What You Can Learn From Buffett’s Billion-Dollar Buyback

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“A billion here, a billion there, and pretty soon you’re talking about real money.”

– Former U.S. Senator Everett Dirksen

Warren Buffett’s investment vehicle Berkshire Hathaway (NYSE: BRK-B) is on fire.

Berkshire recently announced that its quarterly operating profit doubled from $3.44 billion to $6.88 billion.

That crushed the $6.11 billion figure expected by Wall Street.

One analyst called Berkshire’s results “absolutely one of the biggest quarterly earnings reports that have ever come out of a United States corporation.”

But as I looked behind the headlines, another important figure jumped out at me.

Berkshire also confirmed it had plowed $928 million of its cash hoard into buying back its own shares.

Buybacks are rare at Berkshire. In fact, this was the first time Berkshire repurchased its own shares in six years.

As such, it also offers a valuable insight into both what Buffett thinks about the current state of the market… and what he considers “fair value” for Berkshire shares.

It’s now been almost three years since Buffett announced his last big deal – the January 2016 purchase of aircraft parts maker Precision Castparts for $32.1 billion.

That suggests Buffett doesn’t see a lot of value in the buyout market.

Put simply, too much money is chasing too few deals.

Surprisingly, that’s not what the rest of the market thinks.

The value of acquisitions hit $3.5 trillion so far in 2018. That’s up more than 30% from a year earlier.

The market is simply too hot for the Oracle of Omaha’s investment tastes.

Few companies are willing to sell their businesses at a fair price. And Buffett wisely refuses to engage in bidding wars for company assets.

This leaves him with another dilemma: what to do with Berkshire’s $100 billion-plus cash pile.

As it turns out, the best value in the markets just might be under Buffett’s nose: Berkshire’s own stock.

Now, valuing Berkshire Hathaway – with its more than 90 businesses – is a nightmare for outside analysts.

But no one can value Berkshire shares better than Buffett himself.

And therein may lie Berkshire’s single best opportunity.

I’ve written before about how Berkshire amended its (rarely used) share repurchase program in July.

The new terms allow Berkshire to buy back shares anytime both Buffett and partner Charlie Munger believe the share price falls below Berkshire’s “conservatively determined intrinsic value.”

The fuzzy formulation of “conservatively determined” gave Buffett and Munger considerably more leeway than the previous 1.2 price-to-book value target price did.

Here’s the good news…

Through some simple back-of-the-envelope calculations, we can now estimate what Buffett and Munger think Berkshire stock is worth.

Digging into the company’s disclosure documents, I found that the average price Buffett paid for Berkshire’s Class A shares was $312,807.

The book value per Class A share was $228,712 on September 30, 2018.

Dividing the price Buffett paid per A share by its recent book value suggests that Buffett will likely repurchase Berkshire shares when they drop below 1.4 times book value per share.

And multiplying Berkshire’s book value of $228,712 by 1.4 leaves you with a target repurchase price of up to $320,197.

(As if on cue, the price of Berkshire A shares soared more than 5% to $323,935 the day after Berkshire’s earnings announcement.)

Now, it’s worth putting Buffett’s buyback into perspective…

Spending $928 million to buy back shares is not a big bet for Berkshire.

In fact, it’s less than 1% of its current $118 billion cash pile.

Still, the terms of the buyback have revealed crucial information about how Buffett values Berkshire’s stock…

Which will help act as a “put” – or a floor – on Berkshire’s stock price.

Knowing this one fact alone makes a strong case for buying Berkshire stock.

Good investing,

Nicholas

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