The China bubble

GREG HOFFMAN

April 12, 2010

Edward Chancellor, a member of the asset allocation team for Boston-based GMO and, interestingly, the author of a recent Financial Times piece on Australian property, is a financial historian and bubble expert.

His 1999 book, Devil Take the Hindmost: A History of Financial Speculation, examined past speculative manias. Perhaps you've read articles comparing the tech boom and 1990s' bull market to tulipmania in 1630s' Holland.

The difference is that Chancellor was making that comparison before the tech bubble burst, some years before Alan Greenspan claimed it was futile trying to predict bubbles at all.

Chancellor's timing may have been fortuitous. To accurately predict something once might mean little. To repeat the feat perhaps means something more.

His next major piece - Crunch time for credit: An enquiry into the state of the credit system in the United States and Great Britain - included this prescient paragraph:

''The growth of credit has created an illusory prosperity while producing profound imbalances in the British and American economies...When credit ceases to grow, the weakened state of these economies will become apparent.''

That report was written in 2005, years before the credit bubble burst. Chalk two up to Chancellor.

Third time lucky?

He's now turned his attention to China, a fertile ground for his fertile mind. Released last week on the GMO website, China's Red Flags is split into two parts.

Crisis checklist

Section one identifies speculative manias and financial crises, offering a checklist for those trying to identify bubbles in advance of their bursting. Chancellor offers 10 criteria for what he calls ''great investment debacles'' over the past 300 years (the report explains each in far more detail);
 1. A compelling growth story;
 2. A blind faith in the competence of authorities;
 3. A general increase in investment;
 4. A surge in corruption;
 5. Strong growth in money supply;
 6. Fixed currency regimes, often producing inappropriately low interest rates;
 7. Rampant credit growth;
 8. Moral hazard;
 9. Precarious financial structures;
 10. Rapidly rising property prices;

Although all these criteria need not be present in order for a bubble to be present, you can see where Chancellor's heading: not-so-subtly steering readers towards his own conclusion. In section two he takes each factor and applies it to the case of China.

Ponzi scheme

His conclusion is alarming; The very factors that have allowed China to grow so rapidly over the past few years despite the global slowdown - an investment boom, a credit boom, massive increases in money supply, moral hazard and risky lending practices - are all factors that investors and the mainstream press feel they can safely ignore because China is growing so rapidly.

After the past few years, we should all understand the potential negative implications of such major imbalances. But there seems to be general agreement that a ``build it and they will come'' approach is warranted in China because it keeps growing rapidly. There's a Ponzi-like element to the circularity.

Chancellor is concerned that China's high GDP growth is no longer a function of impressive natural growth. Instead, growth is being engineered to achieve high GDP numbers. It's producing a system that's unsustainable and prone to collapse.

This, in essence, is Chancellor's argument:
- Investors are adopting an uncritical attitude to China's growth forecasts;
- Because of the way local officials are incentivised, it's likely that migration of the population from country to city is much further along than the official numbers suggest. So when you hear of another 350 million internal migrants arriving in cities by 2025, many of them are actually already there;
- Hence, future productivity growth will be much more reliant on efficiency gains than urbanisation. China's record in this area isn't at all strong;
- Beijing imposes GDP growth targets on local governments. Thus, ``GDP growth is no longer the outcome of an economic process, it has become the object''. `When the allocation of resources, whether at the corporate or national level, becomes all about ``making the numbers'' then poor outcomes are to be expected';
- In 2009, Chinese fixed asset investment contributed 90% of total economic growth (an incredible statistic and a natural consequence of the previous point);
- Significant overinvestment is present in many areas. For example, capital spending in the cement industry increased by two-thirds despite capacity utilisation running at an estimated 78%;
- The efficiency of investment (incremental GDP growth for each additional unit of investment) is trending downwards towards wasteful levels;
- Interest rates have been kept way too low for decades, sparking economic growth but also imbalances and bubbles;
- China's enormous foreign exchange reserves are not necessarily a plus. As Michael Pettis pointed out recently, only two countries have previously accumulated such large foreign reserves relative to global GDP - the United States in 1929 and Japan in 1989. Oh dear;
- The Chinese stockmarket is in bubble territory. Last October, a new Nasdaq-style exchange opened in Shenzhen with 28 new listings. The minimum price rise (the laggard of the 28) rose 76% on the first day. Price/earnings ratios averaged 150;
- The residential property market also appears to be in a bubble. In Beijing, the house price to income ratio has climbed to more than 15 times, versus 9 times in Tokyo in 1990;

Assuming Chancellor is right, what are the implications for Australian investors? That's what we'll look at on Wednesday.

