about 15 but in low interest rate environments, it's higher, at about 19.


It's certainly true that the average market multiples aren't the same in
high interest rate environments and low interest rate environments.
(the average multiples are also not the same in high barometric pressure
and low barometric pressure environments)

But prevailing interest rates don't change equity values.
They only change the mood of the market by changing the apparent current
relative attractiveness of equities and bonds.
Thus changes in current interest rates might predict the short term
direction of the market, but they don't change the fair value of the market.

Equities purchased at low multiples of trend earnings will give you
high real returns in the next 5,10,20 years whether interest rates or
real interest rates were high or low when you bought, and vice versa.
If an input doesn't change your returns, it isn't a factor for fair value.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=381480

Perhaps (just perhaps) a better way to slice it is to note that average
market multiples are higher when inflation is relatively normal versus
when it's doing something which tells you the economy is broken.
Say, inflation 0% to 6% might be normal but negative or super high are bad.
"Normal" times, trailing year inflation 0% to 6%:
Average observed multiple of trend earnings since 1871 = 15.1x, average since 1940 15.8x
("normal" inflation seen 56% of the time since 1871, 76% of the time since 1940)

"Abnormal" times, trailing year inflation negative or >6%:
Average observed multiple of trend earnings since 1871 = 11.5x, average since 1940 9.8x

Since inflation is by this definition entirely normal right now one
might speculate that seeing a multiple in the ~15.5x range might make sense.
My estimate of current on-trend earnings is in the rough neighbourhood
of $73 which would put expected S&P level at around 1130 on that view.
The downside of this happier viewpoint is that if/when inflation gets
outside the normal range you'd have to drop your expectations of
"normal" multiples by 30% overnight. Ouch.

I prefer to use a single long run average because you don't wake up
one morning with an entirely different definition of "normal" or "fair".
The average multiple of trend earnings since 1940 has been around 13.8x.
13.8 times $73 would be fair value around S&P 1007 (in Dec 2012 dollars)

Jim

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Author: Grakf One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198116 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 4:19 AM
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Remembering a few snippets from Munger this is why he advocates looking for quality businesses but waiting for fair value or below for purchase with a threshold of cper15. His thoughts on this PER may relate to long term market averages of fair value. If you buy at fair value you cannot go too far wrong if the company is growing earnings at 7% plus even if you have wait 3-5 years for valuation to catch up.

I start to get interested in stocks on my list around the 15 range. Say WMT, and JNJ and more interested around the 10-12 range. TSCO.

There are one or two where earnings quality is so good long term eg KO that PERs above may be considered eg up to 18 but the think KO may be the only one.

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Author: mildert One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198117 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 6:17 AM
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Hi All,

Many thanks for the responses. I tended not to think too much about interest rates in the past but this subject interests me now because of what I found Siegel and Buffett have said. Now I'm not so sure. After some searching I've dug out the Fortune article where Buffett talks about this:

That gets to the first of the economic variables that affected stock prices in the two periods--interest rates. In economics, interest rates act as gravity behaves in the physical world. At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset. You see that clearly with the fluctuating prices of bonds. But the rule applies as well to farmland, oil reserves, stocks, and every other financial asset. And the effects can be huge on values. If interest rates are, say, 13%, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%.

http://money.cnn.com/magazines/fortune/fortune_archive/2001/...

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198121 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 8:19 AM
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At all times, in all markets, in all parts of the world, the tiniest
change in rates changes the value of every financial asset.


It's a famous quote, to be sure.
But it's wrong.

The quote should say "perceived value".

There is no such thing as a risk free rate.
Discounting future cash flows using current nominal T-bond yields is not meaningful in general.
Current bond rates aren't real rates, they're nominal rates.
Short term rates aren't useful indicators of the average into the distant future which is what you'd need to determine firms' future
discounted real borrowing costs which would be a factor in valuation for some of them.
High real average yields are good for firms with low debt and/or net cash, not bad.

