by Will Ashworth | December 14, 2012 6:15 am
Everybody’s making a big deal out of Berkshire Hathaway‘s (NYSE:BRK.A[1], BRK.B[2]) $1.2 billion share repurchase. For one, hedge fund manager Whitney Tilson, already an owner of its stock, was buying more on the news[3].
Buffett’s purchase of the shares is a nice demonstration of his genius. Using a few large-cap examples, I’ll show why he’s got it right when it comes to share repurchases, while so many others have it wrong.
By now, most investors probably are aware that Berkshire Hathaway bought back 9,200 of its Class A shares[4] at $131,000 from a long-time shareholder. It shouldn’t come as a surprise to investors that Buffett would do something like this. He’s a very loyal person. Conveniently, it allowed the board to approve an increase in the price it’s willing to pay for its own shares from a maximum of 110% of book value to 120%.
Other large-cap companies should take note of this.
It’s possible to be flexible yet still have stringent purchase requirements. For instance, there is absolutely no chance that Berkshire Hathaway’s intrinsic value is just $131,000. Buffett has a number in his head, and Whitney Tilson believes that number is currently $180,000. If it is $180,000, then Buffett not only was able to help out a longtime shareholder, but he also got a 27% discount on his own shares.
However, intrinsic value doesn’t sit still — it moves up and down based on the activities of the various businesses. Tilson suggests intrinsic value at the end of 2013 will be $201,400, providing an even bigger (35%) discount.
Whatever the number, Buffett knows what he’s doing. The same can’t be said for other CEOs.
Peter Lynch was a big fan of share repurchases. He believed that when companies had excess capital, the buying of one’s own stock was a much better investment than acquiring unrelated businesses in an effort to “diworsify.”
The problem with this approach was he also felt management had a good understanding of intrinsic value, which is simply not the case. Countless essays have been written about the reckless approach to share repurchases that most companies employ. Buying at the 52-week high seems to be a common occurrence, for instance.
If more companies used Buffett’s approach to buybacks, a lot more capital would be available for debt repayment, dividends, and capital expenditures.
| Company | Ticker | Share Buybacks |
Price Paid/ Share |
Book Value/ Share |
Price Paid/ Book Value |
| Berkshire Hathaway |
BRK.A | $1.2 billion | $131,000 | $111,718 | 117% |
| Exxon Mobil | XOM | $15.8 billion | $85.48 | $36.56 | 234% |
| Walmart | WMT | $4.7 billion | $65.69 | $22.00 | 299% |
| Pfizer | PFE | $5.8 billion | $19.59 | $11.09 | 177% |
| Best Buy | BBY | $237 million | $21.74 | $10.38 | 209% |
| * Berkshire Hathaway’s recent purchase included for comparison purposes | |||||
If the four companies besides Berkshire Hathaway stuck to the 120% rule in 2012, only Best Buy (NYSE:BBY[5]) would have been able to repurchase shares, and then only in the last month because its stock nosedived.
What if the four paid special dividends with the cash instead? Exxon Mobil (NYSE:XOM[6]), for one, could have paid a $3.46 one-time special dividend. That’s a yield of 3.8% based on the Dec. 12 closing price of $89.45. It might not seem like much, but it’s 50% more than what the oil giant currently pays.
Supporters of share repurchases will point to the fact that with the exception of Best Buy, all of them repurchased shares at less than the current price, thereby delivering a positive return on investment, with more to come in the future. Furthermore, because share repurchases make a big contribution to the growth of earnings per share, and earnings per share growth ultimately leads to rising share prices, proponents argue they have to be good.
Wrong!
Thomson Reuters issued a report in January that showed that of the 380 companies in the S&P 500 that repurchased shares in at least five quarters since the fourth quarter of 2001, only 60 were able to purchase shares when prices were low[7]. In addition to most firms being unable to purchase shares at low prices, they failed to deliver any kind of meaningful share appreciation in the subsequent 12 months.
Translation: Corporations are poor market timers.
I’ve never understood why so many people blindly support share repurchases[8]. Earnings per share is just a number. I always look at the growth in net income on a dollar rather than per share basis. The idea that you’re getting a bigger piece of the pie, while true, isn’t helpful if the share price doesn’t appreciate.
At the end of the day, Warren Buffett believes he can invest Berkshire Hathaway’s cash in other businesses more effectively than in his own. This recent rare exception suggests that Buffett is willing to pay 1.2 times book value (and not much more) for most companies he looks at — including his own.
To me, it’s just more proof of how much Buffett stands apart from the crowd.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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