Published on February 4, 2014

The nearly continuous rise in the stock market over the past five years has resulted in tough comparisons for many investors who measure their progress against benchmarks such as the S&P 500.  In a recent article, we pointed out that Berkshire Hathaway is nearly certain to fail the five year retained earnings test not because of poor performance in absolute terms but due to unfavorable comparisons with the S&P 500.  While the implications of failing the test are not entirely clear, a return of capital might be on the table in the near future.

Dividends or Repurchases?

Most discussions regarding a potential return of capital at Berkshire assume that distributions to shareholders would be in the form of a cash dividend.  Stock repurchases have been considered less likely primarily due to Berkshire’s self imposed repurchase limit constraining buybacks to levels below 120 percent of book value.

Berkshire announced the 120 percent limit on December 12, 2012 which replaced a prior authorization to repurchase shares at levels below 110 percent of book value which had been in place since September 26, 2011.  Berkshire shares have rarely traded below the published limits.  Over the 591 trading days since the September 2011 authorization was announced, Berkshire closed at or below the limit price on only ten trading days.

The exhibit below shows Berkshire’s stock price, book value, and repurchase threshold since September 26, 2011.

Buyback Threshold

Current Repurchase Limit

It is likely that Berkshire’s management uses the last published book value figure to calculate the buyback limit and then holds that limit constant until the next report released to shareholders.  This is despite the fact that book value is a dynamic figure that is constantly changing due to business operations and changes in the value of marketable securities.  Using an updated value during the quarter would defeat the main rationale of making Berkshire’s potential presence in the market for its own stock transparent to shareholders.  Therefore, we can assume that Berkshire is most likely using book value as of September 30, 2013 to set the threshold.  Book value as of September 30, 2013 was $126,766 per A share which would put the repurchase limit of 120% of book value at $152,119.

Berkshire’s Class A shares currently trade at about $165,000 which puts the price to book ratio at approximately 130 percent.  Based on the current limit, Berkshire would have to decline by another 8 percent to make a return of capital via repurchases a viable option.

Repurchase Limit After Annual Report

Berkshire’s 2013 annual report will be released on February 28, 2014 and shareholders will have access to the book value figure as of December 31, 2013.  Presumably at that point, Berkshire will revise its repurchase limit to reflect December 31, 2013 book value.

While Berkshire’s book value is difficult to estimate due to the variability of earnings and the unpredictable marking of the derivatives portfolio, it is possible to make a ballpark estimate based on changes in the stock prices of Berkshire’s disclosed marketable securities holdings as well as an estimate of operating earnings based on recent trends.  Based on these factors, we would estimate Berkshire’s book value per A share to be in the vicinity of $132,000 as of December 31, 2013 which would put the new 120% repurchase limit at $158,400.  Berkshire would have to decline by only another 4 percent to reach that threshold.

Conclusion

It is important to separate known facts from inferences or speculation regarding what we do not know for certain.  It does appear almost certain that Berkshire will fail its self imposed five year retained earnings test.  We also know that Warren Buffett has pledged to not change the “yardstick”.  However, Berkshire has not spelled out precisely what actions would be taken in the event of falling short of the yardstick nor what the scale of the response will be.  We also do not know for certain what Berkshire’s book value was as of December 31, 2013.

Despite the unknown factors noted above, it does appear that a share repurchase becomes increasingly likely as Berkshire’s stock price falls.  We already know that Mr. Buffett considers 120 percent of book value to be a very good price for Berkshire shares and he didn’t hesitate to increase the limit from the prior 110 percent level when he had an opportunity to repurchase a block of shares in a private transaction in December 2012.  It is not inconceivable that the limit price could be increased again.

If Mr. Buffett intends to stick closely to the five year test and return some capital to shareholders, it seems likely that he is hoping that Berkshire stock falls to a level where he will feel comfortable repurchasing shares.  Returning capital only to shareholders wishing to depart is a more efficient way to handle this situation given the fact that a dividend would impact nearly all continuing shareholders negatively when it comes to tax consequences.

