Young Investor

IN THE LIMELIGHT: Buffett does the 'Twist'

ADARSH GOPALAKRISHNAN | Updated on October 01, 2011

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Renowned investor Warren Buffett's announcement last week that his conglomerate Berkshire Hathaway will deploy part of its $48 billion in cash to initiate a share-buy-back program sent the stock up 6.5 per cent by the week's end.

The repurchase value has been capped at 10 per cent over book value. This works out to around $105,000 a share, going by 2010 numbers. Berkshire shares are down 15 per cent over the last six months.

Quite a surprise

The announcement caught several Buffett observers and the market by surprise. And that's because Buffett, in his last letter to shareholders, boasted that ‘not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years'.

Still, it's not difficult to guess why the ace investor has now chosen to buy Berkshire's shares. Markets currently seem to be steeped in panic and fear — and this state plays right into Buffett's famous adage of being greedy, seeking to scoop up assets for cheap when other market participants are averse.

Another possible reason is that given the low interest rates prevalent across the globe, Berkshire's cash will earn meagre returns from holding treasuries or stable sovereign debt. As this cash pile grows bigger, the pressure will be to generate decent returns. In this context, Berkshire's share buy-back seems a good option.

In addition to boosting the company's earnings per share (though this is not Buffett's favourite metric), it also plumps up Buffett's much-vaunted intrinsic value per share.

Buffett has said Berkshire is a good buy at values around book value.. Criteria for the buy-back shares trading at 1.1 times book-value and not letting Berkshire's cash reserve go below the $20-billion mark. This reflects his aversion to being cash-strapped and having to raise expensive debt when his company may need cash the most.

Of course, Buffet could choose to back off from the buy-back if a large attractive acquisition opportunity comes along. Though given Berkshire's size and the rate at which cash is generated (a billion dollars a month!), it takes a huge transaction to make a notable dent in the company's cash position. Examples? The recently completed purchase of Lubrizol ($9 billion), or last year's purchase of Burlington Santa Fe ($34 billion).

However, acquisitions of this scale are neither frequent nor do they always conform to Buffett's reluctance to engage in a bidding war or hostile takeovers.

As Buffett has noted in the past, acquisitions for the sake of increasing scale when one can buy back their own shares for cheap is detrimental to shareholders.

Investment ‘regrets'?

Buffett, in a 1999 shareholder letter, did say he had missed out on opportunities in the past to buy back Berkshire's shares for cheap, either because he was too conservative in valuing Berkshire or he had better opportunities. Maybe this time around, he will get to remedy one of his few investment ‘regrets' since the 1970s: not buying Berkshire shares for cheap.

Published on October 01, 2011

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