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Berkshire Buyback – Three Simple Words (BRK.A)(BRK.B)

October 11, 2011 | About:
The Science of Hitting

The Science of Hitting

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On September 26, Berkshire Hathaway (BRK.A)(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.

http://video.cnbc.com/gallery/?video=3000047801

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

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Comments

Arpan
Arpan - 2 years ago
Great article. I'm not surprised by the quotes. I often wonder whether CNBC anchors are stupid or publicity whores. I think it might be a little bit of both. Any media company that questions the investment decisions of the greatest investor of all time is bound to get attention, whether they are right or wrong. In this case they are completely wrong. Alice Schroeder is a cunt who would say any mindless thing against Warren Buffett for attention.
windplayer13
Windplayer13 - 2 years ago
Great article The Science of Hitting. One thing I observed after reading many GuruFocus articles was how insiders do a great job of timing when to buy for their own account, but do a horrible job buying back shares for their own company. Check out GuruFocus's insider buy charts and compare them to company buybacks. Buffett has proven to be an exception.

Many managers are not clear in presenting valid reasons why buying back shares is the best choice for shareholders, where Buffett clearly explains his reasoning. Are they not providing supporting evidence of why they are buying back shares because they know it is not in the best interest of the shareholders? Or do they not understand capital allocation? Beware of those managers, there are plenty of them.
Billypilgram
Billypilgram - 2 years ago
Thank you for this information. I own stock in Berkshire and although it is not doing great right now, I do have to give "props" to the many website personal who send daily updates with suggestions on stocks to purchase. I admit I am not a savvy investor hence I accept the advice of others.

We gets ton's of messages to buy this and that stock. What I do is take a general concencus of a recommended stock, if most seem to give a thumbs up, I do research through Morningstar, Schwab and others. When it does look good and my common sense meter says OK, I buy.

BRK/B was one of those as was MT and GGB. The latter two have been stellar the short time I've had them. MOS was a stock "given" to me in the aforementioned "system" but I had already concluded that fertilizer was a smart stock to get into. MOS seemed the best to me because of their vast holdings of Potash although the pun's said POT My error was timing, it had been say, $ 59 but by the time my wife put the call in (a few days) it skyrocketed to $71! Egads, it has not come close since.

Anyway, historical price, undervalued and patience is my motto (as well as listening to others)

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