This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investorwhich provides independent advice to sharemarket investors.

http://www.smh.com.au/business/the-china-bubble-20100412-s34b.html

Buffett (1994): Investing can be done successfully even without making an attempt to figure out the unknowables.

Staying within one's circle of competence and investing in simple businesses were some of the key points that were discussed in Warren Buffett's 1993 letter to shareholders. Now let us fast forward to the year 1994 and see what investment wisdom the master has to offer in this letter.

Are you one of those guys who are quite keen on learning the nitty-gritty of the stock market but the sheer size of literature that is on offer on the topic makes you nervous? Further, with the kind of resources that the institutions, the ones that you would compete against, have at their disposal, it is quite normal for you to give up the thought without even having tried. Indeed, things like coming out with quaint economic theories, crunching a mountain of numbers and working on sophisticated spread sheets should be best left to professionals. While it is definitely good to be wary of the competition, in investing, one can still comfortably beat the competition without the aid of the sophisticated tools mentioned above. All it needs is loads of discipline and patience.

Thus, for those of you, who in an attempt to invest successfully, are trying to predict the next move of the Fed chief or trying to outguess fellow investors on which party will come to power in the next national elections, you are well advised to stop in your tracks because investing can be done successfully even without making an attempt to figure out these unknowables. Some words of wisdom along similar lines come straight from the master's 1994 letter to shareholders and this is what he has to say on the topic.

"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise - none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results."

Infact, the master is not alone in his thinking on the subject but has an equally successful supporter who goes by the name of 'Peter Lynch', one of the most revered fund managers ever. He had once famously quipped, "If you spend 13 minutes per year trying to predict the economy, you have wasted 10 minutes".

Indeed, if these guys in their extremely long investment career could continue to ignore political and economic factors and focus just on the strength of the underlying business on hand and still come out triumphant, we do not see any reason as to why the same methodology cannot be copied here with equally good results.

http://www.equitymaster.com/detail.asp?date=2/1/2008&story=8

Buffett (1993): Staying within one's circle of competence and investing in simple businesses

A key mistake of investors was they never tried to fathom the relationship between the stock and the underlying business.
One should stick with the ones that can be easily understood and not subject to frequent changes.
"Why search for a needle buried in a haystack when one is sitting in plain sight?"

---

In the darkest days in the stock market history, there is no better time than this to imbibe the lessons being imparted by the master in value investing, a discipline or a form of investing that we think is one of the safest around.

One of the key mistakes the investors who suffered the most in the recent decline made was they never tried to fathom the relationship between the stock and the underlying business. Instead, they bought what was popular and hoping that there will still be a greater fool out there who would in turn buy from them. We believe that no matter how good the underlying business is, there is always an intrinsic value attached to it and one should not pay even a dime more for the same. Alas, this was not to be the case in the stock markets in recent times for many 'investors', where no effort was being made to evaluate the business model and the sustainability or longevity of the business.

In his 1993 letter to shareholders, the master has a very important point to say on why it is important to know the company or the industry that one invests in. This is what he has to offer on the topic.

"In many industries, of course, Charlie and I can't determine whether we are dealing with a "pet rock" or a "Barbie." We couldn't solve this problem, moreover, even if we were to spend years intensely studying those industries. Sometimes our own intellectual shortcomings would stand in the way of understanding, and in other cases the nature of the industry would be the roadblock. For example, a business that must deal with fast-moving technology is not going to lend itself to reliable evaluations of its long-term economics. Did we foresee thirty years ago what would transpire in the television-manufacturing or computer industries? Of course not. (Nor did most of the investors and corporate managers who enthusiastically entered those industries.) Why, then, should Charlie and I now think we can predict the future of other rapidly evolving businesses? We'll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight?"