The bottom line is quite clear:  Long term Berkshire shareholders holding shares in taxable accounts should cheer for a ten percent decline in the shares which would place them at a level unambiguously below the current repurchase level.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

Berkshire Hathaway Stock Repurchase Odds Increase
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13 thoughts on “Berkshire Hathaway Stock Repurchase Odds Increase

  • February 5, 2014 at 2:14 pm
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    thanks for the piece, have you considered the possibility Buffett raises the buyback limit to 1.5 xs book ?

  • February 5, 2014 at 10:45 pm
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    The fact that the buyback level was changed from 1.1 to 1.2x book seems to indicate that the level could fluctuate over time. I would like to see the explicit threshold removed to increase flexibility but that is probably unlikely. It would not surprise me if the explicit level changes from time to time.

  • February 6, 2014 at 6:48 am
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    morning rational, thanks for your reply. With all due respect to you and many of the sharper posters on the Fools board if buffett does not initiate a 1.5 ish% div or increase the buyback limit from 1.2 xs book, why will enough willing buyers pay 40 % above buffett’s limit in sufficient size to move brkb back to 1.7 xs book ? It isn’t realistic and it isn’t going to happen. Buffett’s life’s work is being sold approximately 100,000 shs a day forever, and the foundations are enjoying 500k to 1 million a day in lower proceeds from sales as a result of buffett’s refusal to make these 2 shareholder friendly moves. A small div would increase demand for brkb from div paying funds and individuals who will not buy a non div payer. buffett and friends should lobby both parties to change the tax laws and allow divs to be donated pre tax to any charity that benefits American vets and our kids, I’m sure the Forbes 1000 and both parties would support this idea. If buffett also raises the buyback limit to 1.5 xs book the foundations will enjoy an extra 10 % a day from the proceeds from stock sales. since 2007 brkbs stock price has reacted to special events not iv or bv discovery. Since I already did the research I’ll provide you with the key dates to confirm my claim, thanks again for sharing your thoughts on brkb etc. hc.

    brkb options listed 6/18/09,
    1/21/2010- 50- 1, stock split

    3/5/2010 – spy add,
    6/25/2010 – Russell index add,
    3/30/2010- sokolgate,
    9/26/11- buyback authorized, 110 % of book limit,
    12/12/12- buyback limit raised to 120 % of book.

  • February 6, 2014 at 8:35 am
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    It would be better for Berkshire to have a more flexible repurchase policy with no preset limitation in terms of price-to-book ratio. This would be consistent with the policies in place for most companies with a repurchase plan. Based on his statements regarding repurchases, Warren Buffett wants to make sure that future managements do not go crazy with expensive repurchases, which is common for companies with no valuation based limit. However, Berkshire’s management is not (and hopefully will not be) “ordinary” in terms of ignoring value when repurchasing stock. Whoever Buffett’s successor is, he should be trusted to not do unintelligent things with repurchases or it could be argued that he should not serve as CEO at all. Repurchases, at most, will have a modest impact on Berkshire’s intrinsic value compared to overall capital allocation. Capital allocation is the next CEO’s main job.

    It is not clear when or if the market will assign Berkshire a 1.5x or 1.7x multiple. Clearly, the P/B multiple has been much lower than normal since the financial crisis. But it should be noted that this is not really specific to Berkshire. The valuation of companies such as Markel and Loews have been depressed as well.

    In the long run, shareholder returns will mainly depend on how fast book and intrinsic value grows rather than the end point multiple. Let us assume that book value was $132,000 at year-end 2013. If book value grows at a 9% rate over the next decade, that would put book value at around $312,000 at year-end 2023. If the price/book ratio is 1.5 at year-end 2023, the stock should trade around $468,000. This implies 11% annualized returns from the current price. If the price/book value remains constant instead of expanding to 1.5, the annualized return will be equal to the advance in book value – or 9%. The vast majority of shareholder returns will be due to business performance rather than swings in the P/B ratio. It seems quite unlikely for the P/B ratio to FALL materially from the current level. Therefore, shareholders might conservatively assume that shareholder returns will match the trend of book value growth which should be in the 9-11% range and consider a P/B expansion to be an added bonus.

