Why Warren Buffett Loves Big Stock Buybacks
Here is what Buffett said of stock buybacks and stake increases in his annual letter to shareholders in February:
Berkshire increased its ownership interest last year in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 8.4% versus 7.8% at yearend 2014) and Wells Fargo (going to 9.8% from 9.4%). At the other two companies, Coca-Cola and American Express, stock repurchases raised our percentage ownership. Our equity in Coca-Cola grew from 9.2% to 9.3%, and our interest in American Express increased from 14.8% to 15.6%. In case you think these seemingly small changes aren’t important, consider this math: For the four companies in aggregate, each increase of one percentage point in our ownership raises Berkshire’s portion of their annual earnings by about $500 million.
Berkshire Hathaway’s gain in net worth during 2015 was $15.4 billion, and that gain boosted the per-share book value of both the Class A and Class B stock by 6.4%. The A-shares book value was $155,501 at the end of 2015, versus a year-end share price of $197,800. This puts the shares at a value of 127% of its own book value. Buffett outlined the manner in which he would spend the company’s money to repurchase its own stock:
Over time, this asymmetrical accounting treatment (with which we agree) necessarily widens the gap between intrinsic value and book value. Today, the large – and growing – unrecorded gains at our “winners” make it clear that Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value. At that level, purchases would instantly and meaningfully increase per-share intrinsic value for Berkshire’s continuing shareholders.
The unrecorded increase in the value of our owned businesses explains why Berkshire’s aggregate marketvalue gain – tabulated on the facing page – materially exceeds our book-value gain. The two indicators vary erratically over short periods. Last year, for example, book-value performance was superior. Over time, however, market-value gains should continue their historical tendency to exceed gains in book value.
As far as why stock buybacks matter, it is not just one issue. Buybacks can prop up a stock, as sometimes companies are the largest single buyers of their stock on weakness. Buybacks shrink the total float of outstanding shares, and this acts to increase the earnings per share. Buybacks can prevent dilution from past acquisitions and from stock options. And lastly, the role of buybacks decreasing the free float of shares also acts to give existing shareholders an increasingly larger stake (and vote) in the company as a whole.