As is evident from the above paragraph, an investor does himself no good in the long-run if he keeps on investing without understanding the economics of the underlying business. Infact, even when one is close to cracking the industry economics, some industries are best left alone because they are so dynamic that rapid technological changes might put their very existence at risk. Instead, one should stick with the ones that can be easily understood and not subject to frequent changes.

http://www.equitymaster.com/detail.asp?date=1/24/2008&story=3

Buffett (1993): His views on real risk and how 'beta" fails to spot competitive strengths inherent in certain companies

Concentration over excessive diversification and the futility of using a stock's beta were the two key concepts that were discussed in Warren Buffett's 1993 letters to shareholders. However, the master does not stop here and, in the follow up paragraphs, puts forth his views on what is the real risk that an investor should evaluate and how the 'beta' as defined by the academicians fails to spot competitive strengths inherent in certain companies.

First up, the master explains what is the real risk that an investor should assess and goes on to suggest that the first thing that needs to be looked at is whether the aggregate after tax returns from an investment over the holding period keeps the purchasing power of the investor intact and gives him a modest rate of interest on that initial stake. He is of the opinion that though this risk cannot be measured with engineering precision, in a few cases it can be judged with a degree of accuracy. The master then lists out a few primary factors for evaluation. These would be:

• 
  
  The certainty with which the long-term economic characteristics of the business can be evaluated;

  ---

• 
  
  The certainty with which management can be evaluated, both as to its ability to realise the full potential of the business and to wisely employ its cash flows;

  ---

• 
  
  The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;

  ---

• 
  
  The purchase price of the business; and

  ---

• 
  
  The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return.

Indeed, the above qualitative parameters are not likely to go down well with analysts who are married to their spreadsheets and sophisticated models. But this in no way reduces their importance. These parameters, the master says, may go a long way in helping an investor see the risks inherent in certain investments without reference to complex equations or price histories.

Buffett further goes on to add that for a person who is brought up on the concept of beta will have difficulties in separating companies with strong competitive advantages from the ones with mundane businesses and this he believes is one of the most ridiculous things to do in stock investing. This is what he has to say in his own inimitable style.

"The competitive strengths of a Coke or Gillette are obvious to even the casual observer of business. Yet the beta of their stocks is similar to that of a great many run-of-the-mill companies who possess little or no competitive advantage. 

• Should we conclude from this similarity that the competitive strength of Coke and Gillette gains them nothing when business risk is being measured? 
• Or should we conclude that the risk in owning a piece of a company - its stock - is somehow divorced from the long-term risk inherent in its business operations? 

We believe neither conclusion makes sense and that equating beta with investment risk also makes no sense."

He further states, "The theoretician bred on beta has no mechanism for differentiating the risk inherent in, say, a single-product toy company-selling pet rocks or hula hoops from that of another toy company whose sole product is Monopoly or Barbie. But it is quite possible for ordinary investors to make such distinctions if they have a reasonable understanding of consumer behavior and the factors that create long-term competitive strength or weakness. Obviously, every investor will make mistakes. But by confining himself to a relatively few, easy-to-understand cases, a reasonably intelligent, informed and diligent person can judge investment risks with a useful degree of accuracy."

http://www.equitymaster.com/detail.asp?date=1/17/2008&story=2

Buffett (1993): He believes in making infrequent large bets. "We'll now settle for one good idea a year."

Warren Buffett's 1992 letter to shareholders shared his views on healthcare accounting and ESOPs. Let us now see what insight the master has to offer in his 1993 letter to shareholders.

Ardent followers of the master might not be immune to the fact that whenever an extremely attractive opportunity has presented itself, Buffett has not hesitated to put huge sums in it. In sharp contrast to the current lot of fund manager who use fancy statistical tools to justify diversification, the master has been a believer in making infrequent bets but at the same time making large bets. In other words, he believes that a concentrated portfolio is much better than a diversified portfolio. This is what he has to say on the issue.

