Although Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) exemplify the value investing philosophy, some readers may be surprised to learn that the Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) duo put little stock into price-book ratios. At the 1998 Berkshire annual shareholder meeting, they were asked why they had not invested in Japanese companies, as they were trading at low price-book ratios at the time. Here’s what they had to say.
Earnings matter more than book value
Buffett began by explaining that Japanese stocks have lower price-book ratios than U.S.-listed companies because Japanese earnings are lower, and that book value is not an important component of valuation:
“Now if you think that earnings that the return on equity of Japanese business is going to increase dramatically, and you're correct, you're going to make a lot of money in Japanese stocks, but the return on equity for Japanese business has been quite low and that makes a low price-book ratio very appropriate because earnings are measured against book. And if a company is earning 5% on book value, I don't want to buy it on book value.
So a low price-book ratio means nothing to us. It does not intrigue us. In fact, if anything, we are less likely to look at something that sells in a low relationship to book than something that sells at a high relationship to book because the chances are we're looking at at a poor business in the first case and a good business in the second case.”
The difficulty of investing overseas
Munger went on to say that an additional problem with investing outside of your own country is the corporate culture may differ in very significant ways:
“There are also readings in corporate culture that have to be made. Owning stock in a corporation where you know that if shareholders or somebody else has to suffer, the choice is likely to be that somebody else will be chosen. That is a different type of company to invest in than one that thinks that the principal purpose of life is to keep some steam boiler company going in a particular community or something, no matter how much the shareholders suffer. I think it’s hard to judge corporate culture in the foreign countries has well as we can judge it in our own.”
At the end of the day, companies are just ways to organize labor and capital, and the reasons for that organization can differ widely. In the West, it is generally accepted that the end reason is to generate profit for owners (although those perspectives are being challenged). In centrally-planned states, companies may exist to further some social or political aim. In some cases, companies may be granted a monopoly to provide some public good (for instance, the Bank of England was established as a limited liability corporation with the exclusive power to issue bank notes).
Munger’s point is Japanese businesses, though similar to American businesses in some ways, can sometimes operate in ways that may seem unintuitive. As such, investing overseas carries with it an additional barrier in the form of a different corporate culture.
Disclosure: The author owns no stocks mentioned.
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