Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A) ❤
No. of Recommendations: 7
This is an excerpt from the 1996 annual meeting which I found at the CNBC Buffett archives. Interesting topic.
26. Buybacks at what appear to be high stock prices
WARREN BUFFETT: Zone 2, please.
AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, I'm Tim Medley from Jackson, Mississippi.
My question is an allocation of capital one. You've indicated that one thing you like in companies is a willingness on the part of management to repurchase its own shares.
I wonder if you would talk for a minute about your own frame of reference on repurchases when it appears that the current price of the stock is rich in relation to its intrinsic value.
And some have said that, with the right company, ongoing repurchases of stock should be made, irrespective of the price.
So, would you speak for a moment, as to how you think it pencils out when the current price of the stock is rich in relation to its intrinsic value?
WARREN BUFFETT: Yeah. If you're repurchasing shares above a rationally calculated intrinsic value, you are harming your shareholders, just as if you issue shares beneath that figure, you are harming your shareholders.
That's a truism. Now, the tough part of that, of course, is coming up with the intrinsic value.
And, for example ' a good example might be Coca-Cola.
I think a number of people might have thought Coca-Cola was repurchasing shares at a very high price, because they'll look at book value or P/E ratios. But there's a lot more to intrinsic value than book value and P/E ratios. And anytime anybody gives you some simplified formula for figuring it out, forget it.
You have to understand the business. The people who understood that business well, the management, have understood and been very forthright about saying so over the years, that by repurchasing their shares, they are adding to the value per share for remaining shareholders.
And like I say, people who didn't understand Coca-Cola, or who thought mechanistic methods of valuation could ' should take precedence, really misjudged the value to the Coca-Cola Company of those repurchases.
So we favor ' when you have a wonderful business ' we favor using funds that are generated out of that business to make the business even more wonderful. And we favor repurchasing shares if those shares are below intrinsic value.
And I would say that if it's a really wonderful business, we probably come up with higher intrinsic values than most people do.
We have great respect, Charlie and I with ' I think it's developed over the years ' we have enormous respect for the power of a really outstanding business. And we recognize how scarce they are. And if a management wishes to further intensify our ownership by repurchasing shares, we applaud.
We own ' we just went over 8 percent of the Coca-Cola Company, probably, in the last three or so months, by a very tiny fraction. But we had a second purchase one time.
But our percentage interest in the Coca-Cola Company has gone up significantly through their repurchases. And we are better off because they have bought those shares at what looked like, to some people, perhaps, high prices. And we thought they were wrong at the time, and I think now it's been indicated or proven.
So, I urge you, if you're trying to decide on the wisdom of repurchases, or of share issuances, that you don't think in terms of book value. You don't think in terms of specific P/Es. You don't think in terms of any little model.
But you think in terms of what would you really, A, pick businesses you can understand and, then, think what you really would pay to be in those businesses. And that's what counts over time, is whether the repurchases are made at a discount from that figure.
And I would say with the companies that we own shares in, we ' our interest in GEICO went from 33 or so percent to 50 percent over a 15-year or so period, simply through repurchases. And we benefitted significantly.
So, did every other shareholder, I might add, that stayed with the company. And we benefited in no way disproportionate to them.
But that was a very wise action on their part. And there too, they were all ' usually buying that stock at at least double book value. And you could compare it to other insurance stocks and say, 'Well, that's too much to pay.'
But GEICO wasn't an insurance company that was comparable to other insurance companies. It was a very different sort of business. And they were very wise, in my view, to be following that course of action.
No. of Recommendations: 3
Thank you for sharing this excerpt. It is insightful.
If I recall correctly, Mr. Buffett paid around $323 per B share when buying back stock more than a year ago (I could be off a bit as I'm going by memory). Given that Berkshire's intrinsic value has likely risen by around 10 percent since then, and also that Mr. Buffett would not have bought back the stock unless it was at least at a 10 percent discount to intrinsic value, does this mean that the intrinsic value now is at least $323 X 1.1/0.9 = $394.77?
That price corresponds to a P/B of $394.77/$231.95 = 1.70.
Does this also mean that, in terms of P/B, the intrinsic value is around a P/B of 1.70?
If so, this would be higher than what I (and probably some others on this board) have assumed in the recent past (intrinsic value = around 1.5 or 1.55 X book value).
Could it be, at least in part, for this reason that Mr. Buffett asks us to no longer rely on increases in book value to estimate Berkshire's performance and that book value is a 'metric that has lost the relevance it once had'?
No. of Recommendations: 25
This is an excerpt from the 1996 annual meeting which I found at the CNBC Buffett archives....
" If you're repurchasing shares above a rationally calculated intrinsic value, you are harming your shareholders, just as if you issue shares beneath that figure, you are harming your shareholders.
That's a truism. Now, the tough part of that, of course, is coming up with the intrinsic value.
