“It’s such an easy concept to assess…”
That was Warren Buffett on the idea of a company buying back its own shares.
Buffett has stated that he won’t use Berkshire Hathaway’s cash to buy back their own stock
unless both he and Charlie Munger agree it is undervalued.
For a long time, Berkshire never repurchased its own shares - presumably because they always
saw better opportunities in the market or they just preferred to build up their massive
stockpile of cash.
In 2018, they finally dipped their toes in, repurchasing more than a billion dollars worth
of their own stock.
In their 2019 fiscal year, it was almost $5B. And over the last two years, they’ve spent
more than $50B on buying back their own shares.
Did they change their tune about buybacks?
Lower their standards perhaps?
Did they go too long without being able to find enough other places to deploy their rapidly
growing capital?
Did they perhaps start to realize how overvalued pretty much everything was/is?
Were they cleverly anticipating the coming inflation and realized how imprudent it would
be for them to keep all that money in cash?
Their cash position had been building up rather significantly over the last decade - at a
much faster clip than they’ve been able to invest it at least - in fact, it wasn’t
until this year that we’ve ever even seen a meaningful decline (at least over this last
decade) in their cash position.
We’ll hear what Buffett has to say… coming up!
– Welcome back you brilliant 17,000 subscribers.
Thank you for being here.
I’m sure you understand how share repurchases work and why they can be bullish for the future
of a stock.
When a company is buying up their own shares, they are reducing the number of shares outstanding
in the market - they are reducing the number of slices of the whole pie.
If there were 20 slices and you owned 2 of them - that actually represents an ownership
of 10% of the whole.
Now if instead, the company sliced up the same pie into 10 slices (because they bought
up the other ten), as long as you didn’t sell any of your shares, you still own 2.
But now, that represents an ownership stake of 20% of the whole.
Buffett simplified this scenario for Berkshire investors, by tying it back to the Buffett
Munger Lemonade Stand.
Here he is…
“If we had a lemonade stand.
Charlie and I and you owned it.
And the lemonade stand was making us about a buck a week or something and we divided
it up.
And you said you wanted to get out and you said one number and we had the funds in our
little lemonade company, we’d buy you out and if we didn’t like the price…
we wouldn’t buy you out.
It’s the same way we feel - we do feel an obligation to do things that we think are
intelligent and in no way risk - absolutely no way present any risk of financial problems
under any circumstances we can envision (except maybe something like nuclear war), we’ll
do it.”
Now there are absolutely examples of where this practice of share repurchases can appear
(at least) to be a bit nefarious.
For example, if some large corporation indiscriminately received some stimulus money or something
like that from the government and then they just used it to buy back their shares, well…
maybe it turns out they didn’t really need that extra money after all…
In general, stock repurchase programs are purely for the benefit of shareholders.
But they really should only be done if the company cannot find a better, even more beneficial
way to employ that same capital.
On one side, you have the price of the company’s stock.
If it’s overvalued, as a shareholder, I don’t want them wasting money on their own
expensive stock.
The more undervalued it is, though, the more compelling the case will be for them to scoop
up shares.
On the other hand, you have to consider what the company in question is otherwise able
to do with this money - how else could they invest; how else could they employ this capital.
It’s similar to a dividend in that way: if a company like Google (for example) believes
their shareholders are going to get the best bang for their buck by investing their capital
into innovation and further development of their existing business lines and projects,
then that’s arguably what they should do.
If a company is maturing and/or generating more cash than they know what to do with and
(here’s an important part) that seems likely to be their story going forward, a consistent
dividend might be what’s in shareholders best interest in that case.
But if they find themselves flush with cash AND that situation is perhaps just temporary
(as is arguably the case here with Berkshire), buybacks might be the answer.
“If somebody had offered us $50B worth of stock at a certain point in the last 3 to
5 months, we’d have taken it.
It’s that simple.
It’s something that, when we can do it and we know (we think the probabilities are very
high; we certainly believe in terms of our own evaluation and our own investment) we
think we’re improving things for the remaining shareholders, we’ll buy it back.
And if we don’t we won’t buy it back.
And if we have the choice of buying businesses we like or buying back stock - the controlling
factor is how much money we have - we'd rather buy businesses.
So it isn’t… you know… we don’t stay awake at night working out formulas or anything
of the sort.”