In short, changes in interest rates change the value of fixed income
securities purchased now, but not in general the value of equities to any measurable degree.
This changes the relative attractiveness of the two, but not the value of the equities.
Same result empirically: the return you get from equities does not
depend on the prevailing nominal interest rates when you bought.

It's true that a change in relative attractiveness (rational or not)
is enough to move prices for a while, so for some folks it's a distinction
without a difference. But to be precise, the value of the equities hasn't changed.

Jim

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Author: linkmont2 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198123 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 9:51 AM
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it would have been truer to say:

At all times, in all markets, in all parts of the world, the tiniest
change in rates changes the market's valuation of every financial asset.

however, there does appear to be some conditional truth to the original quote. if, for instance, we were to experience a bout of prolonged high real interest rates (pick a reason), then the cost of debt financing would surely negatively impact a co's growth & expansion efforts, extracting higher costs & lower returns

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Author: mildert One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198125 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 12:03 PM
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however, there does appear to be some conditional truth to the original quote. if, for instance, we were to experience a bout of prolonged high real interest rates (pick a reason), then the cost of debt financing would surely negatively impact a co's growth & expansion efforts, extracting higher costs & lower returns


Yes good point. I would have thought therefore that low interest rates mean than business can borrow money more cheaply and that presumably helps ultimately their earnings and thus valuations. I'm not suggesting this is a mighty force but it must have some effect?

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Author: physdude One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198127 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 12:10 PM
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If interest rates are uncorrelated with risk, then this might be true. From theory, expected returns in excess of the risk free rate should be proportional to risk so that expected returns themselves should increase with the risk free rate provided risk is held constant.

However, interest rates decrease in times of high risk and the time variation in risk is probably large enough to wipe out and even reverse the interest rate effect.

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198129 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 12:46 PM
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if, for instance, we were to experience a bout of prolonged high
real interest rates (pick a reason), then the cost of debt financing
would surely negatively impact a co's growth & expansion efforts,
extracting higher costs & lower returns
...
Yes good point. I would have thought therefore that low interest rates
mean than business can borrow money more cheaply and that presumably
helps ultimately their earnings and thus valuations.
I'm not suggesting this is a mighty force but it must have some effect?


No doubt, but it will vary a lot among firms.
Berkshire has net cash, not net debt.
They would gain more from higher real rates on the cash than they
would lose on higher real rates on the debt, so a change in interest
rates has a widely varying effect on different companies.
Higher rates and lower inflation is good for the prudent and cash heavy (and insurers),
lower rates and higher inflation is good for the highly geared.

But in any case what matters is the average real rate that the firm
will realize in the next 30+ years, not today's rate.
Today's nominal rate and changes in today's nominal rate tell you nothing
about the average real rate that firms will pay in the next 30+ years.
The sort of thing that would be an input to this value change would
be (say) when the US drug benefit was enacted, as it probably had
an effect on average long run real interest rates.
I have no idea how to estimate changes in the future long run average
real rate, other than being pretty sure current rates aren't a guide.

Jim

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Author: gamane Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198151 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 8:09 PM
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But prevailing interest rates don't change equity values.
They only change the mood of the market by changing the apparent current
relative attractiveness of equities and bonds.
Thus changes in current interest rates might predict the short term
direction of the market, but they don't change the fair value of the market.


Jim,

I'm not sure Buffett agrees with you. From his November 1999 article in Fortune:

"...we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate.

Consequently, every time the risk-free rate moves by one basis point--by 0.01%--the value of every investment in the country changes. People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In the case of equities or real estate or farms or whatever, other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured. Nonetheless, the effect--like the invisible pull of gravity--is constantly there."

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Author: gamane Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198152 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 8:12 PM
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Oops. Just found the point farther down the thread. I'll try and keep up. :)

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Author: mildert One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198154 of 212026
Subject: Re: Berkshire's P/B Date: 1/25/2013 9:24 PM
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> Oops. Just found the point farther down the thread. I'll try and keep up. :)

No.... Different article! You cited from Buffett's 1999 article whereas the the other quote was from his 2001 article. Both are from Fortune magazine and cover the same broad subject matter though. Thanks for the input.