  • February 6, 2014 at 10:11 am
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    <>

    thanks ravi, does it make sense to you that anyone would argue that brkb may trade up toward a higher price to book valuation as buffett and munger age, or once buffett and munger are gone ? Who is going to replace buffett and munger and charge us less for doing the job ? If buffett and munger had taken a modest pay package of say 1 % of stockholders equity via options grants over the past 30 years what would buffetts net worth be today ? What would book be today if buffett and munger owned an additional 25 % of the shs outstanding as part of a normal pay package ? If brkb remains a non div payer with a buyback limit of 120 xs of book there is very little chance brkb will trade above 1.5 xs book in the near future, maybe not in buffett’s lifetime, imo. Therefore buffett is going to do what he has to do, initiate a 1.5 ish % div and or amend the buyback sec filing to authorize buybacks at a , substantial discount to IV , or raise the buyback limit to 1.5 xs book. If buffett is afraid the BODS will go wild once he passes he can instruct the BOD to amend the buyback limit to 1.3 xs book once he passes. I still say both parties will support the idea that any div should be free of tax if donated to a charity that benefits our vets or our children living in poverty, who would oppose that tax idea ? btw, I’ve argued since 2007 that the foundations selling 100,000 shs of brkb a day IS material. I know you agree with buffett and munger that it isn’t material but 12 million dollars worth of stock for sale every day is material. Adding 30 million shs a year to the FLOAT in the Bs every year, is material, supply and demand matters, even in brkb. Mr market has to absorb 3.5 billion dollars of foundation sales every year forever, in the aggregate over 5 and 10 year periods this added supply is material. Has L underperformed as much as brkb has the past 5 years ? brkb got all those sweetheart deals during the crash , brkb had billions in cash during the crash to take advantage of the weakness of others, buffett was the go to guy during the crash, WHY did brkb underperform spy 5 % a year for the 5 year period if foundations sales were not material ? Did the refusal to authorize a buyback until sept 2011 cause the underperformance ? Did the 110xs book limit help to cause the underperformance ? Thanks again for the exchange you are well suited to answer questions buffett would never agree to answer.

  • February 6, 2014 at 10:38 am
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    It is difficult to point to any single factor that has caused Berkshire’s valuation to remain historically depressed over the past few years. However, Berkshire did trade at around 1.4x book value briefly right at the end of 2013 (based on 9/30 book value) so I’m not sure that 1.5x is inconceivable. If companies like Markel and Loews were trading closer to historical valuation levels while Berkshire languishes, I’d be more interested in looking at Berkshire specific causes. I tend to believe that the issue is that insurers are just depressed but this could be wrong. If Berkshire fails to trade up to 1.5x book over the next five years then it seems more plausible to think that we should not expect much P/B expansion. As things stand, I think shareholders are better served to just count on appreciation equal to book value appreciation rather than P/B expansion and view any expansion as a “bonus”. Time will tell …

  • February 6, 2014 at 10:50 am
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    we agree on that point. I would use a more conservative 7 % for expected growth in book going forward but I would love to ask buffett the simple question I raised a few years ago when brkb was 70ish. IF you agree book will grow at least 7 % a year going forward and if brk can borrow at less than 4 %, if you can buy brkb near 120 xs book how could it not be a no brainer to borrow below 4 % and buyback brkb with both hands over buying ibm ? since buffett would never take that question can you explain what he might have been thinking ? why buy and aggressively promote ibm over brkb ? thanks.

  • February 10, 2014 at 9:20 pm
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    Ravi and Harvey,
    Wonderful discussion. Worth ever second I spent reading it.
    Thank you.

    • February 11, 2014 at 7:48 am
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      Rahul, thanks for your reply. bottom line, as long as buffett continues to limit DEMAND for brkb because it pays no div, has a 1.2 xs book buyback limit, because buffett consistently promotes stocks other than brkb, while the foundations have 100,000 shs of brkb to go every day, brkb will continue to underperform spy as I predicted in 2007. Obviously buffett and munger are getting older and closer to the inevitable every day as well, why not make shareholder friendly moves NOW and set the table for when they both are gone ? WHY buffett is content to sell off his life’s work 10 % below where it should be trading will always be a mystery ?? Lets see what silly excuses he makes in the annual letter to partners. Take care, hc.

