“Derivatives are weapons of mass destruction” –Buffett 2002 “We are delighted that we hold the derivatives contracts that we do” –Buffett 2009
Legendary value investor, Warren Buffett, is no stranger to media attention. Over the past few years, he has been very vocal about economic issues. In August, the second richest American announced a $5 billion deal with Bank of America (NYSE:BAC), which according to Buffett, was conceived in a bathtub. The deal signaled a vote of confidence in the struggling bank, a similar strategy he used to inject confidence into Goldman Sachs (NYSE:GS). Now, Buffett is making headlines once again by announcing that Berkshire Hathaway may repurchase its own shares. Buffett’s latest announcement shows his confidence in Berkshire Hathaway (NYSE:BRKA), but also clouds the teachings of the Oracle.
In The Essays of Warren Buffett: Lessons for Corporate America, Lawrence Cunningham compiles a collection of past annual reports from Warren Buffett to offer insight and wisdom to investors. Buffett writes in his 1983 annual report, “Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers. At $1300, there are very few investors who can’t afford a Berkshire share (NYSE:BRKB). Would a potential one-share purchaser be better off if we split 100 for 1 so he could buy 100 shares? Those who think so and who would buy the stock because of the split or in anticipation of one would definitely downgrade the quality of our present shareholder group.” However, after opposing a Berkshire stock split for many years, Buffett approved a 50-1 split in early 2010. Buffett’s approval split the Class B shares from $3,475 to $69.50. The lower price point received a warm welcome as investors rushed in and sent shares up nearly 5% in the first 30 minutes of trading. The week following the 50-1 split, Berkshire made headlines again. With a lower entry price and its recent acquisition of Burlington Northern Santa Fe (BNSF), S&P announced that Berkshire Hathaway would replace BNSF in the S&P 500 (NYSE:SPY), as well as the more exclusive S&P 100. Shares of Berkshire Hathaway popped 8% on the news. Furthermore, it increased the demand for the stock, because big index funds that seek to replicate returns of the S&P 500 would now be forced to purchase shares. This hardly seems like the type of investor Buffett wanted to attract when he wrote his 1983 annual report.
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For the first time since January 2010, shares of Berkshire Hathaway Class A (NYSE:BRKA) fell below $100,000 last week. By Monday, Warren Buffet announced that Berkshire Hathaway may repurchase its own shares for no more than a 10% premium to book value. The repurchase plan came at a very convenient time, as shares were down 17% YTD prior to the announcement. The company said, “The underlying businesses of Berkshire are worth considerably more than this amount. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares.” This statement also conflicts with another annual report from Buffett. In his 1999 annual report, Buffett writes, “Please be clear about one point: We will never make purchases with the intention of stemming a decline in Berkshire’s price. Rather we will make them if and when we believe that they represent an attractive use of the Company’s money. At best, repurchases are likely to have only a very minor effect on the future rate of gain in our stock’s intrinsic value.”
Investors should now be wondering if the recently announced repurchase plan will truly offer a meaningful gain in the stock’s intrinsic value, or is Buffett trying to inject more confidence into a company to halt a price decline? Perhaps Buffett does see a brighter long-term future for his company, and is trying to learn from past mistakes. In the 1999 annual report, Buffett admits, “You should be aware that, at certain times in the past, I have erred in not making repurchases. My appraisal of Berkshire’s value was then too conservative or I was too enthused about some alternative use of funds.” Either way, Buffett’s differing views caused Berkshire shares to pop 8% again. The sudden pop in shares on Monday also place the repurchase plan in jeopardy, as Buffett’s 10% premium to book value ceiling is already nearly broken.
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