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198187 of 212026
Subject: Re: Berkshire's P/B Date: 1/28/2013 6:33 AM
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I would not be able to accurately predict Berkshire's stock price if my
life depended on it. But I do not view the current 52 week highs to be
very dramatic given the still significant advances required just to
reach valuation levels that prevailed two to three years ago at a time
when the economy was much more fragile than it was today and market
sentiment was generally much less positive.


Just rambling here...

It's true that even after the recent 16-18 month 40% rally Berkshire is
not at all overvalued, well below any plausible fair value estimate and
way below any historically typical multiple of any plausible value metric.

But in a sense my feeling is that the rally won't last. The reason is that
from one point of view there has been no Berkshire rally, merely a broad
US stock market rally that Berkshire has participated in.
Berkshire's performance is almost a perfect track of the performance
of the average S&P 500 company in the last 1-7 months, for example.
Or the last 12-15 months, or the last 22 months...
Heck, for time frames in the 2-3 year range Berkshire is still an underperformer.
What this says to me is that the recent price rise does not appear to
be in any material way caused by an appreciation of Berkshire's superior
price/value ratio compared to other alternatives.
In short, there is no "Berkshire rally" yet and the price changes
we're seeing don't seem to have anything at all to do with BRK's
valuation levels of anybody's appreciation thereof.

This isn't a view I could defend in any rigorous way, and it would not
make sense to change my investment behaviour because if it.
But if the broad market weakens, as seems plausible, it seems pretty easy to
believe that Berkshire will participate fully in that, too, at least for a while.

Jim

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Author: rationalwalk Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198190 of 212026
Subject: Re: Berkshire's P/B Date: 1/28/2013 8:47 AM
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But in a sense my feeling is that the rally won't last. The reason is that from one point of view there has been no Berkshire rally, merely a broad US stock market rally that Berkshire has participated in. Berkshire's performance is almost a perfect track of the performance
of the average S&P 500 company in the last 1-7 months, for example.


This is an interesting distinction (comparing Berkshire to the average S&P 500 company rather than to the index itself). Looking at Berkshire vs. the Index, there has been clear outperformance over the past one, three, six, and twelve month periods, at least according to a quick Google Finance chart. But maybe looking at Berkshire vs. the average S&P 500 company is a better comparison as you suggest.

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Author: mungofitch Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198198 of 212026
Subject: Re: Berkshire's P/B Date: 1/28/2013 10:10 AM
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But maybe looking at Berkshire vs. the average S&P 500 company is a better comparison as you suggest.

I don't really have a solid notion that it's a better idea, but I track it nonetheless.
This is a handy link http://stockcharts.com/h-sc/ui?s=BRK/A:RSP&p=D&yr=3&...
That's the ratio of Berkshire's price to the S&P equal weight index (the average S&P 500 company, in effect)
A flat line is tracking the average S&P 500 firm, a rising line is outperformance.

At the moment you can see the extreme flatness of the last 8-9 months,
showing that Berkshire has been tracking the average S&P firm very closely.
Does it have meaning? Does it have predictive power? Beats me.
But there is no trend of outperformance at any recent timeframe, which
tells me that the current rally doesn't seem to be based on any
particular fondness of Mr Market for the unique charms of Berkshire.
That's what leads me to speculate that there is no particular reason
to think that Berkshire won't participate fully in the next market dip.

Jim

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Author: TMFHockeypop Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 198202 of 212026
Subject: Re: Berkshire's P/B Date: 1/28/2013 10:46 AM
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That's what leads me to speculate that there is no particular reason
to think that Berkshire won't participate fully in the next market dip.

Jim


OT: It's a good reason to be systematic re disaster SPY puts. 2012 wasn't a good year for me, 2011 was, and 2013 is a year to continue to believe in the system, IMO.

FWIW if you want to be fearful when others are greedy then now's a nice time for buy these puts IMO and hang on to BRK, IMO.

Bob
RYR Home Fool

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