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Effects of Charitable Contributions of Berkshire Stock on its Share Price

March 18, 2012 | About:
silvmich

Silvmich

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Does forced selling of Buffett's pledged stock suppress market valuation?

For many value investors, the apparent cheapness of Berkshire stock is both a tremendous gift but also a somewhat puzzling anomaly. Many highly respected analysts and fund managers have spoken with conviction on this subject, notably Witney Tilson (www.tilsonfunds.com/BRK.pdf) and Donald Yacktman. And, of course, Buffett himself (ipse dixit) has made it clear that he believes the stock is selling at a significant discount to intrinsic value and has authorized share repurchases, a declaration to the investing community that he believes his own stock is one of the best bargains available on a risk-adjusted basis.

The list of potential explanations for such a deviation from intrinsic value are numerous: Buffett's age, the question of leadership succession, the sheer size of the business, etc. However, one under appreciated and possible explanation may be found in Buffett's explicit and irrevocable pledge of a large portion of his Berkshire stock to charitable foundations. This article examines the extent to which such contributions could suppress the stock's price and how an investor might interpret this phenomenon.

In his seminal work “How to Be a Stock Market Genius”, Joel Greenblatt extolls the virtues of the astute “special situations” investor who can identify when certain market participants may, in fact, be compelled to liquidate certain positions irrespective of their underlying value. These “forced sellers” cause an anomaly in the market's pricing system, at least for a short period of time, because their actions are not necessarily governed by the discernment of value versus price-received in a transaction. Could this same situation exist with respect to the charitable foundations who benefit from Berkshire stock donations by Buffett?

Indeed, this is the case to some extent. In 2006, Buffett made five major pledges of stock to private foundations. Each of the five are irrevocable (though some conditions exist for the largest pledge) and follow a basic formula, whereby 5% of the total amount of pledged stock remaining in a given year is given away in that year. The following is a list of the pledges: (note: pledges are in Class B stock, such numbers adjusted and shown below in 2012 Class B equivalent to account for stock split that occurred during the BNSF acquisition).

-Bill and Melinda Gates Foundation (BMG): 500 million

-Susan Thompson Buffett Foundation (STB): 50 million

-Howard G. Buffett Foundation (HGB): 17.5 million

-The Sherwood Foundation (formerly Susan A. Buffett Foundation: SAB): 17.5 million

-NoVo Foundation (Peter Buffett, NoVo): 17.5 million

For a total of 602,500,000 (2012) Class B equivalent shares. See: http://www.berkshirehathaway.com/donate/webdonat.html

Below is a table showing the total pledged shares and the donation schedule of the aggregate amounts to the five entities.







































Year

Donated Stock


Pledged Stock Remaining, Year End


2006


28,618,750


572,375,000


2007


27,187,813


543,756,250


2008


25,828,422


516,568,438


2009


24,537,001


490,740,016


2010


23,310,151


466,203,015


2011


22,144,643


442,892,864


2012


21,037,411


420,748,221


The most restrictive conditions are on the BMG, in that each year's share donations “must be fully additive”, more fully explained in that “annual giving [of BMG] must be at least equal to the value of [Buffett's] previous year’s gift plus 5% of BMG’s net assets. If this amount is exceeded in any year, however, the excess can be carried forward and be offset against a shortfall in subsequent years. Similarly a shortfall in a given year can be made up in the following year”. In effect, the value of shares Buffett gives to BMG each year must be added to BMG's total giving. It appears that BMG has, to some extent, sold Berkshire shares to meet this requirement. In several years, though, it has sold less than the amount of donated shares.

With respect to the other foundations, it is presumed that the vast majority of their funds are solely the result of the pledge of stock from Buffett. Therefore, the foundations have a strong incentive to sell Berkshire stock to raise cash for their charitable mission. Reviewing the 990's for each of those foundations (source: Guidestar), where available, it appears that they have, to a large extent, sold shares roughly in function to the donation schedule referenced above.

Therefore, we conclude that the charitable foundations are selling Berkshire stock at a rate that is

approximate to (but somewhat lower than) the schedule of total share donations in a given year. If effect, they might not be “forced sellers” in the strictest sense of the word, but they are acting in a way that may be similar to forced sellers. We note that, as charitable foundations, their mission is not investment gain but philanthropy and so maximization of good perhaps trumps maximization of monetary return.

But, this is selling of a material amount? According to Morningstar.com, average daily volume of Class B stock is 4.1 million and Class A volume is 500 (or roughly 750,000 Class B equivalent) for a total Class B equivalent volume of 4.85 million. We compare this to a total annual “volume” of 22 million donated shares in 2011 and we see that these donated-and-sold shares could account for as much as about four and a half trading days worth of volume (assuming all 22 million are, in fact, sold). But, this is hardly a fair comparison! 5 million shares traded daily includes actors such as high-frequency traders that are exploiting minute stock price movements and are holding shares for minutes if not seconds. According to Thompson Reuters, such high-frequency traders account for 60% of the volume of trading.

Other sources push that number to 70% and beyond:

http://www.moneynews.com/MichaelCarr/carr-High-Frequency-Trading/2011/09/14/id/410924).

It is impossible to know what portion of the Berkshire share volume is what we might refer to as “real” trading, but it is safe to say it is significantly less than 5 million per day. For the sake of argument, and recognizing the uncertainty of the figure, let us assume that only 50% of the trades are net of high-frequency traders. That would give us a more fair estimate of about 9 trading days worth of “forced-seller-equivalent” supply. Given roughly 250 trading days in a given year, that represents 3.6% of the trading volume (again, after discounting high-frequency traders).