"And, for example, a good example might be Coca-Cola.
"I think a number of people might have thought Coca-Cola was repurchasing shares at a very high price, because they'll look at book value or P/E ratios. But there's a lot more to intrinsic value than book value and P/E ratios. And anytime anybody gives you some simplified formula for figuring it out, forget it.
You have to understand the business. The people who understood that business well, the management, have understood and been very forthright about saying so over the years, that by repurchasing their shares, they are adding to the value per share for remaining shareholders.
"And like I say, people who didn't understand Coca-Cola, or who thought mechanistic methods of valuation could ' should take precedence, really misjudged the value to the Coca-Cola Company of those repurchases.
So we favor ' when you have a wonderful business ' we favor using funds that are generated out of that business to make the business even more wonderful. And we favor repurchasing shares if those shares are below intrinsic value.
"And I would say that if it's a really wonderful business, we probably come up with higher intrinsic values than most people do.
"We have great respect, Charlie and I with ' I think it's developed over the years ' we have enormous respect for the power of a really outstanding business. And we recognize how scarce they are. And if a management wishes to further intensify our ownership by repurchasing shares, we applaud.
We own ' we just went over 8 percent of the Coca-Cola Company, probably, in the last three or so months, by a very tiny fraction. But we had a second purchase one time.
"But our percentage interest in the Coca-Cola Company has gone up significantly through their repurchases. And we are better off because they have bought those shares at what looked like, to some people, perhaps, high prices. And we thought they were wrong at the time, and I think now it's been indicated or proven.
"So, I urge you, if you're trying to decide on the wisdom of repurchases, or of share issuances, that you don't think in terms of book value. You don't think in terms of specific P/Es. You don't think in terms of any little model."
A comment which admittedly relies on 20:20 hindsight:
Though it's certainly an admirable line of reasoning, it's always good to matter that even for a seemingly very good firm, price matters.
So, perhaps I would suggest reading emphasis into "If you're repurchasing shares above a rationally calculated intrinsic value, you are harming your shareholders", and a bit less emphasis on "we are better off because they have bought those shares at what looked like, to some people, perhaps, high prices".
Consider:
Starting from the time of that speech, the real total return from Coke stock in the next 20 years was inflation + 1.49%/year.
The real total return right up to today (26.1 years) has been 2.53%/year. (and not because of a cheap endpoint, they're at 27 times earnings these days)
These are really, really bad numbers.
This demonstrates two things:
* KO management were, in fact, paying far too much when buying back shares.
* The buybacks were a very poor capital allocation decision on the part of Coca Cola management, showing the firm was not in fact a top-notch firm.
That's because there is no other skill more important in the management of a company.
I guess that to the extent that Coke is allegedly a good business, it's more because of the "ham sandwich" rule than because of its stellar management, then or now.
For fun, consider an alternate reality.
Imagine if Coke had simply paid more dividends instead of doing buybacks at unjustified levels for all those years, and Berkshire had used those dividends to buy back Berkshire shares...
Berkshire's valuation was also crazily high, but only for the first couple of those 26 years.
This would have been a good thing overall, simply because Berkshire was and remains a very much better business than Coke.
Jim
No. of Recommendations: 19
Does this also mean that, in terms of P/B, the intrinsic value is around a P/B of 1.70?
If so, this would be higher than what I (and probably some others on this board) have assumed in the recent past (intrinsic value = around 1.5 or 1.55 X book value).
Could it be, at least in part, for this reason that Mr. Buffett asks us to no longer rely on increases in book value to estimate Berkshire's performance and that book value is a 'metric that has lost the relevance it once had'?
The degree to which book value tracks intrinsic value over time is, as far as I can tell, no worse than it ever was.
The two can be expected to drift apart at some point, but I haven't seen it happening yet.
However, the key bit is "no worse than it ever was". It was never perfect.
Book value per share drops sometimes, as some stock positions have lower market prices.
I would argue that all such drops are "errors"...the value of a share of Berkshire is not lower during a market dip.
Indeed, the rate of value generation is probably boosted on most such dips as capital is allocated at good rates of return.
Consider: Real book per share at end March was 5.3% below its peak to date five quarters earlier.
It's pretty certain that the real value of a share is higher than it was then.
So, I think any mismatch you're seeing at the moment is more reflecting the fact that book value hasn't really risen in a while,
despite the fact that value per share HAS risen. This has always been a limitation of book value as a yardstick.
Any valuation metric using mark-to-market values for the stock portfolio will have similar problems, unless you do a lot of smoothing.
FWIW, using a smoothed valuation metric (16 quarter WMA, so heavier weight on recent quarters), the current stock price is at a valuation level within 1% of its 10-year average.
The purpose of the smoothing is to eliminate "fake" value dips in bear markets, while still adapting (albeit with a little bit of lag) to recent financial results.
The time lag due to my data smoothing averages 1.4 years.
Jim