"Charlie and I decided long ago that in an investment lifetime it's just too hard to make hundreds of smart decisions. That judgment became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart - and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year. (Charlie says it's my turn.)

The strategy we've adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as "the possibility of loss or injury."

The master does not stop here. Like his previous letters, he once again takes potshots at academicians who define risk as the relative volatility of a stock price with respect to the market or what is now widely known as 'beta'. He very rightly contests that a stock which has been battered by the markets should as per the conventional wisdom bought in ever larger quantities because lower the price, higher the returns in the future. However, followers of beta are very likely to shun the stock for its perceived higher volatility. This is what he has to say on the issue.

"In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs. He may even prefer not to know the company's name. What he treasures is the price history of its stock. In contrast, we'll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company's business. After we buy a stock, consequently, we would not be disturbed if markets closed for a year or two. We don't need a daily quote on our 100% position in See's or H. H. Brown to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?"

http://www.equitymaster.com/detail.asp?date=1/10/2008&story=5

Buffett (1992): "How many legs does a dog have if you call his tail a leg?"

The master has taken potshots at every accounting convention that understates liabilities and overstates profits and asks investors to guard against such measures. Things like ESOPs and post retirement health benefits should be appropriately accounted for and considered as costs.



In his 1992 letter to shareholders, Warren Buffett's discoursed on valuations and intrinsic value.  In the same letter, let us see what he has to speak on employee compensation accounting and stock options.

In the year 1992, two new accounting rules came into being out of which one mandated companies to create a liability on the balance sheet to account for present value of employees' post retirement health benefits. The master used the occasion to turn the tables on managers and chieftains who under the pretext of the old method avoided huge dents on their P&Ls and balance sheets. The earlier method required accounting for such benefits only when they are cashed but did not take into account the future liabilities that would arise thus overstating the net worth as well as profits by way of inadequate provisioning. This is what the master had to say on the issue.

"Managers thinking about accounting issues should never forget one of Abraham Lincoln's favorite riddles: "How many legs does a dog have if you call his tail a leg?" The answer: "Four, because calling a tail a leg does not make it a leg." It behooves managers to remember that Abe's right even if an auditor is willing to certify that the tail is a leg."

By quoting the above statements, the master has taken potshots at every accounting convention that understates liabilities and overstates profits and asks investors to guard against such measures. Next he criticizes accounting standard for ESOPs prevailing in the US at that time and this is what he has to say on the topic.

"Typically, executives have argued that options are hard to value and that therefore their costs should be ignored. At other times, managers have said that assigning a cost to options would injure small start-up businesses. Sometimes they have even solemnly declared that "out-of-the-money" options (those with an exercise price equal to or above the current market price) have no value when they are issued.

Oddly, the Council of Institutional Investors has chimed in with a variation on that theme, opining that options should not be viewed as a cost because they "aren't dollars out of a company's coffers." I see this line of reasoning as offering exciting possibilities to American corporations for instantly improving their reported profits. For example, they could eliminate the cost of insurance by paying for it with options. So if you're a CEO and subscribe to this "no cash-no cost" theory of accounting, I'll make you an offer you can't refuse: Give us a call at Berkshire and we will happily sell you insurance in exchange for a bundle of long-term options on your company's stock."

The master has hit the nail on the head when he has further gone on to mention that something of value that is delivered to another party always has costs associated with it and these costs come out of the shareholders' pockets. Thus, things like ESOPs and post retirement health benefits should be appropriately accounted for and should not be hidden under the garb of fuzzy accounting standards and ingenious rationales.

Before we round off the 1992 letter, let us see how the master in a way that he only can so strongly puts up the case for ESOPs to be considered as costs.

• "If options aren't a form of compensation, what are they? 

• If compensation isn't an expense, what is it? 

• And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?"

http://www.equitymaster.com/detail.asp?date=12/27/2007&story=4

Low P/E stocks: Are they trash or are they treasure?