Another way to look at the situation would be to compare the number of “forced seller” shares being sold annually (22 million) to the number of Class B (2012) equivalent shares in existence. As of the 2011 10-K filing, Berkshire stock included 1,072,262,656 shares of Class B stock and 936,053 share of Class A stock. Using a conversion of 1/1,500 for Class A stock, we arrive at a total Class B equivalent share count of about 2.476 billion. Therefore, stock involved in “forced selling” in 2011 could amount to 0.89% of all stock in existences as the end of 2011.

Given these two metrics (with all their flaws and approximations), it appears that the volume of stock

subject to donation in recent years could be having a material impact of the current stock price of Berkshire Hathaway. This effect should be moderated somewhat by value investors spotting a bargain and purchasing shares, but only to the extent that their actions neutralize the forced-seller's sales. If there are not enough value-conscious investors tracking this opportunity, and if they have insufficient resources to “soak up” the excess selling that should not otherwise occur, it seems only natural that the stock price would be suppressed below value. Perhaps this is another reason Buffett, as Chairman of the Board, might be interested in share repurchases: to neutralize the adverse effect on share prices of his charitable contributions of stock. In effect, he gets to both purchase undervalued shares of a great company while also supporting the charitable foundations to whom he has pledged his fortune.

A final encouraging note: unless Buffett were to pass away in the near future, the volume of shares

subject to this “forced seller” effect should diminish gradually according the pledge agreements. So, the enterprising value investor can take heart that the shares are available at a great price and one of the elements contributing to that below-value price should resolve itself in the coming years.

Disclosure: the author holds a long position in Berkshire.


Rating: 3.5/5 (12 votes)

Comments

softdude2000
Softdude2000 - 2 years ago
Just like there is a dedicated seller(foundations), there is now a focused, dedicated and powerful buyer(BRK). So it has zero effect.
batbeer2
Batbeer2 premium member - 2 years ago
Thanks for an article worth reading.

I disagree on one point:

>> So, the enterprising value investor can take heart that the shares are available at a great price and one of the elements contributing to that below-value price should resolve itself in the coming years.

I hope Buffett lives for a very long time to come. Having said that, I would find it more encouraging if all the shares were dumped on the market in a week, driving the price down 75%. Some investors probably own the shares on margin... forced selling, great !

AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Batbeer, we had a bit of your scenario in early 2009. Going forward we'll have more charitable sales, recession driven volatility fears (again) and of course those tiresome succession fears. The coming years don't look good for sellers of BRK.

Moreover, I would guess that many of BRK's early investors are passing on their shares and, of course, the new generation will be selling out of the egotistical expectation of being able to out-perform Buffett and his successors or simply fund lifestyles they've grown accustomed to.

In terms of charitable sales, can we look to MSFT for patterns?
coda
Coda - 2 years ago
You considered an interesting scenario but this is not the case.

Why Warren's share will go to Bill and Melinda Gates?Because Bill is a friend,a smart guy and an investor committed to Berkshire's principles,he will not sell shares in a way to affect its stock price and he will sell its shares really slowly...like he's been doing with the actual stocks in the trust
Dr. Paul Price
Dr. Paul Price premium member - 2 years ago
Why should BRK be giving away shareholder money at all?

silvmich
Silvmich - 2 years ago
A few responses...

Softdude2000 --- I think you make a point that there is a dedicated seller and a dedicated buyer. However, the dedicated buyer is buying at well below intrinsic value. Therefore, there remains an effect in that the stock is stilling at well below intrinsic value.

Batbeer2 - on a similar vein --- you are right that it would be great to have the stock dumped so that value investors pick it up at an even bigger discount. (I picked up a large block of shares when they fell to $68 for Class B, so I have real-life experience). As Softdud2000 points out, this is not going to happen. So, the lesson is don't look to Berkshire for a gigantic play. But, that does not mean that Berkshire is not a good buy resulting for forced selling. If you can get Berkshire at a significant discount to intrinsic value (even if it is not a HUGE discount to value), I would still say that is a great way to invest. You may not make 100%, but you may make 50% while taking very little risk. After all, superior risk-adjusted returns is what we are all looking for (me, at least).

Coda - the BMG foundation is obligated by the pledge agreement to make the value of the donation fully "additive" to its current operations. So, BMG would have to sell an even larger chunk of MSFT to "keep up" with the BRKB donations. Until very recently, MSFT has also been selling at a large discount to intrinsic value, so Bill and Co would have had to pick the lesser of two evils. Now, MSFT is more appropriately priced, so BMG will likely sell more MSFT over BRKB for some time, so you are probably right that BMG will have less downward pressure.

hclasvegas
Hclasvegas - 2 years ago
the foundations MUST SELL regardless of valuation the brk buyback is at 110 % of book or below ! huge difference.
hclasvegas
Hclasvegas - 2 years ago
<< A final encouraging note: unless Buffett were to pass away in the near future, the volume of shares

subject to this “forced seller” effect should diminish gradually according the pledge agreements. So, the enterprising value investor can take heart that the shares are available at a great price and one of the elements contributing to that below-value price should resolve itself in the coming years>>

go back and read the donation letter. buffett said to expect brks share price to increase at least 5 % a year going forward to more than make up for the fewer number of shs gifted. as of sept 2011 buffetts very low hurdle rate had not been met. if the stock continues to underperform the foundations will have to sell more shs to meet its budgets needs, no ?

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