- (1) a $5 billion 6% preferred stock of Bank of America that came with warrants allowing us to buy 700 million common shares at $7.14 per share any time before September 2, 2021; and
- (2) 63.9 million shares of IBM that cost us $10.9 billion. (= $170.58 per share)
This discussion of repurchases offers me the chance to address the irrational reaction of many investors to changes in stock prices. When Berkshire buys stock in a company that is repurchasing shares, we hope for two events:
- First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and
- second, we also hope that the stock underperforms in the market for a long time as well.
Let’s use IBM as an example. As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today.
- Their operational accomplishments were truly extraordinary.
- But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved.
- The company has used debt wisely,
- made value-adding acquisitions almost exclusively for cash and
- aggressively repurchased its own stock.
- Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us.
- Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares.
I won’t keep you in suspense.
- We should wish for IBM’s stock price to languish throughout the five years.
Let’s do the math.
- If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company.
- If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares),
- you are hurt when stocks rise.
- You benefit when stocks swoon. Emotions, however, too often complicate the matter:
Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here a confession is in order:
- In my early days I, too, rejoiced when the market rose.
- Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices.
- Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life.
- But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity.
- And if repurchases ever reduce the IBM shares outstanding to 63.9 million, I will abandon my famed frugality and give Berkshire employees a paid holiday.
- 7% of $20 billion = $1.4 billion
- 6.5% of $20 billion = $1.3 billion.
- The difference due to the sharebuyback at lower prices give an extra $100 million in profit.