Some Lowest P/E Stocks

LTKM 3.02
KUMPULAN FIMA 4.06
MEASAT GLOBAL 4.54
COASTAL 5.31
AJIYA 5.40
KLCC PROP 5.76
PANTECH 5.87
DXN 6.15
POH KONG 6.22

The above was posted on 25th January 2010.


There are reasons that stocks sink to a discount. 

Low PE stocks may have:

• 
  
  high risk earnings or
• 
  
  low growth.

Buying discounted shares doesn't always end happily, but it often does.

Nevertheless, if earnings gains keep improving, so should the P/E.


LOW P/E stocks don't just do more on the upside; they behave better when the market is falling.


Low PE stocks have little anticipation or expectation built into their price. Therefore, any improvement in performance is likely to boost the attention they get, while they suffer little if their results don't meet the Market's already low expectation.


The investor's call now is to decide 

• whether these groups can stage yet another comeback, or 
• whether they are on the slow train to oblivion.

The challenge of course, is separating the stocks 

• that are unfairly being beaten down because of overreaction 
• from those that deserve their low prices.

The graph below depicts the KLCI index.  The KLCI has risen since January 2010, lifting the prices of many stocks with it.




It should be interesting to see what have happened to these above counters since.





Wright Quality Rating: LBD8 Rating Explanations




Wright Quality Rating: LAB1 Rating Explanations




Wright Quality Rating: DBL1 Rating Explanations




Wright Quality Rating: LAA2 Rating Explanations




Wright Quality Rating: LAB1 Rating Explanations




Wright Quality Rating: CCB0 Rating Explanations





Wright Quality Rating: DANN Rating Explanations





Wright Quality Rating: LBC0 Rating Explanations





Wright Quality Rating: LBC6 Rating Explanations


The last 3 months and 5 years charts were shown for each of the above stocks.


Looking at the last 3 months price action:


Prices trending upwards:  LTKM, KFima, Measat, Coastal and Ajiya  (That's not a bad bet for investors willing to wait for multiple expansion)
Prices moving sideways:  KLCCP, Pantech, DXN
Prices trending downwards:  Pohkong


A rising tide (market) lifts all boats (stocks).  Also, there are always a lot of casualties after a bull market.  Knowing that the bull market is a more dangerous period than a bear market, what can we learn, if any, from these price behaviours?


John Neff wrote, "Indifferent financial performance by low PE companies seldom exacts a penalty. Hints of improved prospects trigger fresh interest. If you buy stocks when they are out of favour and unloved, and sell them into strength when other investors recognize their merits, you'll often go home with handsome gains."


If you have any last doubts about low P/E investing, consider this:The history of low P/E investing makes it clear that you stand to make money twice. 

• First, you win when companies start to earn bigger profits and share them with you by way of fatter dividends and rising share prices. 
• This will wake up all those investors who've been sleeping on the sidelines. They'll start buying, the multiple will increase, and presto!--you've won again. 

Related posts:

Low PE stocks may have high-risk earnings or low growth.

Low Price-Earnings Investor

Finding great values in low P/E stocks that are set to rise

Are you investing or speculating? Have a look at the investment policies of Benjamin Graham.

Investment Policies (Based on Benjamin Graham)

Summary of Investment Policies

A. INVESTMENT FOR FIXED INCOME:
US Savings Bonds (FDs or Amanah Sahams for Malaysians)

B. INVESTMENT FOR INCOME, MODERATE LONG-TERM APPRECIATION AND PROTECTION AGAINST INFLATION:
(1) INVESTMENT FUNDS bought at reasonable price.
(2) Diversified list of primary common stocks (BLUE CHIPS) bought at reasonable price. 

C. INVESTMENT CHIEFLY FOR PROFIT:
5 approaches are opened to both the small and the large investors:
(1) Representative common stocks bought when the MARKET level is clearly LOW.
(2) GROWTH STOCKS, when these can be obtained at reasonable prices in relation to actual accomplishment – GROWTH INVESTING.
(3) Purchase of securities selling well BELOW INTRINSIC VALUE – VALUE INVESTING.
(4) Purchase of WELL-SECURED PRIVILEGED SENIOR ISSUES (bonds and preferred shares).
(5) SPECIAL SITUATIONS: Mergers, arbitrages, cash pay-outs.


