On the Berkshire Hathaway Buyback

He finally decided to do it.  He’s going to buy back stock.

Don’t get me wrong.  I am not a critic here, nor an admirer; I am just an observer.

Buffett is a rational guy. Hyper-rational.  More rational than I am.

He thinks that his stock is a good buy below 1.1x unadjusted book value.  I don’t know that he is right there, but I give him and Whitney Tilson the benefit of the doubt.

My friend Josh Brown said:

Full disclosure, I’m long Berkshire Hathaway B shares for client and family accounts and have been forever and a day, so of course I’m thrilled with the news this morning.

Normally I detest buybacks.  The primary reasons are:

They usually occur at the top of a cycle and are a sign of a top when they peak en masse

They usually are used to mask massive stock option issuance to enrich insiders while doing nothing other than offsetting dilution to shareholders

They are financial engineering and are thus suspect

They are inferior to dividends

They can be a sign that management has no idea what to do to grow or improve a business

But Buffett is not masking stock issuance, he is purely concerned with building shareholder value and sees an investment in his own stock (and hence the various companies he owns) as the best use of capital.  This is very different from when Cisco issues 50 million in options and then announces the requisite buyback that would offset it.

As far as buybacks go, this is a good one, but the question remains, how good is it?  If Buffett had better uses for cash, he would not be buying back stock, and this is at a time when all equity valuations are depressed.

To me this indicates that Buffett does not have any large places to deploy cash superior to the cost of capital of Berkshire Hathaway, which is pretty low, aside from investments with an inadequate margin of safety.

That doesn’t mean the whole market is overvalued, but it does mean that a bright guy like Buffett anticipates no more large productive places in the near future to put large amounts money to work than by shrinking his own balance sheet.  Not a good sign for the economy.

He could sit on the cash and wait.  He has done it before at valuation levels like this in the mid-2000s.  It’s not as if the compression in valuations has only hit BRK.  Many companies seem cheap now on a current earnings basis.  This is especially true of many insurers, of which BRK is one.

Buffett was willing to expend cash to make a superior offer for Transatlantic Reinsurance at a little more than 70% of book, and 8x forward earnings.  Granted, that would have only deployed $3B+, and given him more float to invest.  Still, it shows the cheapness of the environment.  But perhaps there is more uncertainty around the valuations of less well-capitalized firms than BRK, so buying back higher quality BRK stock is preferred to buying in the liabilities of companies of which Buffett has less knowledge.

There is the more radical act: Buffett could buy the stock outright himself.  He has significant personal outside holdings; why not sell them and buy more BRK?  That would make an even greater statement then the buyback.  An insider buy from the ultimate insider at BRK would say a lot more than shrinking BRK’s balance sheet through buybacks.  Think of it this way: Buffett’s interest in BRK increases 4 times as fast if he uses his own money versus the corporation doing the buyback.

As an investor in insurers here, I have better places to put money than BRK.  I like BRK, but the whole industry is cheap amid the uncertainty of the macroeconomic environment.  BRK deserves the higher valuation because it is a diversified industrial/insurance conglomerate, and not merely a despised insurer.

I will sit and own my cheap insurers because their cash flows will more than justify higher valuations eventually.

PS — there had to be a better way to do this.  BRK could have struck a deal to do an accelerated share repurchase, without jolting the market, and pushing up the price of a repurchase.  Perhaps it could have been done by simply announcing that the Board has approved buybacks, should the price ever become favorable for that, and then repurchase slowly and quietly.

2 Comments

  • RichL says:

    Another way to look at it is that the stuff that is stupidly cheap in the market now are the financials. 1 year performance of the S&P is UP maybe 2%, and the financials are down a little over 20%.

    Why should Mr. Buffett buy a financial stock that he doesn’t know as intimately when he can simply buy his own stock?

    Add to the equation that a fair portion of Berkshire’s business isn’t financial, but the stock is performing like a financial, and it is a logical trade.

  • Adam says:

    David: Just a thought here. He must see the writing on the wall for the equity markets over the next while (as you have suggested). Had he pulled this off in 2008/2009, he would have done his shareholders a great favour given the collapse in BRK.A and the subsequent rise after. Note that there’s no pressure to do anything. But depending on how far things swing, he might be able to buy back 10-20% of the stock (just using figures from last crash). That would be worth the effort and attention this change in policy has got him. Certainly for long-term shareholders this would be a huge plus considering there isn’t a whole lot the company can buy and make a significant dent in the company’s earnings or growth rate whether the economy is good or bad.

    Warren was very aware of trouble on the horizon in 2008 (as were most people). However, he did nothing when it came to his own stock because of policy. If memory serves, he didn’t get too much applause for that. Maybe that experience changed him. Maybe this time around it’s just better for him to have the option to act as before he didn’t have that.

    And finally, isn’t it more interesting that he just made 2 key hires during an important time in the markets for value investors and he’s possibly going to buy back stock rather then watch them spend the company’s money during this bear market (or Blue Light special as value investors look at it). It will be interesting to see how the fight for ideas and capital works out.

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