In a press release late Tuesday, the company said that it has amended its policy regarding share repurchases, now allowing for repurchases of Berkshire stock to be made at the discretion of Buffett and vice chairman Charlie Munger so long as both men “believe that the repurchase price is below Berkshire’s intrinsic value, conservatively determined.”
Following this news, shares of Berkshire were up as much as 4%, indicating investors sees the company’s decision to rework its share buyback plan as a sign that repurchases are likely to occur in the months ahead.
Previously the company had said it would not repurchase shares unless they traded at less than or equal to a 20% premium to the stock’s book value. As of Tuesday’s close the stock was trading at a roughly 40% premium to its book value.
Additionally, the company will not repurchase stock in excess of an amount that would reduce its cash and equivalent holdings to less than $20 billion. In its release Tuesday, Berkshire said no repurchases will be made under this new program until after its second quarter earnings are released after the market close on August 3.
In his 2016 letter to Berkshire shareholders, Buffett wrote that, “By our estimate, a 120%-of-book price is a significant discount to Berkshire’s intrinsic value, a spread that is appropriate because calculations of intrinsic value can’t be precise.”
Adding, “The authorization given me does not mean that we will ‘prop’ our stock’s price at the 120% ratio. If that level is reached, we will instead attempt to blend a desire to make meaningful purchases at a value-creating price with a related goal of not over-influencing the market.”
Buffett said in his 2015 annual report that intrinsic value is most simply defined as, “the discounted value of the cash that can be taken out of a business during its remaining life.”
In a note to clients published late Tuesday, UBS analyst Brian Meredith said he estimates the intrinsic value — excluding certain qualitative judgements — of Berkshire’s A-shares to be around $361,000. A-shares were trading at around $301,000 on Wednesday morning.
Notably, Berkshire’s announcement comes as Buffett has been very clear in recent years about his desire to use the company’s enormous cash pile on something more productive.
In his most recent letter to shareholders, Buffett noted that the company’s holding of $116 billion in cash and equivalent securities provided the company an “extraordinary” level of liquidity that is “far beyond the level Charlie and I wish Berkshire to have.”
Buffett added that, “Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.” Many saw this line as an indication that Buffett would like to make another major acquisition along the lines of its 2015 purchase of airplane parts maker Precision Castparts for $37 billion.
It seems that Berkshire Hathaway’s own stock will at least in part fill this void.
In 2011, Berkshire initially put its share repurchase program in place, saying it would repurchase stock when the price fell below 110% of book value. The company repurchased $67 million worth of stock in 2011 before the price moved beyond this threshold. The company amended this program in 2012 to increase the threshold to its former level of a 20% premium to book value.
Berkshire has not repurchased any of its shares since December 2012, when it bought back $1.3 billion worth “through a privately negotiated transaction and market purchases.”
And though stock buybacks have been roundly criticized as the scourge of post-crisis capitalism whereby managements simply borrow money to prop up share prices and enrich themselves, Buffett has defended the practice as an efficient way to reward shareholders — so long as they are made at the right price.
“In the investment world, discussions about share repurchases often become heated,” Buffett wrote in his 2016 letter to shareholders.
“But I’d suggest that participants in this debate take a deep breath: Assessing the desirability of repurchases isn’t that complicated. From the standpoint of exiting shareholders, repurchases are always a plus. Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market. For continuing shareholders, however, repurchases only make sense if the shares are bought at a price below intrinsic value.”
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland