 Good day, fellow investors! Last week I started explaining my view over the markets. Last week I explained how that creates the risks into investing, then how valuations are sky high and today I'm going to go a little bit more deeper and into the deeper waters that are not so obvious to the rest of the population. And today we're going to discuss book value and how that affects your investing, your wealth creation over time. It's a key metric, Buffett always uses not the actual book value, book value is just an accounting concept. The change in the book value is what counts in successful investing and wealth creation. So we're going to focus on that, see how that works in this market and why that is a huge risk for the markets or better to say somebody stealing from you, from your retirement funds out of the blue without anybody caring about it. Let me show you. The topics for today are how book value works, book value in the current market, how they are stealing from you, we'll discuss the perspective and we'll show you what to do. So how does book value work? As I said book value is an accounting concept and there is a big difference between book value and intrinsic value. Let me give you an example if there are two students and the parents pay equally for their education, then their book value, the book value of their education is equal. However, if one has been having a great time partying all night long at the university and the other has been studying like crazy, the intrinsic value, the future cash flows of that education will be opposite. One will be probably zero or if the student has been partying with the right people, it will be much higher than this one. Nevertheless, apart from the jokes, one will be much different, the future cash flows will be much different and that's what determines book value. However, there is something that tells you how much is the intrinsic value and that's the change in the book value year per year. That is the metric for performance that Buffett uses and that's the only objective metric for investment. The change in the book value is the actual change in the intrinsic value and those numbers don't lie. Second page of Buffett's annual red letter tells it all. First column is the change in per share book value of Berkshire and that's the metric he focuses on because, as I said, earnings are correlated with long-term returns which means earnings increase the book value and the compounded annual gain is 19.1% for the book value which translates into currently 20.9% for the market value. If the market crashes 50% and becomes fairly valued then you have a perfect correlation between the book value and the market value over the last 52 years for Berkshire head to way. The SAP 500 with dividends did 9.9%. That's a very interesting story to make another video but let's leave that for another time. So we have book value, increases in book value is what determines your long-term return. Okay let's see about the market as most people are invested in the SAP 500 through pension funds, through mutual funds, through 401Ks. Let's see how that works. If you look at the book value of the SAP 500 you can see how it is growing constantly over the last 18-19 years so it was below 300 now it is almost at 800. However, if you look at it a little bit deeper you will see that the situation isn't that stellar as there is a lot of value that disappears. Here I have compared the SAP 500 earnings in relation to the added intrinsic value so the change in the book value year over year and you can see how there is a big discrepancy between the blue line the earnings in SAP 500 points and the actual intrinsic value added. Okay now you would say Sven did you think about the dividends? A dividend is a payment to the shareholder that actually increases the intrinsic value to the shareholder not to the company does not to the SAP 500. Okay I have here added the dividends and you can see how most of the time the earnings line the blue line is higher than the book value change plus the dividends which means that there is a lot of value that disappears even better it will be shown in this table. You have the earnings SAP 500 earnings in the second column then the book value plus the dividends and the difference year by year and you can see how the cumulative difference over the last 19 years has been 326 which is 40.1% of SAP 500 book value which is almost at 800 this means that in the last 19 years 40% of the SAP 500 book value has disappeared and look at the differences in the last four years 54 points is the difference between the increased book value and the dividends in 2014 30 points 21 28 points this is due huge buybacks and you can see how similarly there was a big difference 2005 6 7 and 8 before the crash as the companies have a lot of money they invest a lot in buybacks do crazy things delusions etc which destroys the long term value of the shareholder for me this is clear pure theft I will make another video about buybacks to clearly distinguish how capital can be allocated positively and negatively but that's for another topic going back to here in the last four years 136 points of SAP 500 book value disappeared into buybacks and and other shareholder value destroying activities so for me this is theft they are stealing from the people and this is misallocation of incentives and misallocation of risks is a misallocation of everything and the current market environment is not really the interest of it is not 100 aligned with the owners where the owners are I don't know the Norwegian pension fund your pension fund from the Netherlands 401ks little people own those big funds but the management tries to get higher bonuses by pushing the stock price usually higher no matter the book value no matter the actual value creation and this is one of the biggest risks that I see in the markets because if there is no book value when the earnings dry out and businesses work in cycles when earnings dry out there is nothing else to save the stock price drop than book value and if there isn't any book value the stock drops like a rock and that's a huge risks until earnings grow until the economy grows it's not a risk but when that turns when the cycle turns it becomes a huge huge risk and this is also the different perspective on book value some people say it doesn't matter book value is not important because current businesses are light on capital and they have value in other things I don't know the subscriber base monthly accounts added or something like that or just growth okay that's a good perspective however book values are not important if the company will continue to constantly create equal or bigger cash flows over the very long term every year by year by year then of course you can pay everything in dividends who cares because next year you will have the cash flow that gives you protection from for the stock price however if that doesn't happen some year in the next 10 20 years then the stock price will drop because people will lose faith into the company because of one year of low cash flows and this is also what you have to be very careful with what you own you have to own companies where the cash flows are stable if there is no book value of course where the cash flows are as stable as possible so that there is no risk that the cash flows dry up and you see the stock price drop 50 70 percent secondly the second thing you can do is if a company is really aggressively buying back stocks and even if that is not sustainable in the long term you might actually be the one that gets the best value out of that deal by selling the stock to the management that's the person who gets the value that evaporates when management buys back stocks at a very high price and thirdly of course you might avoid investing in such companies which are clearly cyclical in nature and do buybacks at very very high prices and at stretched valuations so that's a big risk that I see the book value the book value is one thing that change in the book value I see that part of it disappears every year and that's a disservice to shareholders and anyone who wants to benefit from long-term investing this will lead me to the next risk video which will be about index funds and ETFs which is an even worse situation because of the herd mentality and when you combine all those risks there is a very very big risk in the stock market and something to be careful about how you're exposed and how you're allocated and how are you invested which will be the final video of the series thank you for watching looking forward to your comments let me tell what you think about this and I'll see you in the next video