Berkshire Hathaway inc. (BRK.A) has been a high-profile market laggard in 2019, its shares unchanged year-to-date through the close on Aug. 2, while the S&P 500 Index (SPX) has soared by 17.0%. Many investors were hoping that the company would try to boost its sagging stock performance by increasing its stock buybacks significantly. However, in 2Q 2019 Berkshire spent only about $440 million on share repurchases during the quarter, per the company's 10-Q report released on Aug. 3.
Berkshire CEO Warren Buffett has defended share repurchases against political attack, saying that they "benefit both those shareholders leaving the company and those who stay," and that "when stock can be bought below a business's value it probably is its best use of cash," per his latest annual letter to shareholders. He also stated that "Berkshire will be a significant repurchaser of its shares," and previously suggested that it might spend up to $100 billion on buybacks across an unspecified time horizon.
Significance For Investors
"Size is a drag on performance," as Buffett admitted during Berkshire's 2019 annual meeting. The company ended 2Q 2019 with over $122 billion in cash and cash equivalents plus short term investments, up from $114 billion at the end of the prior quarter. Interest rates at historic lows are making that growing cash pile a serious drag on performance.
Given that Berkshire is having increasing difficulty in generating market-beating returns, the rationale for returning capital to shareholders and shrinking its equity base should be clear. However, in the second half of 2018, the company spent only $1.4 billion on buybacks, followed by $1.6 billion in 1Q 2019, Barron's reports.
With a market capitalization of about $500 billion, the 2Q pace of buybacks is shrinking the equity base by less than 0.1% per quarter, hardly enough to make a discernible impact on the stock price. Raising buybacks to $10 billion per quarter, for example, would decrease the equity base by about 2% per quarter, which may be enough to boost the share price noticeably.
By comparison, both Bank of America Corp. (BAC) and Wells Fargo & Co. (WFC), two banks in which Berkshire has ownership stakes of about 10% each, repurchased between 7% and 8% of their shares in the past year, per Barron's. Property insurers Chubb Ltd. (CB) and Travelers Companies Inc. (TRV), major competitors of Berkshire's own insurance business, bought back between 2% and 4% of their shares. the same report notes.
"While our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years," Buffett wrote in his annual letter. Indeed, Jay Gelb of Barclay's has estimated that Berkshire's market price is significantly below the sum of its parts, per an earlier report in Barron's.
There are several reasons why Berkshire is unlikely to become a more active repurchaser of its shares in the near term. First, Buffett continues to "hope for an elephant-sized acquisition" which he would fund with cash, as he stated in his annual letter.
Second, Buffett also wrote, "We consider a portion of that [cash] stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities."
Third, Barron's notes, Berkshire does not appear to have set up a formula-driven plan under SEC Rule 10b5-1 that allows it to repurchase shares when it is in possession of material non-public information.
Lastly, Berkshire stock is relatively illiquid and lightly-traded, due to having many long-term investors, and thus a more aggressive buyback program is likely to move the price significantly, quickly raising its cost, also per Barron's. For example, the average combined daily trading volume of Berkshire's Class A and Class B shares is about $1 billion, whereas Facebook Inc. (FB), with a $550 billion market cap, has a daily volume about 4 times larger, Barron's adds.
Another possibility is that Berkshire may make a tender offer for a large block of stock at a price that is simultaneously above the market price but below Buffett's estimate of its intrinsic value. However, Barron's gives this very low odds of happening.