Buffett goes on to explain (1) how Munger has greatly profited from this strategy in
the past (the strategy of thoughtfully issuing and buying back shares) and (2) why they won’t
be able to ultimately buy back all that much of Berkshire…
“Charie, he spoke the other day … I think he bought back 89% of the company over time.
And he sold stock like crazy (or issued it) much earlier when it was overpriced.
And he bought it back underpriced.
But the key to that, of course, is having people think you’re wrong in doing it.
So he was able to buy a ton of it.
And there are some other companies that have bought a ton of it.
And Berkshire isn’t going to get the chance to do that because… we’ve got sensible
shareholders is what it amounts to.
If we had the same group of shareholders that own two day puts and they were our shareholders,
we’d buy back the whole company in a very short period of time!”
Now while many finance writers and academics seem to make some of these issues very complicated,
Buffett has a way of finding as many analogies as he can to help simplify the way he’s
thinking about this.
Here was another analogy he gave, this time with farmland…
“Now imagine, imagine if you owned a farm and you had 640 acres and you farmed it every
year and you made a little money on it and you enjoyed farming.
And somehow, 20 or so years later, it had turned into 1100 or 1200 acres.
I mean, you’d say, how long has this been going on?
You know?
What could possibly be, you know, is this unamerican?
Or whatever it may be!
I mean, is it sensible use to meet its cost of capital…
blah, blah, blah, blah, blah…
If you do it at the right price, there’s nothing better than buying into your own business.”
“It is the simplest thing in the world and then I read all this stuff…
It is unbelievable how people can’t figure out something that… you know, if they owned
a farm and the guy next to them owned a farm and somehow you were getting more of his farm
the whole time without putting up any money while you farm your own farm, that at least,
you know you were using some of the earnings for that, you’d feel very good about it.”
And of course, he’s right.
If my business was publicly traded, I would view it in the exact same way.
Not all managers do, so something you might want to keep in mind when evaluating a management
team - many succumb to these outside pressures and criticisms, one way or the other: buying
shares when they’re obviously overvalued, or investing in something else when repurchasing
undervalued shares would have actually been the most prudent decision.
I especially loved Buffett's real world examples of the value of repurchases in action with
some of the companies Berkshire owns today.
We’ll start with his explanation of this playing out with their stake in Apple and
then we’ll play my favorite which was his description of what has happened with their
stake in American Express.
Check it out…
“We own - I mentioned Apple as an example - of how our interest in Apple, you know,
everytime the company earnings $100B in a year, you know, it means our interest in it
goes up a tenth of a percent.
So we’ve added another $100MM to earnings.
Well that…
it takes a lot of work to add 100MM to earnings.
And in the first quarter, you know they just reported their March quarter and they earned
more money and had fewer shares outstanding.
And we actually bought a little more Apple in the first quarter so we decided we wanted
to own a greater interest and on top of that we knew we would own an even greater interest
if they kept buying their shares - which we didn’t have any inside information or anything
but it certainly seemed the way to bet - and well, you feel better because we bought the
shares we bought in the market and we feel just as good by the fact they used some of
their cash to buy out some of the other people.”
“We owned in 1998 - that was more than 20 years ago - we owned about 150MM (I don’t
whether they’ve split… if they’ve split, it’s split adjusted, but we owned 150MM)
shares of American Express.
I think we bought our last share in 1998 or something like that.
And we then owned 11.2% of the American Express company - wonderful company!
And since then, they’ve sent us a check every quarter as a dividend, so we’ve taken
some cash a little bit as they’ve gone along.
And now we own 20% of American Express.
That’s happened because they’ve repurchased shares.
That happens to have worked out extremely well.
If they overpaid for the stock and all that…
well, it doesn’t solve every problem.
But it’s a wonderful thing if you’ve got an asset that you like and they take your
ownership interest up - and like say we’ve gone from 11.2% to 20%.
If you’re using your American Express card or whatever it may be, 20% of whatever earnings
are attributable to our interest and it used to be 11.2% and we’ve done it without putting
up any money!”
Pretty incredible, right?
Bought his last share in 1998, been collecting dividend checks ever since, and now owns a
significantly larger piece of the American Express pie.
Sounds like a pretty sweet deal.
What do you think?
Let me know in the comments.
Now, although I’ve learned a ton from Buffett over the years, I don’t always agree with
him…
Here, I’ll link out to a super old video I put together of one thing I think Buffett
is seriously wrong on.
I appreciate you so much.
Take care!