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Investment Analysis Clubs / The BMW Method
|Subject: The Polygraph Machine||Date: 12/11/2012 12:21 AM|
|Author: kelbon||Number: 40837 of 42009|
I posted this on another board, but as the thread before last was on the subject of Berkshire Hathaway, I think it appropriate to post it here too.
I'm reading Tap Dancing to Work the new book on all things Warren Buffett. Unlike most books on Buffett, he's actively promoting this one and doing the chat show circuit as a double act with the author, Carol Loomis.
Tap Dancing to Work
April 29, 1985
An excerpt from an article by Carol Loomis
The Exxon investment is new, built up only after the company started acquiring its shares in 1983. "A big reason I got in," Buffett says, "is that the company has recognized the value in its stock and been smart enough and pro-shareholder enough to repurchase it." On the other hand, Buffett has sold the stocks of certain companies because they would not make repurchases.
He is convinced, in fact, that the market discounts the prices of companies that should be making repurchases and don't, instead frittering their money away on acquisitions or other investments of far less value. The corollary, he says, is a markup in prices for companies that do repurchase shares, because investors identify the buybacks as a sign that management will be consistently inclined to act in the interests of shareholders. "All managements say they're acting in the shareholders' interests," he observes. "What you'd like to do as an investor is hook them up to a machine and run a polygraph to see whether it's true. Short of a polygraph, the best sign of a shareholder-oriented management —assuming a stock is undervalued—is repurchases. A polygraph proxy, that's what it is."
More recently, a big reason Buffett got into IBM shares is because their management has repurchased, and is committed to repurchasing, a meaningful amount of their shares. Nothing much seems to have changed in Buffett's reasoning about buying stock in shareholder friendly companies. Which naturally brings up the question of is Buffett really inclined to act in the interest of Berkshire's shareholders? Although he has set a floor under the stock by announcing the intent to buyback shares at less than 1.1 times book he's created a situation where it's unlikely that Berkshire's shareholders will see meaningful share repurchases, even though it's no secret that Berkshire's management consider the shares undervalued. Presumably most of Berkshire's shareholders hold shares hoping for a meaningful increase in their market price. It's worth considering that the share price is being anchored because, indeed, the market is punishing Buffett for not acting in the best interest of his shareholders. Perhaps it's time to hook him up to that polygraph machine?
A glutton for punishment—as always—I posted the above on the Berkshire board and got the reaction I expected (though some readers there seemed to agree with me): that Buffett is an exception to the rule, even a rule he himself advocated; that Berkshire is different; and, something along the lines of: "I don't want Buffett buying Berkshire even at a 25% discount to intrinsic value if Company X can be purchased at a 40% discount." There's logic in this one provided the intrinsic value of X is actually purchased at a 40% discount and X will produce a very attractive rate of return for Berkshire well into the future. Two "ifs." Even if these two hurdles are cleared, is it truly shareholder friendly to go only this route when the stock is demonstratively undervalued, especially considering it shouldn't be an either/or situation as Berkshire's cash reserves are enormous?
Because of the limited longevity of Buffett's likely remaining tenure and the enormous conglomerate that Berkshire Hathaway has become, the past is unlikely to repeat itself; it probably won't even rhythm, but it might echo. Sure, Berkshire's earnings and book value will increase, but it's more or less guaranteed that the growth-rate will be far slower than in the halcyon days of yore. A realistic expectation is an annual rate of 8% – 10% in book value growth, which may, or may not, come to pass.
There's a lot to be said for the ability of an investor to either enter, or exit, a position close to fair value more than once in a decade. If a stock is cheap I think a responsible management would seriously consider where the majority of their shareholders stand: that is, they bought their shares with capital appreciation in mind, without the intention of locking up their capital for decades at a time.
Coming up… Buffett the baseball player and the architect.
I do think a legitimate issue to raise is Buffett's age. Although he hasn't shown any signs of being off his game, it's worth remembering he's now in his eighties and, like the rest of us, is human. It's possible he'll be successfully running Berkshire Hathaway ten years from now, but (statistically) it's more likely that he won't be. The stock is cheap, he is in the last innings, he could hit a few more balls out of the park, but buying back a meaningful amount of stock isn't going to put the kibosh on his coronation in the Hall of Fame. Far from it. It's already happened.
My inclination is to believe that Warren Buffett is still hard at work building his Taj Mahal. Tearing down a tower or two for efficiencies sake, consequently making the building slightly smaller, just isn't in the cards, even though the great architect advocates for more efficient buildings and those are the kind he favors for his own acquisitive collection.
Don't get me wrong, I'm not saying that Berkshire's shares are a bad investment. Not at all. By announcing that he'll buy back shares at 1.1 x book value Buffett's probably put a floor under the share price. If book value grows at around 8% a year, stockholders will likely make the 8% in share price appreciation without much worry of a significant downturn in the stock price. Not a bad situation to be in with the potential for an upside too. But, it is within Warren Buffett's power to do better for his shareholders; at least for a while; at least for the stock price. After all, he is on the record as defining a stock-holder friendly company as one that buys back shares when they are undervalued.
Incidentally, Berkshire's shares are now trading for around 1.17 x book value, only just north of the broadcast strike price.
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