Buffett On Buybacks

Commentary

Warren Buffett defended stock buybacks in Berkshire Hathaway Inc.’s  2022 Annual Report (pdf), pushing back on those railing against the practice he believes benefits all shareholders.

“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”

This quote was grabbed by the media with all their might, but apparently they didn’t take time to look at what Warren Buffett wrote in his annual letter.

“The math isn’t complicated: When the share count goes down, your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices.

“The continuing shareholders also lose when the company pays too much for repurchases. These times are when the only beneficiaries of the gains are the sellers and the friendlier, yet more expensive investment banker that recommended these foolish purchases.

“Gains from value-accretive repurchases, it should be emphasized, benefit all owners—in every respect.”

Buffett’s right. Repurchases can be made at any time. “value-accretive” They can be a benefit to all shareholders by increasing their stake in the company. Contrary to popular belief, it isn’t a. “return of capital to shareholders,” But it is the exact opposite of shareholder dilution.

The mainstream media has jumped to the defense of those who oppose share repurchases quickly, however, they have failed to understand what Buffett meant. This is critical to the current financial markets.

An Example of a Basic

I’ve already discussed some of the issues with stock buybacks. We will start by giving you a quick example of stock buybacks.

While share repurchases aren’t necessarily bad, they can be a poor use of cash. The cash can be used instead of cash to grow production, increase sales or acquire competitors. This is an easy example.

• Company A makes $1/share and has 10/shares left.
• Earnings per share (EPS) =$0.10/share
• Company A spends all its money to purchase 5 shares.
• Next year Company A makes $0.20/share (1/5 shares).
• Stock prices rise because EPS jumped 100%
• The company spent all its money to purchase back shares and had no other options to expand its business.
• The next year, Company A continues to earn $1/share while EPS stays at $0.20/share.
• The 0% annual growth rate has caused a decline in stock prices

While this may seem extreme, it illustrates the fact that shares repurchases can only have limited and temporary effects on companies. If a company engages with share repurchases, they will be bound to continue repurchase stock to increase asset prices. This takes cash away from profitable investments and reduces the potential for long term growth and profit.

The chart below shows that the number of shares in public corporations has fallen sharply over the past decade, as companies race to boost bottom-line earnings against the backdrop of slowing sales and an economy growing.

(The following chart shows the differential per share through stock backs. This chart shows cumulative growth of EPS/Revenue/Share between 2011 and 2011. It will be apparent that although operating earnings per shares have increased, sales are still very poor.

According to Mr. Buffett, shareholders benefit from buybacks that are value-accretive. But that is not what has happened since the beginning of this century.

Mostly not Value-Accretive

“Over the past five years, according to S&P Dow Jones Indices, big U.S. companies have spent $3.9 trillion repurchasing their own stock.

“They are not good or bad. Buybacks are merely a tool. You can either use your hammer to build a home or take it down. Buybacks, however, are only useful for the right company hands.“ Jas