What is Berkshire Hathaway's AUM

Would you have bought Berkshire Hathaway in 1975?

Graphic: 1966-1970: Berkshire Hathaway, S&P 500 and Oil in comparison

After two rather modest years, Buffett Holding went through the roof in 1968 with an increase of 70 percent. The stock was more volatile than the index, but the volatility was pointing in the right direction: up. In contrast, the oil price fell after adjusting for inflation.

At this point in time, if most investors had to choose between the three options, they would certainly have chosen BRK. While the company only had a five-year history under Buffett's leadership and the stock was riskier than the S&P 500, it was performing well enough to put such objections aside.

Let's go to the 1970s

Let us now fast-forward to the next five-year period.

Chart: 1971-75: Berkshire Hathaway, S&P 500 and oil in a performance comparison

Boy what have times changed! At the beginning of the period, BRK continued the success of the previous period and increased by 73 percent in 1971. But then came the crash. In 1974 the loss was 54 percent. The share did not recover from this and ended the period with a significant loss. If you had bet $ 10,000 on Warren Buffett in January 1971, that would have left just under $ 7,200 at the end of 1975. The title “Oracle of Omaha” (which did not exist at the time) would probably have been turned into the “Debacle of Omaha”!

It didn't go much better for the S&P 500, but at least it was ahead of BRK - and with significantly lower volatility. The star of the management, on the other hand, would have been an oil investment. A theoretical investment of $ 10,000 would have grown in value to nearly $ 26,000 by the end of 1975.

The whole picture

After considering the two five-year periods separately, let us now look at the (until then) full ten years.

Graphic: 1966-75: Berkshire Hathaway, S&P 500 and Oil in comparison

For the decade, the BRK recorded a modest real gain of just over two percent annually (30 percent cumulatively). The S&P 500 posted a real loss. Aggressive investors would probably have chosen BRK and not a market portfolio. For risk-averse investors, on the other hand, the S&P 500 would have been the more digestible choice due to the lower fluctuation intensity.

The first ten years gave little evidence of Warren Buffett's genius. Yes, BRK had gained more than 70 percent in two calendar years, but the best result of the remaining eight years was a relatively modest gain of 13 percent. BRK had lost money in five calendar years. Today, BRK is seen as a performance machine that delivers positive returns year after year. It was very different then.

For full professionals there were important indications of what happened afterwards

For professional observers, however, there was one indication of BRK's potential: the company's book value. Of course, investors cannot buy the book value of a company, but have to bet on the shares in the expectation that the share price will move in line with book value over the long term. The same thing could have been done with the BRK share, which at the end of 1975 was quoted well below its book value.

Let's jump into 2018. On its 50th anniversary, BRK recorded an annual nominal price gain of 21.6 percent and a book value increase of 19.4 percent. (With the S&P 500, the annual increase was 9.9 percent).

Of course, a share can lose its book value in a shorter period of time. That was always the case at BRK. In the fourth and final chart, we've added the changes in the book value of BRK. And there we have the winner! The purple line of the book value clearly outperforms the three alternatives. It has by far the most stable performance and almost missed the highest cumulative gain. One could have come to a much more positive assessment of BRK than the ten-year share price trend at the end of 1975 indicated.

Graphic: BRK book value as part of the 1966-1975 balance sheet 

I would learn the following lessons from this exercise:

1) Never make decisions based on five-year returns. You already know this, of course, but it is worth pointing out that many fund investments continue to be made on the basis of five-year results.

2) Ten year periods are better but still imperfect. From 1966 to 1975, the most successful investor looked very ordinary. Granted, that was his only worst ten-year trip. But our initial question was whether an investment in BRK would have been necessary in 1975.

3) The growth in the book value of BRK would have reflected Buffett's quality better than its share price performance. Fund investors should therefore pay more attention to such key figures, even if they are not part of the classic fund valuation figures.

The analysis in this article is based on our professional investor tool. For more information on Morningstar Direct, please visit here.

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