On September 26, Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) announced that they had authorized a repurchase of both classes of the company’s shares at a price “no higher than a 10% premium over the then-current book value of the shares.” As they went on to explain, there was a very simple reason for doing so: “In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.”
The response was widespread, with some implying that he has “run out of ideas” (http://blogs.wsj.com/deals/2011/09/26/berkshire-hathaway-announces-stock-buyback/) and others saying that this was a signal that he thought the economy was facing impending doom with this as the backstop for Berkshire (despite Warren’s frequent appearances on multiple media networks stating otherwise). In a piece on CNBC the day of the announcement, Gary Kaminsky had this to say:
“It is important to remember that Warren Buffett, a very nice gentleman, somebody who gets tremendous accolades in the media in terms of being the folksy sort of charming guy that he is, he gets away with something that many CEOs wish they could get away with, which I believe is this ability to say one thing and ultimately change your mind and do it…”
Rather than continue with the quotes, feel free to watch the video for Mr. Kaminsky’s own words. In the end, he touches on three things that he thinks fit this description: Berkshire’s stock split, the company’s entrance into the S&P 500 index, and the buyback authorization.
I won’t argue the first two points; the split had to be done for the Burlington Northern deal, and Berkshire replaced BNSF in the S&P 100 & 500 as a result of the acquisition.
On the buyback, Mr. Kaminsky implies that it may be the result of pressure from institutional buyers as a result of becoming an index stock; Alice Schroeder, who was making a guest appearance, thought it may be a way to avoid a dive in the stock when succession plans are eventually implemented. At the end of the day, I think the answer is as simple as three words: the stock’s cheap. It’s right there in the press release, and in Warren’s own words multiple times in prior shareholder letters:
“The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two important reasons - one that is obvious, and one that is subtle and not always understood. The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended.
The other benefit of repurchases is less subject to precise measurement but can be fully as important over time. By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value. These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.”
In the CNBC piece, Mr. Kaminsky lays out his views on capital allocation, saying that buybacks are last in line among organic growth (I’m assuming that means reinvestment in the business), dividends, and acquisitions (“the only thing worse than buybacks is sitting on the cash”). He says this is based on “history,” what equity investors want managers “to do with capital.”
As noted in Warren’s quote, this is simple arithmetic: Major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When Mr. Kaminsky talks about “history”, he is likely referring to companies that indiscriminately buyback shares regardless of price, which is the exact opposite of what Berkshire is doing. In regards to acquisitions, they are known to often lead to value destruction, not creation (in 2004, McKinney found that only 1/4 of acquisitions have a positive return on investment). In reality, buying back stock at a price substantially below intrinsic value should be at the top of the list, not the bottom.
My point: don’t just listen to what the media has to say. The fact that they never mentioned the valuation of Berkshire, the reason stated in the press release for the repurchase authorization, says a lot in itself. While they look for a way to spin the buyback, just remember that Warren is continuing to do what he’s done consistently for over 50 years: make smart decisions for long-term shareholders.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.