Warren Buffett's valuation gap reveals why book value is a meaningless indicator of wealth

Investors who prioritize intrinsic value over accounting constructs can acquire high-quality companies at fair prices to leverage compound interest over the long haul. Warren Buffett, now worth approximately $140 billion, identifies book value—the calculation of total assets minus liabilities—as a meaningless indicator of intrinsic value.

Book value can mislead in both directions. In 1964, Berkshire Hathaway's book value per share was $19.46, but the intrinsic value was far less because the company's textile assets were worth less than their stated values. By December 2001, the book value per share had grown to nearly $38,000, and by December 2011, it reached almost $100,000. During this period, those figures actually understated the intrinsic value because most of the company's underlying businesses were worth far more than their carrying values.

Buffett defines intrinsic value as "the discounted value of the cash that can be taken out of a business during its remaining life." He argues that businesses are logically worth far more than net tangible assets when they can be expected to produce earnings on such assets.

For those who do not wish to spend six to eight hours per week analyzing these valuations, Buffett recommends dollar-cost averaging into S&P 500 index funds. He maintains that the most important quality for an investor is temperament, avoiding the impulse to follow the crowd.

Wealth building is achieved by focusing on the economic performance of a business rather than cosmetic accounting, specifically by buying wonderful companies at fair prices based on their intrinsic value.