D. SPECULATION:
(1) Buying stock in new or virtually new ventures (IPOs) .
(2) TRADING in the market.
(3) Purchase of "GROWTH STOCKS" at GENEROUS PRICES.

.... brought to you by Bullbear :-)

When to Sell? The QVM approach to Selling Stocks

QUALITY:  First and foremost, investors should sell when they conclude that they have made a mistake.  Buffett sells his stock holdings infrequently because he buys only after he is convinced of their long-term value.

VALUE:  You should sell when the stock price is high in relation to its intrinsic value.  One reason to sell is the price of the stock in relation to alternatives available, including holding cash.  Buffett sold PetroChina for this reason.

MANAGEMENT:  He sold the Disney holding because he did not seem to have as much confidence in the new management as he had in the old management.  Once again, this shows that quality of management is very important to hi.

Finally, I liked the cockroach theory of earnings manipulation or management behaviour that Buffett described.

"When you see any sign of improper management behaviour or questionable numbers that make you uncomfortable with the company, you should sell the stock because if you are picking up on one problem from the outside, there is likely more wrong with the company on the inside.  There is rarely just one cockroach in the kitchen."


Read also:

The QVM approach to finding promising Growth Stocks

Warren Buffett interview on how to read stocks (Petrochina)

My strategies for buying and selling (KISS version)

Should you invest in companies that repurchase their own shares?

Summary:

• When a company buys its own shares and you have confidence in the quality of that company's management, chances are that the stock is undervalued, and you should expect the stock price to rise over time.
• On the other hand, if the repurchase of stocks seems to be motivated by a desire to reduce the number of shares and, hence, increase earnings per share, you should avoid investing in the company.

Share repurchasing is good news.

When a publicly traded company buys its own shares, the outcome is a smaller number of shareholders owning the business.  Through repurchases, the company may signal that its shares are undervalued.  The academic literature supports the view that companies repurchasing their own shares are frequently undervalued.

"Firms repurchase stock to take advantage of potential undervaluation."

Investors can infer that a company that repurchases its shares frequently is unlikely to waste free cash flow in unproductive acquisitions.

"Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value of each $1 expended."  

Coca-Cola decided to invest its cash flows in itself by purchasing some of the shares back.  From 1989 to 1999, the number of the company's common shares outstanding decreased from 2.79 billion to 2.49 billion - a drop of 11 percent, or about 1 percent per year.  At current prices in 2009, this amounts to about $1 billion annually.

Buffett writes:
Companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value.


By making repurchases, when a company's market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management's domain but that do nothing for (or even harm) shareholders.

He continues:
Investors should pay more for a business that is lodged in the hand of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.

Sometimes, share repurchases can boost reported earnings because the number of shares go down due to repurchasing.  Before investing in a company that is repurchasing its own shares, you should investigate the company fundamentals and its management quality.

The annual letter to Berkshire shareholders on March 11, 2000 further clarified Buffett's thinking on share repurchases:
"There is only one combination of facts that makes it advisable for a company to repurchase its shares:  

• First, the company has available funds - cash plus sensible borrowing capacity - beyond the near-term needs of the business, and, 
• second, finds its stocks selling in the market below its intrinsic values, conservatively-calculated."

If profitable investment opportunities exist, then management should not repurchase the company shares even when the price is attractive.  This is probably one reason Buffett did not choose to repurchase Berkshire shares.  

Investors should also consider the potential value added.  Buffett continues,
"A purchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value produces only a 1/2 % gain in that value at most."

Thus, when management reputation is well established, as in Buffett's case, the advantage in repurchasing may not be substantial.

Buffett further emphasizes his interest in shareholder wealth:
"Please be clear about one point:  We will NEVER make purchases with the intention of stemming a decline in Berkshire's price.  Rather we will make them if and when we believe that they represent an attractive use of the Company's money."

Overall, if a company purchases its own shares on a regular basis and its fundamentals appear sound, you should consider buying shares in the company.