  • February 11, 2014 at 9:28 am
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    It seems likely that Berkshire will have to spell out the conditions for repurchase in more detail in the future. At this point, we have a fixed ratio of price-to-book value that is being used as a limit but this is problematic for a number of reasons. The initial 1.1x limit was so low that it effectively ruled out the possibility of repurchases and had to be increased to 1.2x in order to facilitate the private purchase in late 2012. Since that time, Berkshire has only traded below 1.2x book on a few isolated occasions lending credence to those who view the limit as a “floor”. While no “floor” really exists, particularly in a sustained bear market in which Berkshire might find other opportunities more attractive than repurchases, the 1.2x level effectively removes repurchases as a tool the majority of the time.

    Perhaps more significantly over the long run, from an intrinsic value perspective, the ratio of intrinsic value to book value is not likely to remain constant over time. It is more likely to increase over time as the market value of subsidiaries grows beyond the subsidiaries book value. We have already seen this most clearly at BNSF and Marmon but the same is true of other subsidiaries. If Berkshire were to remain static in terms of the collection of operating companies, in ten years the ratio of intrinsic value to book is going to be quite a bit higher than it is today.

    The price/book limit is intended to prevent future managements from doing what most companies do with repurchases: buy more shares when the price is high and less when the price is low. This dysfunctional behavior is common and to be avoided. However, the job of Berkshire’s future CEO is going to be primarily capital allocation. If he cannot be trusted to do intelligent things with repurchase activity without handcuffs, then neither can he be trusted with capital allocation more generally. If the next CEO takes over at a time when we still have a fixed P/B limit such as 1.2x, he will have great difficulty ever raising the limit even if the ratio of IV/book increases since, rightly or wrongly, that will be viewed as violating one of Warren Buffett’s principles. If we are to have a published criteria for buybacks, it would be better to have one that is more dynamic. Perhaps a limit based on the widely known “two column” method would make more sense.

  • February 11, 2014 at 9:52 am
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    morning ravi, if buffett is so uncertain about his pick that follows him with respect to discipline and intelligent use of capital what do you suspect will happen to brkb’s stock price IF he passes sooner than expected ? bud, I live in a retirement community with over 7000 homes, over 10,000 people , everyone here is 55 and over. people have heart attacks, die , etc regardless of net worth, income, or their last doctors visit opinion of their current health every week !! buffett should reduce his role now, mentor and observe his successors now, while he is in good health and can monitor their actions and give sage advice ,imo. if buffett really wants to understand brkb’s true value why not call in GS for a meeting ? IF buffett wanted to spin out 20 % of Geico and take it public, how would GS price it ? At book ? Take 20 % of bni and lz and take it public, how would GS price them, at book ? We can go on and on, book should not be the hurdle for brk to buyback its stock. a discount to IV should be the hurdle. if buffett doesn’t trust his successors to allocate capital he should keep looking ! I vote for YOU !! I trust you. thanks. hc

  • February 11, 2014 at 10:14 am
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    To be fair to Buffett, he has been taking steps to ease the transition by giving Combs and Weschler increasing responsibilities managing the investment portfolio. I expect that they will continue to be given more funds to manage over time. Within a few years, I suspect that no one will have much anxiety regarding the management of the marketable securities portfolio once Buffett is gone. Of course, neither of them will be the CEO most likely. It is not outside the realm of possibility that Berkshire will have someone step into a COO type of role if Buffett is still running Berkshire into his late 80s or beyond. If he lives long enough, perhaps he will even do as you suggest and step into a Chairman role while handing the CEO job to someone else. I only expect that he will do that if in poor health where he cannot devote all his time to Berkshire anymore. I trust that Buffett and the Board will make good decisions or I wouldn’t own as much Berkshire stock as I do.

  • February 11, 2014 at 10:25 am
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    seems to me the time to hand off the baton is while buffett is healthy and alert so that he can mentor his successor and make sure he made a wise decision, he has made poor decisions on character in the past, no ? btw, is there any proof that giving todd and ted billions to manage was a better decision than just buying back brkb with those funds ? we can’t judge the new kids on the block based on a 3-4 year monster bull market. how will they do in a 25 % sell off ? buying back brk near book in the past was money in the bank I have no idea why buffett was and IS so stubborn with respect to the buyback hurdle ?? Maybe this year he will allow serious questions at the annual , certainly the jokers at cnbc will never go there. btw, rather than waste time with a clown like doug kass this year buffett should invite you to ask the questions, at least you own the stock. I’m serious.

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